Corporate Insolvency and Governance Act 2020—temporary changes to the wrongful trading regime revived until 30 April 2021

Corporate Insolvency and Governance Act 2020—temporary changes to the wrongful trading regime revived until 30 April 2021

What has changed with wrongful trading?

The coronavirus (COVID-19) pandemic and the resulting lockdowns and social distancing measures introduced by the UK government continue to have a crippling effect on many businesses and the economy overall. When the original national lockdown was announced in March 2020, the government introduced a package of support measures designed to assist businesses and keep large parts of the private sector on life support. This included temporary changes to the wrongful trading regime that largely removed the financial consequences of wrongful trading. This temporary suspension was back-dated to 1 March 2020 and expired on 30 September 2020 (see section 12 of the Corporate Insolvency and Governance Act 2020 (CIGA 2020)).

Despite originally allowing the suspension to lapse, the government has now revived the changes to the wrongful trading regime by introducing the Corporate Insolvency and Governance Act 2020 (Coronavirus) (Suspension of Liability for Wrongful Trading and Extension of the Relevant Period) Regulations 2020. These regulations were introduced under the general power to amend in CIGA 2020, s 20(1)(c). The revived provisions commence on 26 November 2020 and are due to expire on 30 April 2021.

Why did the wrongful trading regime need amending?

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, 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, see Practice Note: Wrongful trading claims under sections 214 and 246ZB of the Insolvency Act 1986.

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 consequences of coronavirus is that directors could be liable for wrongful trading even though they are prevented from trading due to forced closures and lockdowns.

The original temporary suspension

In an attempt 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.

CIGA 2020 received Royal Assent on 25 June 2020. CIGA 2020, s 12 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 ran from 1 March 2020 (therefore providing retrospective effect, as promised) and ended on 30 September 2020. CIGA 2020 provided flexibility to allow the ‘relevant period’ to be extended by secondary legislation, but the government originally chose not to extend the wrongful trading provisions—see News Analysis: Corporate Insolvency and Governance Act 2020—extension of temporary measures.

Revival of the temporary provisions

While the government initially decided to allow the temporary relaxation of the wrongful trading regime lapse at the end of September in favour of supporting only ‘viable businesses’, the economic pressures of a ‘firebreak’ in Wales and a second national lockdown in England in November 2020—together with a challenging Christmas trading environment for the retail and hospitality sectors—has led to a u-turn. Through a revival of the Job Retention Scheme (furlough) and increased financial support for businesses, the government has made clear its intention to preserve as many jobs as possible and to this end wants to avoid directors being bounced into commencing an insolvency procedure for fear of personal liability for wrongful trading.

The temporary changes to the wrongful trading regime have been revived by secondary legislation from 26 November 2020 and will expire on 30 April 2021. For the purposes of determining any compensation payable with regards wrongful trading, the court is to assume that the director was not responsible for any worsening of the financial position of the company or its creditors that occurred during that period.

As with the original suspension, the wrongful trading regime is not actually suspended during this period, 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’. In this sense, the financial sting will be taken out of the wrongful trading regime. The Corporate Insolvency and Governance Act 2020 (Coronavirus) (Suspension of Liability for Wrongful Trading and Extension of the Relevant Period) Regulations 2020 provide that, in determining for the purposes of IA 1986, s 214 (liquidation) and IA 1986, s 246ZB (administration), the contribution (if any) a person should properly 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.

However, as before, the suspension does not apply to certain entities, including insurance companies, banks, and certain financial and capital markets entities.

In cases where wrongful trading is pleaded in relation to the relevant period, it remains unclear how the courts will interpret their obligation to ‘assume’ the director was not responsible for any worsening of the company’s position. The legislation is silent on whether the assumption is rebuttable, such that a court may be persuaded on the evidence that a director did in fact cause the financial position to deteriorate. The language of assumption may be contrasted with the language of presumption in IA 1986, ss 238–240 (relating to transactions at an undervalue and preferences), where the court is asked to make a presumption that is expressly rebuttable.

It also remains to be seen whether the courts will be prepared to examine the wrongful trading assumption in certain circumstances, for example where the directors have acted in bad faith or with no regard to the position of creditors. Alternatively, office-holders may seek to challenge directors’ conduct under alternative heads of claim, such as fraudulent trading or breach of duty/misfeasance.

For further details on the fraudulent trading regime, see Practice Note: Fraudulent trading claims under sections 213 and 246ZA of the Insolvency Act 1986.

What are the practical implications for directors?

The temporary changes to the wrongful trading regime in force from 1 March 2020 to 30 September 2020 provided directors with a temporary breathing space during the height of the pandemic either to continue to trade or ‘wait and see’ while the economic outlook remained uncertain. With a vaccine now in sight, there appears to be an ending in sight to the public health crisis. However with many companies already reeling from a year of forced closures, reduced income, increased borrowings and redundancies, it is not clear how many will survive until a vaccine is rolled out and consumer confidence resumes. The revival of the temporary wrongful trading provisions will therefore go some way towards reassuring directors considering filing for insolvency.

In addition, while the directors’ disqualification regime is not specifically modified by changes to the wrongful trading regime, it is usually the case that directors who are found liable to contribute to the company’s assets as a result of wrongful trading or fraudulent trading run the risk of disqualification. By requiring the court to assume that the director was not responsible for any worsening of the company’s position during the ‘relevant period’, it appears that directors will be at a significantly reduced risk of disqualification on this ground (at least insofar as their decision to continue trading relates to that relevant period(s)). For further details on the directors’ disqualification regime, see Practice Note: How can a director be disqualified as a company director?

However, despite the revival, directors will not benefit from the temporary suspension during the period 1 October 2020 to 25 November 2020 and therefore directors of companies may face liability for wrongful trading relating to that period; it remains to be seen how challenging it might be for an office-holder to bring a wrongful trading claim where the conduct complained of straddles both the temporary relaxation periods and the interim period. Moreover, liability for wrongful trading is only one risk faced by directors of financially distressed companies. Directors’ duties otherwise continue as before (including under the Companies Act 2006 and in relation to fraudulent trading under IA 1986, s 213). Indeed the Explanatory Statement expressly makes this clear.

In particular, directors should still consider their duties to the company and the pivot to creditors that requires directors to act in the interests of creditors at the point when they know, or ought to know, that the company is, or is likely to become insolvent (as the Court of Appeal held in BTI 2014 LLC v Sequana SA). For further information on directors’ duties in the context of insolvency, see Practice Note: Directors’ duties: companies in financial difficulties.

More practically, wrongful trading claims are rarely successfully pleaded. Claims for misfeasance, preferences and transactions at an undervalue are more common and these risks remain. To that extent it could be argued that the temporary changes to wrongful trading will have a less significant impact than might appear to be the case.

There is little doubt that this is a challenging time to be a director. As well as navigating the economic challenges created by coronavirus, recent changes to the law introduced by the Finance Act 2020 mean that, in certain circumstances (including in cases of repeated insolvencies), directors now also face the risk of personal liability for their companies’ unpaid tax liabilities. For further information see News Analysis: What does the Finance Bill 2019–21 mean for insolvency lawyers?. The revival of the temporary relaxation to the wrongful trading regime will therefore be welcomed by directors and restructuring professionals alike as providing reassurance to directors during a difficult period.

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About the author:
 
Helen joined LexisPSL in 2019, prior to which she was a Professional Support Lawyer at CMS specialising in insolvency and restructuring. She has broad experience in advisory, non-contentious and contentious work, including directorsâ?? issues, formal appointments, security issues and cross border recognition and assistance. She advised on financial institution insolvency and the insolvency of professional partnerships.

Helen trained at Lovells (now Hogan Lovells), qualifying in 2008. She was previously an associate at Lawrence Graham (now Gowling WLG) as well as the commissioning editor of Corporate Rescue and Insolvency journal.