There will undoubtedly be many directors who, increasingly concerned about the solvency of their businesses and their potential exposure to personal liability for trading whilst insolvent, may have been considering whether to shut down during this pandemic. The UK Business Secretary, Alok Sharma, recently announced proposed new insolvency measures to suspend the laws on wrongful trading to offer some protection to business directors.
What is ‘wrongful trading’?
The law on ‘wrongful trading’ is essentially the duty placed on directors to ensure that a company is not trading whilst insolvent. Where wrongful trading is established, directors can be held personally liable for any losses incurred during the period of trading whilst insolvent.
The intention behind the proposed changes is presumably to stop otherwise viable, healthy businesses failing by giving them some breathing space to see whether the various incentives offered will work and allow them to survive the pandemic.
New rules may be open to abuse
Where businesses are looking at restructuring to avoid insolvent liquidation, the relaxation of the laws on wrongful trading will, no doubt, be welcomed. However, these proposals have prompted concerns that unscrupulous directors, or those who are running companies already in difficulty before the pandemic struck, taking advantage of any loosening of the rules around personal liability, deliberately flouting the rules. For instance, some businesses may use the current situation as an excuse to defer payment to suppliers which will, inevitably, have a domino effect on the liquidity of otherwise solvent companies up and down the supply chain.
The other concern is that, while there is no question that businesses face unprecedented disruption and, for some, a real fight for survival, there will be others who will use the coronavirus pandemic as a convenient cover for abusing the rules. We would strongly advise any director making the difficult decision whether or not to continue trading to keep the business afloat, or enter into insolvent liquidation, to take legal advice quickly, otherwise they could be facing potential personal liability. Businesses will also need to show that it was the economic fallout from the coronavirus pandemic that forced them to continue trading while insolvent; a circumstance that would never have occurred in normal times.
Proving business was solvent before the pandemic
This question is likely to create legal arguments over the true cause of the insolvent position and directors are still likely to be expected to show that the balance sheet was solvent prior to the pandemic announcement, and only became insolvent as a result of the pandemic. The timing of the shift from solvent to insolvent is also likely to be critical.
Businesses such as restaurants and pubs that were instructed by the government to close their doors to the public but still retain rent and staffing liabilities, may find it easier to demonstrate the cause of balance sheet insolvency; however, it is likely to be much less clear cut for other businesses affected by a multitude of external factors such as cancelled contracts and reduction in demand.
What should directors do now?
Directors will need to make careful notes of their decision-making process, underpinned by a genuine belief that the business will revert to being solvent once the pandemic is over. Regular board meetings will need to take place with frequent circulation of management accounts to keep the balance sheet under review. Directors should be prepared to satisfy the subjective tests that may later be applied should their decision-making process be scrutinised. This is particularly important as it is proposed that the new legislation will apply retrospectively from 1 March 2020.
The government has stated that the proposed suspension of the law on wrongful trading will not affect directors’ other ongoing duties, and those other checks and balances to ensure proper conduct are still expected to continue. The changes should not be seen as an opportunity for directors to turn a blind eye to their obligations, but to protect otherwise viable businesses during this challenging and uncertain time.