COVID-19: changes in UK insolvency law to protect businesses and directors

The Government has announced proposals for retrospective changes for the urgent reforms to UK insolvency law, designed to protect companies and their directors during the COVID-19 outbreak. 

Wrongful trading

These changes will include a temporary suspension (to the end of June 2020) of section 214 Insolvency Act 1986 in relation to wrongful trading, subject to passage of the upcoming Corporate Insolvency & Governance Bill through Parliament in the coming weeks.

As background, where a company enters administration or (insolvent) liquidation, an administrator or liquidator may pursue a director for a court order requiring that director to contribute to the company’s assets where at some point prior to the commencement of the administration or liquidation, that director “knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation or administration”.

Essentially then, if the directors allow the company to trade after the point at which they know or ought to know that the company has no reasonable prospect of returning to solvent trading, then they can be held personally liable. The Court has a wide discretion to order the level of any such compensation to be made to the company by the director, but ordinarily the director would be held liable for the increase in the deficiency to creditors that occurred between the date the directors should have ceased trading and the date the company actually ceased trading.

We need to see the detail of the new measures (which are due to be published soon after this article goes to press) but we anticipate that date on which the director knew or ought to have concluded that the company could not avoid insolvent liquidation or administration will not be a date during the period to which the new law will apply (which will be backdated with effect from 1 March 2020).

Whilst this is a welcome development, we would strongly advise against any substantive change in approach by boards of directors for the following reasons:

1. Wrongful trading cases are often difficult to pursue (for various evidential reasons) and it has been confirmed that there will be no relaxation to directors’ fiduciary and statutory duties to the company and/or its creditors in the meantime, nor to the rules on fraudulent trading. Consequently, administrators and liquidators will continue to focus on and pursue directors for breaches of those duties, irrespective of whether they can pursue a wrongful trading claim or not.
2. Having a period of suspension may cause administrators and liquidators to look more closely at whether the directors ought to have ceased trading before 1 March 2020 and/or immediately following the lifting of the proposed suspension. In respect of the latter, there may have to be some transitional provisions to allow directors to try and get their companies ‘back on their feet’ without fear of risk of claim, but prudent financial hygiene and monitoring throughout the period of suspension will put the directors in the best possible position to hit the ground running when the suspension is lifted.

In the circumstances and irrespective of whether the law on wrongful trading has been suspended, boards of directors should constantly keep the question as to the company’s future viability under consideration. We appreciate that is extremely difficult given the uncertainty that every business is facing but this highlights the need for regular board meetings and the need carefully to minute decisions throughout the process.

The introduction of a new debtor-in-possession process?

The Government has also stated that the new law will include provisions introducing a “moratorium for companies giving them breathing space from creditors enforcing their debts for a period of time whilst they seek a rescue or restructure”.

This initiative for changes to the UK’s Insolvency Framework would likely introduce a form of “debtor-in-possession” proceeding, akin to a US Chapter 11 restructuring process (with similar processes currently being rolled out across the EU), that would enable companies to file for insolvency protection, whilst retaining the board’s control of their companies. This follows Government announcements in late 2018/early 2019 that such reforms would be introduced – these may now be accelerated. The new law will:

1. Impose a moratorium preventing creditors from taking action whilst the directors formulated proposals to restructure their business. Unlike administration and liquidation, the board would retain control of the company throughout the process.
2. Prevent the operation of clauses in supplier contracts that terminate the parties’ relationship upon an event of insolvency (a so-called “ipso facto” clause).
3. Temporarily suspend statutory demands and winding up petitions, while voiding statutory demands issued against companies during the emergency. In this regard, on 23 April 2020, the Department for Business, Energy & Industrial Strategy announced measures to “ban the use of statutory demands (made between 1 March 2020 and 30 June 2020) and winding up petitions presented from Monday 27 April, through to 30 June, where a company cannot pay its bills due to coronavirus”. 

These measures will be included in the forthcoming Corporate Insolvency & Governance Bill, which is expected to come before Parliament in May 2020, and once in force, will be retrospective to 1 March 2020. The English High Court has already had to consider on at least two occasions whether a debtor’s inability to pay its debts is “due to coronavirus” and it is hoped that the forthcoming legislation will provide some clarity in this regard. 

Until the new provisions become law, directors will need to remember that they still remain subject to the current (undoubtedly more creditor friendly) landscape of CVAs, administration, liquidation and schemes of arrangement, while bearing in mind (subject to our caveats above) the protections that the Government has announced will become effective retrospectively once the new legislation comes into force.

Should you wish to discuss any aspect of this note or the issues that your business is currently facing, please do not hesitate to contact Daniel or Roger or your usual member of Charles Russell Speechlys’ Corporate Recovery & Insolvency Team.