Covid-19: Changes to Insolvency Law to Relieve Some Pressure from Directors

31 / 03 / 2020

Over the weekend, the UK Government announced changes to insolvency law to help UK companies keep trading during the Covid-19 pandemic. The government is advancing its plans to introduce new insolvency restructuring procedures. The detailed legislation to introduce the changes is expected in the coming days.

Suspending Wrongful Trading Provisions

A company director can be found personally liable if they  continue to trade and increase the company’s losses after they knew or should have known that the business was unable to avoid going into liquidation and the loss to creditors after that point (this is called “wrongful trading”).

The government has announced wrongful trading provisions will be suspended for all companies for three months (which may be extended). This will protect directors during the Covid-19 outbreak, allowing them to pay staff and suppliers even if there are fears that the company could not survive. The aim is for companies to “emerge intact the other side of the Covid-19 pandemic.”

The legislation will apply retrospectively from 1 March 2020 and will be introduced as soon as possible. Directors will be able to concentrate on their businesses without worrying about being personally liable due to circumstances outside of their control.

However, this does not absolve directors of all of their responsibilities. In particular,  companies that  were financially unstable or insolvent before the pandemic cannot trade with impunity. Directors should make sure they comply with all of their other duties as all other checks and balances will remain in force. A subsequently appointed liquidator can still bring actions against directors for misfeasance (breach of duty to the company / its creditors or misappropriation) and there are wider powers for liquidators or administrators to challenge transactions  entered into by companies at a time when it was insolvent (such as transfers out of money or assets, putting friendly creditors in a better position than other creditors and deliberately prejudicing or defrauding creditors). Therefore, notwithstanding the recent announcements, companies and directors of companies that were in financial difficulty prior to the recent situation should still seek specialised advice and carefully consider the position of the company.  Decisions of directors should be carefully considered and properly documented to ensure that there is sufficient evidence to justify the making of decisions that may be subsequently challenged.

Whilst not addressed in these changes, we cast a word of warning about declaring dividends.  Having sufficient profits in a company for a particular year is not the be all and end all to declaring a dividend.  Not only do directors have to consider whether they can declare a dividend but they also need to consider if they should declare a dividend given the wider context and finances of the business (particularly the cash position), particularly where you have a scenario like this that is going to have a very quick and potentially catastrophic effect on profits, liquidity and survival.

Temporary Relief for Businesses Undergoing Restructuring

There will be a temporary moratorium for businesses undergoing a restructuring process. Creditors will be unable to take enforcement action during this period. This is to augment the restriction on forfeiture of lease provisions announced in the last week or so.

This means firms which need to undergo a restructuring process can keep trading but is also intended to result in a better return for creditors  once these difficult times are over.

New Restructuring Procedure

A new restructuring procedure is also planned, which would bind all creditors. This suggestion has been in the pipeline for some time but further clarification is needed on the detail.  However, it may prove a useful tool to assist struggling companies.

The sentiment behind the announcement is therefore welcome for directors and allows them to focus on genuine attempts to save businesses, but care must still be taken.

The Wedlake Bell team would be happy to chat through the implications for your business or your position as director.