Directors of companies in financial difficulties face a number of issues, including:
- How to keep the company in business without committing an offence or incurring personal liability;
- When they must decide to cease trading; and
- Which insolvency procedure should the company enter should they cease trading.
The risk of liability for wrongful trading is one of the main catalysts for seeking professional advice; but what is it and what provisions have been placed to reduce the risk?
What is Wrongful Trading?
Sections 214 and 246ZB of the Insolvency Act 1986 state:
‘If, in the course of an insolvent winding up or insolvent administration of a company, it appears that a person who is, or was, a director of the company knew or ought to have concluded at some point before the commencement of the liquidation or administration that there was no reasonable prospect that the company would avoid going into insolvent liquidation or insolvent administration, the liquidator or administrator of the company can seek a court declaration that the director make a contribution to the company’s assets’.
The potential liability incurred by the director is calculated by measuring the increase in the company’s net deficiency of assets over the relevant period. This has inevitably caused concern for directors during the COVID-19 lockdown, with many directors being concerned that they may be at risk of a wrongful trading claim if they continue to trade.
What Provisions are in Place?
The Government has recognised concerns from company directors, and details of the measures to protect them in these exceptional circumstances have now been published in the Corporate Insolvency and Governance Bill.
The provisions largely suspend the potential for wrongful trading liability to be incurred during the relevant period – between 1 March 2020 and 30 June 2020 (or one month after the Bill comes into force, whichever is later).
There is a blanket requirement on courts to assume that a director is not responsible for any worsening of the financial position of the company, or its creditors, during the relevant period. Furthermore, there is no requirement to show that the deterioration of the company’s financial position was due to the COVID-19 pandemic.
This will be positive news for directors. However, these provisions do not affect the duties that a director owes to a company, and director abuse of these provisions could lead to action for breach of these duties.
As soon as directors are aware that a company is in financial difficulty, they should immediately seek professional advice.