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This latest article in our series on the Corporate Insolvency and Governance Bill relates to the already well-publicised relaxation of liability for ‘wrongful trading’. For those less familiar with the concept of wrongful trading we have set out a summary herein so that the relaxation is given its context. For those already familiar with the wrongful trading rules, they may consider skipping ahead to the analysis later in this article.

Update - The Corporate Insolvency and Governance Act came into force on 26 June 2020.  This article has been updated to reflect that suspension of wrongful trading measures will continue until at least 30 September 2020 in accordance with section 12 of the Act.

Background of Wrongful Trading (S.214 & S.246 ZB, Insolvency Act 1986)

In short, the current wrongful trading provisions are a mechanism by which a company liquidator (under s.214 of the 1986 Act) or an administrator (under s.246ZB) may sue for an order that a Director(s) make a financial contribution to the assets of the company (likely to then be used for expenses of the insolvency process and/or distribution to creditors).

The contextual underpinning of the wrongful trading provisions is that there did at some stage come a point in the life of the now-insolvent company at which it became clear that the company was going to fall into an insolvent administration or liquidation process; and where the Director(s) has chosen to keep trading past that point, thereby causing additional loss to creditors, he should bear some responsibility for that.

It should also be noted that wrongful trading provisions are only one of a number of mechanisms which exist in law to regulate the conduct of company Directors. Those mechanisms include Director’s duties, fraudulent trading, remedies for misfeasance and similar mischief, and more recently Compensation Orders under Directors Disqualification legislation. An explanation of those would go beyond the scope of this article, but for present purposes it is worth noting that wrongful trading is only one mechanism within a legal landscape which allocates risk among Directors, companies and their creditors.

Existing Legal Provisions

Only the court can order a Director to make a contribution to the company’s assets. The court will only grant such a remedy where there can be identified a point in time before the liquidation/administration at which the Director “knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation or entering insolvent administration.”

However, even if that is proved, the court will not make the order if it finds that the Director has “[taken] every step with a view to minimising the potential loss to the company’s creditors as…he ought to have taken.”

In determining what the Director knew or ought to have known, the court will apply an objective test by speculating as to what “a reasonably diligent person having both the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that Director in relation to the company, and the general knowledge, skill and experience that the Director has.”

So in practice what that means is that the burden lies with the liquidator/administrator to prove to the court that there was a specific point in time at which a hypothetical ‘reasonable’ Director, if put in the (real) Director’s shoes, would have come to the realisation of the inevitability of insolvency. That requires good evidence of the financial position of the company in the months and even years prior to insolvency and to present a compelling picture to the court which covers how the business trading was going and what were its prospects of survival. The period from that date to the date of liquidation/administration is the period of wrongful trading.

After the period of wrongful trading has been identified, an assessment needs to be done to understand the consequence of the wrongful trading for the creditors. That is done by assessing how bad the position would be for the creditors (in pounds and pence) had the insolvency process started at the beginning of the wrongful trading period and then comparing that to the position the creditors now find themselves. The difference for the creditors is usually the sum the insolvency practitioner will seek as a contribution from the Director(s). I.e. the contribution is intended to compensate the creditors, not penalise the Director.

That is not a particularly easy legal case to bring and in most instances, generally speaking, an insolvency practitioner is not likely to relish, even if there are funds, a protracted litigation in an attempt to obtain such an order.

Not only may the Director defend the claim by attacking any part of what the insolvency practitioner requires to prove, but the Director may also seek to prove that he/she took every step to minimise the loss to the creditors.

Claims for wrongful trading against the Directors are reasonably rare in liquidations and administrations due to the difficulty of such cases and the cost such a litigation likely entails.

The Proposed Temporary Suspension

The Corporate Insolvency and Governance Bill seeks to make a fairly simple adjustment to the foregoing provisions. It states that there will be a period of time during which the court shall “assume that the [Director] is not responsible for any worsening of the financial position of the company or its creditors”.  The Bill has now come into force and Section 12 of the Corporate Insolvency and Governance Act states that the relevant period will begin 1 March 2020 and end on 30 September 2020.

In practice this means that when calculating the prejudice caused to the creditors by the wrongful trading a further calculation is required to assess the loss to the creditors during the suspended period. That sum then shall be deducted from the calculation described above.

So the suspension does not mean that a wrongful trading will not happen, just that the amount of contribution the Director could be liable for is reduced. Put another way, if wrongful trading commences before or during the suspension period and continues on after the suspension period has ended then the Director would be liable for such losses to the creditors as can be attributed to before and/or after the suspension period.

Analysis

It is worth getting the political part of this out the way succinctly. Will this have the effect of keeping some businesses alive that would otherwise have been shut down by the Directors? The answer is necessarily guess work. But we would certainly tend towards the answer being that it will make relatively little difference. Any Director who is particularly knowledgeable of the various ways in which he might become personally liable as a result of his actions should also be aware that wrongful trading is only one part of a landscape of obligations and remedies that may be taken against him. Therefore this particular relaxation simply does not absolve him substantially of risk. For the Director who is ill-advised or is simply not aware of the broad range of obligations and remedies, or simply does not care, one might imagine that he/she was never too worried about wrongful trading liability in the first place. Ultimately, wrongful trading is quite a technical matter which is generally poorly understood by most Directors and therefore this technical relaxation is probably unlikely to generate any real impact on the conduct of Directors.

Another intention behind the relaxation was stated to be to remove a potential obstacle to Directors choosing to make use of the Government’s COVID funding initiatives. However, one certainly wonders whether those many businesses who have taken up the government backed loans may well have likely done so without any change to wrongful trading.

Insolvency practitioners and the creditors they represent are generally well aware of the various remedies that might be available against Directors and they know that wrongful trading is only one of a number of tools in the toolbox. For them, this will complicate and make more difficult wrongful trading claims if the wrongful trading period overlaps with the suspension period. They will inevitably look at other mechanisms against Directors. But ultimately if there is compelling evidence to support a wrongful trading claim, reasonable prospects of a return for the creditors, and funding arrangements are available then insolvency practitioners are still likely to be open to making claims.

Since the provisions about what constitutes unlawful trading remain intact and there is clearly a prospect that decisions made now may have consequences which run beyond the suspension period, Directors would remain well-advised to continue to give careful consideration to the solvency of the company and the interests of creditors (and minute as such in writing e.g. Board Minutes).

As with many legislative reforms, particularly those that are rushed, the real winners here may well end up being the lawyers. While superficially the carve-out devised by the drafters of the Bill may appear to be a ‘light touch’ approach which does not fundamentally disturb the underlying legal provisions, one might see scope for argument (and therefore litigation costs) in relation to how this carve-out of a suspension period translates to the practicalities of prosecuting such a case and defending it.

Think of a scenario where the Director is alleged to have commenced his wrongful trading in January 2020 and that wrongful trading continued on through to August 2020 when the liquidator was appointed. Superficially one might say that you simply discount the loss during the suspension period from the loss during the wrongful trading period. However, the methodology as to how the loss is calculated and in what periods loss can be attributed is something there could be litigation about. Did the loss really occur during the suspension period, or before, or after? Instead of the insolvency practitioner requiring to produce to the court a financial position as at the alleged date of the commencement of wrongful trading and thereafter use that as a means to work out the overall prejudice to the creditors of that wrongful trading period, the insolvency practitioner will now require to work out potentially multiple financial positions depending on how the period of wrongful trading overlaps with the suspension period. Each asserted financial position is ripe for dispute. There may well be other unintended consequences which will only become apparent when a real life scenario is being litigated. Ultimately, this additional complexity is likely to increase the legal costs for both insolvency practitioner and the Director.

We have long advised and acted for insolvency practitioners in respect of wrongful trading claims and advised and represented Directors on the defence of such claims. We would be happy to discuss in more detail with clients and contacts alike. Please also note we are presently running a COVID-19 Directors Helpline which is aimed to help Directors with some of these thorny issues. Follow/subscribe to Stronachs on social media to be kept up to date with our continuing analysis of the Bill throughout June. 

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