A limited breather for directors of UK companies

Temporary Suspension of Wrongful Trading until 31 May 2020: a limited breather for directors of UK companies

In response to the COVID-19 crisis, the UK Government announced on 28 March 2020 that it intends to amend insolvency law to suspend the offence of wrongful trading by directors of UK companies. At the time of drafting this article, we are still waiting for the exact terms of the proposed new regulations.

The suspension of the offence of wrongful trading is intended to ensure that, in the current uncertain COVID-19 environment where many businesses may be nearing insolvency, directors are able to take decisions to continue to trade and incur additional debt, including under the new government funding initiatives, without the threat of potential personal liability in respect of wrongful trading should the company ultimately fall into insolvency.

Directors have become increasingly concerned about the risk of personal liability that can arise in respect of wrongful trading. Under current legislation a director can be liable if they are found to have continued trading a business and did not minimise losses to creditors at a time when they knew, or ought to have concluded, that there was no reasonable prospect of avoiding insolvent liquidation or administration.

The measure is aimed at giving companies a breathing space and avoiding premature insolvencies by allowing directors to keep businesses going without the threat of personal liability.

What is the current legislation?

The current insolvency rules provide that if directors allow their limited liability company to continue to trade while insolvent or where liquidation becomes unavoidable, then they can become personally liable for business debts.

Under the wrongful trading provisions, a company director has a duty to take every step to minimise potential loss to the company’s creditors upon concluding that there is no reasonable prospect of the company avoiding insolvent liquidation or administration.

The court may order a director that is found liable of wrongful trading to make a personal contribution to the company’s assets in the amount the court thinks proper in light of the loss suffered by the company’s creditors. Any award is compensatory in nature and only arises if the company is worse off as a result of the continuation of trading.

These rules are often the trigger for directors claiming formal insolvency proceedings, in order to minimise the risk of incurring personal liability. Click here for the latest guidance.

What is being changed

In response to the COVID-19 crisis, the UK Government announced that the wrongful trading provisions would be temporarily suspended for three months with retrospective effect beginning from 1 March 2020 until 31 May 2020; and that the end date could also be reviewed thereafter.

The new measures do not modify the existing regime on directors’ duties. When taking on new debt whether under the government schemes or otherwise, directors should ensure that they meet their general duty to act in the way they consider, in good faith, to be most likely to benefit the company members as a whole, or, when there is a heightened risk of insolvency, to instead act in the interests of the company’s creditors.

Once a company enters formal insolvency proceedings, the directors’ duties will be owed to the company’s creditors instead. It is at this point that the suspension of the wrongful trading provisions will have a practical effect by removing the threat of personal liability where company directors elected to continue to trade in good faith using their best endeavours despite the company facing a high risk of entering insolvent liquidation.

The limitations to the change

However, this change will not affect the directors’ duties regime and other insolvency law offences such as fraudulent trading, transactions defrauding creditors and misfeasance. These rules remain in force to deter directors from misconduct.

In addition, a director may still be disqualified for wrongful trading under the Company Directors Disqualification Act 1986. The minimum period of a disqualification order is two years and the maximum is 15 years.

The proposal will therefore provide a limited “breathing space” for directors of UK Companies. It is still important for them not to overlook the need to comply with existing laws and mitigate the risk of breaching their duties when exploring options for corporate rescue. Directors still need to ensure that they obtain professional advice and not breach their duties.

To find out more, please contact Paul Marmor