Corporate Insolvency and Governance Bill—temporary changes to the wrongful trading regime

Corporate Insolvency and Governance Bill—temporary changes to the wrongful trading regime

This News Analysis looks at the proposed changes to the wrongful trading regime introduced by the Corporate Insolvency and Governance Bill.

What is the background to the changes? 

The coronavirus (COVID-19) pandemic and the resulting lockdown and social distancing measures introduced by the UK government continue to have a profound effect on businesses and the economy. On 20 March 2020, the government announced that businesses including restaurants, pubs and leisure centres must close, and on 23 March 2020 a full lockdown was introduced, sending huge parts of the private sector into hibernation. The forced closure of businesses has threatened the financial health of many previously successful companies, while for those already struggling it has proved to be the tipping point.

In order to mitigate the economic consequences of coronavirus and keep the economy on life support, the government has introduced a range of measures, from financial support initiatives to legislative reform. For further details of the financial support available.


One of the key concerns for directors of companies facing financial difficulties is the threat of liability for wrongful trading under section 246ZB of the Insolvency Act 1986 (IA 1986) (in the context of insolvent administration) and IA 1986, s 214 (in the context of insolvent liquidation). While there is no offence of trading while insolvent as such, directors and shadow directors of a company that goes into insolvent administration or insolvent liquidation can be liable to make a personal contribution to the company’s assets where wrongful trading applies. Essentially a wrongful trading claim arises where:


  • at some time before the commencement of the company's administration or liquidation, its director knew or ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation or administration, and
  • from that point, the director failed to take every step with a view to minimising the further potential loss to the company’s assets/creditors
If a director is found liable, they can be ordered to make a contribution generally reflecting the increase in the company’s net deficiencies (ie losses to creditors as a whole) since the point of insolvency. For further reading on the wrongful trading regime.

There is no requirement to show that the company actually traded during this period, provided losses are increasing, nor is the word ‘trading’ referred to in the wording of IA 1986, ss 214 or 246ZB. Therefore, one of the immediate consequences of coronavirus was that directors could be liable for wrongful trading even though they were not in fact able to trade.

In a bid to prevent directors commencing insolvency proceedings prematurely in order to avoid personal liability for wrongful trading, the government announced its intention to legislate to temporarily suspend the wrongful trading regime, with such suspension being back-dated to 1 March 2020.

On 20 May 2020, the much-anticipated Corporate Insolvency and Governance Bill was introduced. The Bill seeks to make a number of far-reaching changes to UK insolvency law, some permanent and some temporary (see News Analysis: Corporate Insolvency and Governance Bill). Unlike the temporary changes to the wrongful trading regime, many of the changes are based on the 2016 Insolvency and Corporate Governance consultation, which the government responded to in August 2018. However, in the end the changes to the wrongful trading regime are more nuanced than the original announcement led many practitioners to anticipate.

For further information on the other key aspects of the Corporate Insolvency and Governance Bill, see News Analyses:


 

What are the proposed changes?

Section 10 of the Bill is headed ‘suspension of liability for wrongful trading’, but the section itself does not suspend the wrongful trading regime. Instead, it provides that in determining for the purposes of wrongful trading (whether under IA 1986, ss 214 or 246ZB) the contribution (if any) that a person should make to a company’s assets, the court is to assume that the person is not responsible for any worsening of the financial position of the company or its creditors that occurs during the ‘relevant period’. This period runs from 1 March 2020 (therefore providing retrospective effect, as promised) to either 30 June 2020 or one month after the provision comes into force, whichever is later.

Therefore technically the wrongful trading regime is not suspended, but there is an assumption that directors will not be liable for the consequences of wrongful trading ie to make a financial contribution in respect of any liability for wrongful trading during the ‘relevant period’. There is also no requirement to show that coronavirus played a part in the company’s troubles, meaning that the changes have wide application.

It should also be noted that the changes do not apply to certain entities, including insurance companies, banks, and certain financial entities. The changes may also be extended using secondary legislation.

What are the practical implications for directors ?

The changes to the regime will provide directors with some breathing space to either continue trading or ‘wait and see’ during this period of uncertainty. However, it remains to be seen what form the final legislation will take once it passes both Houses of Parliament.

Assuming the provisions remain unamended at the time the Bill receives Royal Assent, directors of companies in financial distress will be conscious that the breathing space provided is potentially a relatively short one (and perhaps largely retrospective) in the context of a pandemic that could leave businesses unable to return to pre-coronavirus trading conditions for many months or perhaps longer. Indeed, there are many uncertainties as to what post-coronavirus trading might look like, with both suppliers and customers potentially being affected. While directors may not incur personal liability for the company’s losses during the period in which the provisions are in force, the company’s liabilities will likely continue to increase, putting pressure on the company’s cash flow and balance sheet. As such the question of ‘when is enough, enough?’ will remain at the forefront of many directors’ minds.

 

 

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About the author:

Anna joined the Restructuring and Insolvency team at Lexis®PSL in August 2013 from Berwin Leighton Paisner where she was a senior associate in the Restructuring Team.

Anna has worked on a number of large scale restructurings primarily in the UK market acting on behalf of lending institutions.

Recent transactions include the restructuring of a UK hotel chain and the administration sale of part of the Connaught group. Anna has also spent time on secondment at The Royal Bank of Scotland and trained at Clifford Chance qualifying in 2007.