Suspending wrongful trading: The wrong move

09 April 2020

Alongside new tools for corporate insolvencies announced by the Business Secretary at the end of March, the Government has also said that wrongful trading provisions will be suspended for three months, retrospectively from 1 March. This move was taken to "give company directors greater confidence to use their best endeavours to continue to trade during this pandemic emergency, without the threat of personal liability should the company ultimately fall into insolvency", according to the Government. However, R3, as the insolvency and restructuring trade body, has concerns over this suspension.

Wrongful trading provisions: the background

The wrongful trading provisions in the Insolvency Act make directors liable for a contribution to an insolvent company's estate if it can be shown they continued to trade but knew, or ought to have known, that there was no reasonable prospect of avoiding insolvency. However, directors are not liable if they can establish they did everything they practically could to reduce the potential loss to the company's creditors while continuing to trade. It is up to the insolvency office holder (i.e. the administrator or liquidator, who is appointed to oversee the insolvency process) to decide whether or not to bring a claim.

It is worth noting that actions under the wrongful trading provisions are difficult to bring successfully, and both insolvency practitioners and judges bear context in mind when considering a potential case in normal circumstances, let alone the ones we find ourselves in currently. If a business is trying to keep going and is only struggling because of COVID-19, that will absolutely be taken into account by the court.

Suspension: Unconsidered consequences and possible alternatives

We can understand why the Government decided to suspend the wrongful trading provisions, and indeed we do have great sympathy with the Government's stated aim of providing certainty and confidence to directors amid huge economic upheaval.

However, the wrongful trading provisions are there for a reason and play an important role in protecting creditors from higher losses than they might otherwise see. The suspension may do very little to help directors acting in good faith, while unintentionally aiding those directors acting in bad faith and wishing to abuse the insolvency framework.

Another key unintended consequence of suspending the provisions is that it will make it more difficult for an office holder to challenge the directors of businesses which would have entered an insolvency process or become insolvent regardless of the COVID-19 outbreak.

As a result, our members feel there are more useful alternatives out there which would help the profession and the businesses and people it supports.

One of these would be to ensure the word 'reasonable' is present in the legislation where appropriate - such as Point 3 of Section 214 of the Insolvency Act, which could be amended so that directors would be expected to consider "every reasonable step with a view to minimising the potential loss to the company's creditors".

A rebuttal presumption could have been introduced to absolve directors from personal liability for debts incurred in the ordinary course of business for the next six months, as these debts are likely to be incurred as a result of the COVID-19 outbreak. Introducing a measure such as this would also give a liquidator the opportunity to attack the presumption if they considered that there was evidence this was not the case.

A further option would have been the introduction of a proviso that directors could be made personally liable for debts incurred in the period prior to the six months or after the six months, or if there was evidence of fraud or misfeasance, and for the court to consider the effect of COVID-19 in any case involving a trading period from 1 March 2020 to 1 March 2021.

Help for directors - current and future measures

One other positive measure would be to introduce advice and guidance for directors relating to wrongful trading. Directors need to be reassured about how the provision is used in practice. Until this happens, the best approach for any director is to seek advice from an insolvency practitioner or insolvency lawyer and keep a record of why decisions were taken - and retain these records for a number of years.

Next steps?

R3 is disappointed that the wrongful trading provisions have been suspended, despite agreeing with the Government's overall point that directors certainly need extra support and reassurance in the current crisis. The provisions were rarely used against directors in practice, but were an important backstop to deter abusive behaviour from a small minority of bad actors.

Any director who is unsure about the next steps for their business should consider seeking expert advice, while taking care to document all business decisions made and the reasons behind them. With demand for insolvency and restructuring support at a high level, as businesses try and navigate the challenges presented by the coronavirus, ensuring that the source of any advice is qualified, regulated, and reputable is more important than ever.