The Coronavirus pandemic has caused a serious and evolving health crisis which will continue to present significant challenges to our everyday lives. Furthermore, the implications for many businesses including those in the construction sector will likely be profound.
All businesses are now operating in uncharted waters. The government is reviewing its support for business on an almost daily basis and the Business Secretary has announced measures to help those businesses facing potential insolvency as a result of Covid-19. In addition to relaxing the law around ‘wrongful trading’ for three months, thereby giving directors of otherwise viable businesses space to see whether the package of government incentives will enable them to survive the pandemic, Alok Sharma also announced he was considering other measures, largely based on the government response to the proposed changes to the insolvency regime in 2018.
New insolvency measures to helping struggling businesses
The impact of coronavirus on the economy will be felt for months, and probably years. Businesses will face pressure from the breakdown of supply chains, cash flow issues, labour shortages and disruption to manufacturing schedules. Directors are under a duty to act in the best interests of the company and its shareholders. However, once a director forms the view that the company is insolvent, on a cash flow and/or balance sheet basis, their duty is to act primarily in the interests of the company's creditors. If there is no reasonable prospect of avoiding an insolvent liquidation or insolvent administration, a director’s obligation is to manage the affairs of the company with a view to minimising the potential losses to creditors. Therefore, 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.
Wrongful trading temporarily suspended
As mentioned above, the UK Business Secretary, Alok Sharma, recently proposed new insolvency measures to suspend the laws on wrongful trading temporarily to offer some protection to business directors. The intention behind the proposed change is to stop otherwise viable, healthy businesses failing by giving them some breathing space to see whether various incentives, including government-backed business interruption loans, will work and allow them to survive the pandemic
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 about 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, or 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 some a real fight for survival, there will be others who use the Coronavirus pandemic as a convenient cover for abusing the rules.
We would strongly advise any director making the difficult decision of 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 is was only 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.
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.
Extending the moratorium
What has become abundantly clear is that the unexpected, and rapid, economic fallout from the spread of COVID-19 has caught every business unaware. Coupled with the government’s instructions on social distancing, the subsequent lockdown and closure of office, retail and industrial premises bar those carrying out essential activities, most businesses are facing unanticipated challenges. Therefore, in order to ensure the survival of those that have had their cashflow hit hard by the attendant disruption, thus compromising their solvency, the government is proposing a moratorium (the length of which has yet to be confirmed but is considered likely to be a minimum of 28 days) during which no creditor can present a winding-up petition.
This move is not designed to throw a life line to businesses that were in danger of insolvency before the crisis but is designed to rescue those that had no liquidity problems before Covid-19 struck. Directors would need to apply to the courts to benefit from the moratorium and insolvency practitioners will assess whether the business in question is a suitable candidate which will hinge on its overall financial viability. Creditors can lodge an objection with the court if they felt they are being unfairly prejudiced.
Not terminating contracts
Both the JCT and NEC suites of contracts allow the contract to be terminated if one party is insolvent. In both cases the contracts list insolvency categories: the JCT authors cross referring to specific legislation, the NEC authors preferring generic terms. Parties will therefore need to be careful to apply these mechanisms correctly because terminating incorrectly may be a breach in itself. Even if the termination correctly follows the contract procedure, parties will also need to consider how current changes in insolvency practice affect their approach to handling contract problems.
Change in the restructuring rules
In common with similar procedures in the US (Chapter 11) and Europe, the government may introduce a new restructuring plan which will sit alongside the current scheme of arrangement. This will be overseen by the courts and apply to both solvent and insolvent companies. The new plan would bind all creditors, both secured and unsecured, including those that object. The idea is to give companies more time to come up with a rescue remedy.
Legislation to introduce these changes will be introduced in Parliament at the earliest opportunity, although the exact timing remains uncertain (Parliament was in recess until 21 April 2020. However, as ever, the devil will be in the detail.
What should directors be doing?
As the uncertainty of the impact on the economy continues, directors are well advised to:
- Maintain accurate and up-to-date company financial records and consider the potential impact on creditors of the decisions they take.
- Continually monitor the financial state of the company by reviewing the company’s balance sheet and cash flow position. Consider the need to increase the frequency of management accounting and internal financial reporting.
- Consider ways to reduce expenditure, if necessary.
- Hold frequent board meetings convened specifically for the purpose of reviewing the company's financial position and keep proper minutes of those meetings, noting any decisions made and the reasons for them. Any contingency plans that are implemented and/or steps taken to mitigate the effects of Coronavirus should be carefully documented so that it is clear how and why those decisions were taken.
- Continually monitor market developments and set up alerts in order to keep abreast of such developments.
- Take professional advice aimed at reviewing whether an insolvency process is inevitable or whether there is some way of resolving or mitigating the company's financial difficulties.
Please contact any member of the team below if you would like to discuss the options open to you. It is important to take advice at an early stage and we will be very happy to talk through any concerns you have.