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This analysis looks at directors’ duties, particularly concerning wrongful trading, in the context of companies facing financial difficulties as a result of coronavirus (COVID-19).
Although there is no definition of ‘insolvent’ in the Insolvency Act 1986 (IA 1986), a company may be wound up by the court if the company is unable to pay its debts.
Under IA 1986, s 123(1)(e) a company is deemed to be unable to pay its debts the company is unable to pay its debts as they fall due (so-called 'cashflow insolvency'). Under IA 1986, s 123(2), a company is also deemed to be unable to pay its debts if the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities (so-called 'balance sheet insolvency').
Both tests require a consideration of the company’s present, prospective and contingent liabilities. However, while ‘cashflow insolvency’ is concerned with whether the company is likely to be able to meet its liabilities in the short to medium term, ‘balance sheet insolvency’ requires a longer-term view on whether the company has sufficient assets to have a reasonable expectation of meeting its liabilities.
It is important to note that directors may be liable for wrongful trading even though their business is not actually trading, but losses are increasing.
Coronavirus will create different challenges for different businesses.
Directors of supermarket chains are seeing record sales, so assuming their supply chains hold out they are in a good position. Directors of businesses that rely on face-to-face interaction will encounter greater challenges, as will those who rely on cross-border supply and trade chains. If non-essential shops and leisure facilities close, directors will need to consider how long they can continue meeting their liabilities when they can no longer trade. Directors may also need to consider how long they can continue operating with a reduced workforce, either due to illness, health and safety concerns, or employees being forced to stay at home.
Subject to contractual provisions, directors of businesses such as gyms and sports centres, for example, may find that many annual subscriptions have already been paid which may allow the business to be mothballed if forced to close. Landlords may agree rent holidays and financiers may be willing to support businesses while they continue to pay wages. The UK government announced a package of measures on 17 March 2020 aimed at supporting businesses during this period. This support package continues to expand as the Government tries to keep the economy on life support. Depending on the business model, specific help may also be available, for example in the case of the aviation industry.
Provided short-term cash flow can be managed, despite being unable to trade, many directors may conclude that insolvent administration or liquidation can reasonably be avoided, at least for the time being.
The decisions directors take will inevitably evolve in line with the national situation. Directors should carefully record decisions made and the reasons for those decisions in case they come under scrutiny in the future.
Discussions with stakeholders will be essential, particularly with those in the supply chain. If necessary, directors may need to consider whether alternative suppliers are available.
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