Suspension of Liability for Wrongful Trading Until April 2021
The Corporate Insolvency and Governance Act 2020 (Coronavirus) (Suspension of Liability for Wrongful Trading and Extension of Relevant Period) Regulations 2020 (the "Regulations") came into force on 26 November 2020. The Regulations suspend the effect of the wrongful trading provisions.
The risk of a wrongful trading claim is a real concern to directors of companies in financial difficulties. The suspension brought about by the Regulations comes at a crucial time for many directors, who are facing extremely challenging conditions due to the pandemic across a range of sectors. Whilst this may offer some comfort there are other issues directors need to consider in what will continue to be a very difficult environment across a range of sectors in 2021.
Added to pressure created by the pandemic (and not forgetting Brexit), HM Revenue & Customs revert to preferential creditor status from 1 December 2020. This may have far reaching consequences at a time when many businesses are deferring tax to provide short term liquidity. Cash flow problems may become more acute for businesses reliant on asset based lending - floating charge lending is likely to scale back. This is because a simple floating charge, for example over a borrower's stock or receivables, may no longer be adequate security for a lender as HMRC's debt would take precedence. At the least we expect lenders to become more guarded in offering funding to companies without personal guarantees. This may mean it is more difficult for companies to borrow, increasing both cash-flow pressures and the risk of trading whilst technically insolvent.
What is Wrongful Trading?
Directors and former directors of a company in liquidation or administration may be held personally liable for wrongful trading in certain circumstances. Wrongful trading occurs when a person knew or ought to have known, when he/she was a director, that there was no reasonable prospect of the company avoiding insolvent liquidation or administration but continued to trade and incur liabilities.
There are defences available to directors but, unless they can show that they took every step with a view to minimising the potential loss to the company's creditors, the decision to continue trading may attract personal criticism.
What is the effect of the Regulations?
The Corporate Governance and Insolvency Act 2020 suspended the wrongful trading provisions from 1 March 2020 until 30 September 2020. The intention was to provide directors with comfort in the ability to continue trading during the pandemic with a greatly reduced risk of a wrongful trading claim being brought against them if the company later entered liquidation or administration.
The Regulations introduced today mean that the court is to assume that a director is not responsible for worsening the financial position of the company or its creditors for issues taking place between 26 November 2020 and 30 April 2021.
This does not give directors a licence to trade recklessly. Directors must continue to have regard to their statutory duties which, in the zone of insolvency, change so that the position of creditors must take precedence. Directors could still face misfeasance or breach of duty claims for actions taken during this period, notwithstanding the suspension of wrongful trading. The office holder will still be able to review and challenge certain transactions entered into prior to the onset of insolvency.
However, the Regulations may reassure those directors who are trying to turn their companies around in extraordinary economic circumstances. We wait to see whether there will be similar extensions to other emergency measures, such as the prohibition on presenting winding up petitions in certain circumstances until 31 December 2020.