On 28 March 2020, Business Secretary Alok Sharma announced measures designed to support businesses experiencing distress as a result of COVID-19. These included the temporary suspension of wrongful trading provisions for an initial period of three months (from 1 March 2020 to 31 May 2020) which have later been extended until 30 June.
What is wrongful trading?
A business can be classed as insolvent if it can’t pay debts as and when they fall due (cash flow basis) or if the value of its liabilities exceeds its assets (balance sheet basis).
When a company is insolvent, the directors must continue to discharge their duties but have an overriding duty to act in the best interest of the company’s creditors.
If a business continues to trade while insolvent, it risks making the position worse for creditors, who may continue to supply goods/services on credit with no prospect of repayment.
Wrongful trading is a provision of UK insolvency law that is designed to deter directors from continuing to trade an insolvent business by making them personally liable for certain debts of the business.
If a director knows, or ought to have concluded that there was no reasonable prospect the company would avoid going into insolvent liquidation, the Court may order them to make a personal contribution to the company’s assets.
What does that have to do with COVID-19?
COVID-19 has had two notable impacts for directors in respect of wrongful trading:
- The immediate shock of the COVID-19 pandemic may have already created an immediate cash flow insolvency in some businesses.
- There is no certainty as to when the effects of COVID-19 will end, nor what their eventual impacts may be (prolonged staff illness, supply chain disruption, loss of customers, bad debts, etc.), thus bringing medium-term viability into question.
As a result, directors may already be questioning whether they ought to reasonably conclude that the business is, or is likely to become, insolvent.
Newly introduced Government support schemes themselves may also increase a Company’s liabilities at a time when the business might arguably be insolvent (such as CBILS loans, VAT Deferral and Time To Pay arrangements).
Given the level of ongoing uncertainty, is it possible for a director to reasonably conclude that the business will be able to recover and meet these new commitments in full post-pandemic?
As a consequence, trading on and incurring further debt to do so carries significant personal financial and reputational risk for directors.
What does it mean?
Logically, wrongful trading provisions have been relaxed temporarily given that much of the government support in response to COVID-19 will necessarily mean the company is increasing its liabilities.
This will provide comfort to directors acting in good faith and in creditors’ interest, and help them access emergency Government funding without personal liability (save for any personal guarantees) as they navigate the coming months.
Helpful – but not carte blanche
The measures above are intended to help directors and businesses that are trying to do the right thing in exceptional circumstances.
However, it is possible to see how a relaxation of wrongful trading and a longer moratorium might be open to potential abuse from unscrupulous directors, stymieing creditors reasonable expectations of payment, for example.
All other statutory obligations and fiduciary duties of directors remain in force. The temporary “relaxing” should not be seen as carte blanche to act without due consideration or reasonable skill and care; or to take on additional debt without fully understanding the potential consequences to:
- them (personal guarantees)
- the business (such additional debt service costs and a weaker balance sheet) and
- creditors (who may be put in a worse position).
A failure of a director to do so will still carry significant risk as there remain many potential actions through which creditors can seek financial recourse.
Creditors (including employees, key suppliers and lenders) will be hard pushed to support any restructuring proposal if they suspect they are disadvantaged in some way.
Now more than ever, it is critical for directors with solvency concerns to seek timely advice to ensure they are not exposing themselves and their businesses to undue risk or putting creditors in a worse position than they would otherwise be.
If you would like to know more about how our team can help you through some of these challenges and choices, please contact Tim Smith.
We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.