The rapidly changing impact of COVID-19 on companies and the wider economy continues to present directors with the unenviable task of balancing the immediate need to secure the survival of their company against the longer-term implications for their stakeholders. In March 2020, the UK Government announced that wrongful trading measures would be temporarily suspended to ease this pressure. The suspension measures are included in the Corporate Insolvency and Governance Act 2020, which introduces both temporary measures, such as this, and permanent and significant changes to UK insolvency law. On 26 November 2020, The Corporate Insolvency and Governance Act 2020 (Coronavirus) (Suspension of Liability for Wrongful Trading and Extension of the Relevant Period) Regulations, introduced a second suspension on wrongful trading liabilities which applied for the period between 26 November 2020 and 30 June 2021.
Suspension of liability for wrongful trading
Insolvency legislation on wrongful trading stipulates that directors of a company can become personally liable for the company's debts if they fail to take every step to minimise potential losses to creditors once there is no reasonable prospect of avoiding insolvency.
The Act does not, as was expected, entirely switch off the wrongful trading rules. Instead the Act states that when considering the contribution that a director is required to make towards the company’s debts, the court is to assume the director is not responsible for any worsening of the financial position of a company or its creditors during the period 1 March 2020 to 30 September 2020 or the period 26 November 2020 to 30 June 2021.
There is no requirement to show that the company’s worsening financial position was due to the COVID-19 pandemic in order for this change to apply.
Certain specified entities, largely those involved in the financial markets (banks, insurance companies, payment institutions etc) are excluded from the suspension.
Could directors still be personally liable for wrongful trading?
Possibly, in the most extreme cases. While the temporary changes to wrongful trading legislation should mean that directors will not be required to make a contribution under those provisions, it is not entirely clear whether any circumstances remain in which the court could order contributions for wrongful trading during the relevant periods. This is because legislation merely provides that if the conditions for wrongful trading are met, i.e. a director knew or ought to have known there was no reasonable prospect of avoiding insolvency and did not take every step to minimise loss to creditors, the court may order the director to make such contribution as the court thinks proper.
Case law has developed such that, in general, the courts will consider whether the financial position of the company has worsened after the directors knew, or ought to have known, that there was no reasonable prospect of the company avoiding insolvency. The contribution that directors are required to make will, again in general, not be more than the amount by which the company’s financial position has worsened. There have been cases where it was not possible to make an assessment of the worsening of financial position and therefore a different approach has been taken.
In addition, the courts are required to assume that the director was not responsible for a worsening of the company’s financial position. It was not entirely clear whether this would operate as a rebuttable presumption, and therefore where, for example, directors had acted recklessly and clearly did cause the worsening of financial position, this could still be taken into account. In debate on the legislation in the House of Lords, the response from government on this point was that in their view the clause is sufficient to direct the court to make the assumption and that the provision does not invite argument to the contrary.
It therefore seems clear that the intention of the provisions in the Act is that the courts should not be ordering contribution from directors in relation to the period from 1 March 2020 to 30 September 2020 or the period between 26 November 2020 and 30 June 2021.
What should directors do?
The temporary changes to the wrongful trading legislation removed some of the pressure on directors whilst they assessed the impact of measures being introduced and evaluated the changing economic climate. The business secretary, Alok Sharma, said "the measures taken will [give] bosses much needed breathing space to keep their workers employed and their companies going.”
This did not, however change the steps that a director should have taken when assessing the financial position of the company and considering the steps needed to continue trading. Directors' actions remained subject to scrutiny, most notably under the directors' disqualification regime and laws on fraudulent trading.
Under the directors' disqualification regime, a director can be disqualified if their conduct is considered unfit, and a factor in determining this is the extent to which the person was responsible for the company's insolvency. Directors could be faced with a compensation order if their actions caused a quantifiable loss to one or more creditors.
Under the fraudulent trading regime, directors can face criminal proceedings if they knowingly carry on the business of the company with the intent to defraud creditors, with the consequences for directors including disqualification, custodial sentence and personal financial liability.
As directors continued to face personal liability under these two regimes (albeit that there's a higher threshold to breach before such liability attaches to the directors than under the wrongful trading regime), it remained crucial that decisions to continue trading were taken only after obtaining expert advice, holding detailed board discussions, and considering carefully the impact on the company's stakeholders.
Directors should have continued to act responsibly and reasonably to protect value and minimise loss and carefully evaluated whether continuing to trade is in accordance with their wider duties as directors.
Directors are generally obliged to consider their duties by reference to the company’s shareholders. But when the directors know, or should know, that the company is or is likely to become insolvent, they must take into account the interests of the company’s creditors. The weight that must be given to creditors' interests is difficult to pinpoint; prudent directors will err on the side of caution.
If you have any queries, please contact your DLA Piper relationship partner or another member of the DLA Piper team.
For more coronavirus-related guidance, please visit the DLA Piper Coronavirus Resource Center.