The Corporate Insolvency and Governance Act (the Act), enacted on 26 June 2020, is the most noteworthy alteration to the UK insolvency framework since the Enterprise Act 2002.
The Act sets out a number of permanent and temporary measures that are aimed at rescuing businesses under financial distress as a result of the COVID-19 pandemic and the subsequent economic crisis.
One of the key measures in the Act is the continuation of the temporary suspension of wrongful trading, which was originally introduced in March 2020 at the start of the COVID-19 outbreak in the UK, as a key emergency measure. However, although this provided company directors with some much-needed breathing space, it does not completely relieve them of all their duties.
A short background to wrongful trading
The Insolvency Act 1986 included several provisions that protected creditors from the actions of rogue directors and is the historic benchmark we must measure against.
In particular, section 214 on wrongful trading required company directors to assess the likely prospects of avoiding insolvency. Continuing to trade when there was no reasonable prospect of avoiding insolvency can have dire consequences including personal liability for debts and trading losses.
Furthermore, disgruntled creditors can commence direct action against the director and protection of limited liability would not apply. This is commonly known as ‘piercing the corporate veil’, thus ensuring that in distressed situations directors were acting in the interests of creditors, rather than shareholders.
What has changed?
Section 12 of the Act temporarily suspends liability for wrongful trading for company directors so they can keep their businesses going without the threat of personal liability.
The Act stipulates that, when considering the input that a director must make towards a company’s debts, the court must now act as though they are not responsible for any worsening of the financial position of the business or its creditors.
For directors who may have previously hurried to start insolvency proceedings and avoid the possibility of any personal liability, the temporary suspension will help postpone many from triggering that process and assist them to emerge intact on the other side of the COVID-19 pandemic.
Directors aren’t completely immune from liability
In my experience, the vast majority of directors understand the difference between steering the business through a challenging period and crossing the line into wrongful trading for which there remain severe penalties, including personal liability and disqualification.
However, on a more cautionary note, company directors must keep in mind that all other sources of risk and liability under the Insolvency Act 1986 are unaffected by the Act. For example, directors are still bound by their fiduciary duties, and also by the fraudulent trading provisions of section 213, which means that they will still face sanctions and penalties if they knowingly attempted to defraud the company or creditors.
In addition, directors will still have duties under the Companies Act 2006 and must continue to act and be mindful of the interests of creditors if the likelihood of insolvency increases.
Overall, this means that the temporary suspension of wrongful trading doesn’t change the attention that directors should be giving when evaluating the financial position of their company. Directors’ actions will remain subject to scrutiny, making it critical that they consider very cautiously whether to continue trading if there is not a realistic chance of their company avoiding insolvency.
The majority of businesses are now facing unprecedented financial challenges, with the UK economy enduring its worst quarterly fall since 1979. In response, the government has made sweeping changes to insolvency law, but it has stopped short of providing company directors with complete immunity from liability and their duties.
Although the easing of lockdown measures are picking up pace and businesses are beginning to open their doors, numerous challenges lay ahead, particularly with the expected reduction in consumer demand and confidence. Many company directors will likely face challenging decisions over whether to continue trading or instigate an insolvency process in the coming months.
If directors are worried that their business is in or expecting financial difficulty, it is crucial that they continue to consider the needs of all key stakeholders and creditors in any decision and maintain ‘good housekeeping’ in the form of board meetings and keeping records of actions taken with an assessment of the reasons for certain decisions. Where possible, they should also seek appropriate professional advice.