On Saturday the Government announced a raft of changes to insolvency law to assist businesses facing challenges as a result of the coronavirus pandemic. In the short term, directors have been given a three month window from 1 March where they will not face personal liability for wrongful trading and the Government is also moving forward with key elements of the long delayed and much debated proposed reforms of insolvency law first consulted on by the Law Commission in 2016.
The legislation to implement these changes is not expected to be moved until after Parliament’s Easter break and when the draft is available it will be clearer how these changes will work in practice. In the meantime, we consider the likely effects and challenges of the proposals.
Temporary suspension of wrongful trading
Where a company enters an insolvency process, its directors may be made personally liable if, after they knew, or should reasonably have known, that it would not be possible to avoid an insolvent liquidation, they failed to take all steps to minimise the loss to creditors. The liability of the directors would be for the liabilities incurred by their continuing to trade which are not discharged.
It is important to note that, unlike other jurisdictions which have more draconian rules, directors of UK companies are not obliged to enter an insolvency process within a fixed period. Instead UK law takes a more nuanced approach that allows directors to conclude whether it will be in the best interests of creditors to keep the business out of insolvency until a better outcome can be achieved, such as the sale of the business as a going concern rather than a fire-sale which would typically not achieve best value. Indeed it could be argued that seeking immediate insolvency protection is not the correct approach as it may increase the loss to creditors.
It is a high standard to take all steps to minimise the loss to every creditor, but in normal times this is a standard that well advised directors are typically able to navigate in order to preserve a going concern business. The COVID pandemic introduces additional challenges and it is right in these circumstances that directors should be allowed greater latitude to operate without fear of personal liability.
Given the extreme uncertainty it will be highly challenging to identify a point at which directors should have known that insolvency was unavoidable. There is always a prospect of a restructuring or further Government support becoming available in the future. Equally, there are companies that were facing insolvency prior to the COVID outbreak and directors here may already be clear that an insolvency process will occur at some stage, regardless of what further support is made available.
That being said, the Government announcement makes clear that directors are not absolved of their general duties to act in the interests of creditors when a company is insolvent or nearing insolvency. While wrongful trading will not be enforced, directors are still required to consider how best to protect the value of the business and the interests of stakeholders. The suspension of wrongful trading is a welcomed measure, but equally it is not a licence for directors to bury their heads in the sand and avoid taking necessary difficult decisions.
For the moratorium and designation of key suppliers, the current circumstances may lend themselves to implementing a slimmed down version of the previous proposals to give pragmatic protection to businesses. However we believe the restructuring plan provisions will become a necessary tool for the Restructuring profession in time but the current focus of directors must be on taking steps to maintain liquidity and preserve businesses as going concerns. The time for balance sheet restructuring, if required, will come later.