Insolvency in the time of Coronavirus

It is already clear that the economic damage caused by Covid19 has been enormous, although the overall scale of this damage remains unclear and will depend to a large extent on the speed with which the economy recovers. This will mean many company directors will face difficult decisions in the weeks and months ahead and will need to bear in mind that, when the continued solvency of their companies is uncertain, they have a legal duty to consider the best interests of the creditors as a whole, or risk personal liability.

In the short term, government measures such as the Coronavirus Job Retention Scheme and the deferral of tax payments have gone a considerable way towards mitigating the worst immediate effects of the coronavirus pandemic on cash flows for many UK companies.

However, much of this assistance was put in place in the immediate aftermath of the lockdown and appears to assume a relatively quick economic bounce-back. It remains to be seen whether this is the case, but it is clear that a prolonged downturn could mean that many formerly viable businesses face the possibility of insolvency.

The long-established position for company directors is that when the continued solvency of their company becomes uncertain, although the normal legal duties applicable to directors will continue to apply, these will also include a requirement to consider the best interests of the creditors of the company as a whole. A failure to do so can result in personal liability for directors in a number of ways, including:

• Wrongful Trading

Under the Insolvency Act 1986, a director can be made personally liable for the losses of a company which continues to trade in circumstances where the director knew, or ought to have known, that there was no reasonable prospect of avoiding a formal insolvency.

• Misfeasance/Breach of Duty

Directors can incur personal liability by allowing their company to enter into transactions, prior to a formal insolvency, that breach the provisions of the Insolvency Act 1986 (for example by allowing the company to pay certain creditors in preference to others with the intention of putting those creditors in a better position than the general body of creditors, or allowing the company to transfer assets for less than their true value).

• Fraudulent Trading

Anyone who is knowingly a party to a company recklessly incurring credit when there is no reasonable prospect of meeting the debt could be liable under the fraudulent trading provisions of the Insolvency Act 1986, resulting in both civil and criminal sanctions.

Introduction of new legislation

The economic consequences of the Coronavirus pandemic are without modern precedent and, when considering how to best preserve their businesses amid enormous uncertainty, directors have been understandably nervous about the potential consequences of getting things wrong. This is particularly so when considering whether or not to take on significant new debt (for example under the Coronavirus Business Interruption Loan Scheme). With this in mind, on 28 March 2020, the government announced that it would introduce legislation at “the earliest opportunity” to:

• temporarily suspend the wrongful trading provisions retrospectively from 1 March 2020 for three months (this has since been extended to 30 June); and

• add new restructuring tools, including:

• a moratorium for companies giving them breathing space from creditors enforcing their debts for a period of time while they seek a rescue or restructure;
• protection of supplies to enable them to continue trading during the moratorium; and
• a new restructuring plan, binding creditors to that plan.

The hope is that, by removing the risk of personal liability for wrongful trading at a time when companies’ survival is in question, this will make it easier for directors to take advantage of the substantial government-backed financial support being made available to support the economy during the current crisis – much of it in the form of loans which will ultimately need to be repaid.

It should be noted that directors still have a clear duty to act in good faith to promote the interests of the company and that other provisions of the Insolvency Act, including those relating to fraudulent trading, continue to be relevant.

As always, where a company is in financial difficulties one of the best steps its directors can take in order to guard against personal liability is to seek professional advice from insolvency practitioners, lawyers, and accountants.

For further information, please contact Stephen McElhone on 0116 281 6237 or email stephen.mcelhone@bhwsolicitors.com.