Corporate Insolvency and Governance Act 2020 – Wrongful Trading
On 28 March 2020, the UK Government announced plans to bring forward legislation to introduce new measures to aid restructuring of companies.
As a result, the Corporate Insolvency and Governance Bill was laid in Parliament on 20 May 2020 and this came into force as the Corporate Insolvency and Governance Act 2020 (CIGA 2020) on 26 June 2020.
The overarching objective of CIGA 2020 is to provide businesses with the flexibility and breathing space they need to continue trading and avoid insolvency during this period of economic uncertainty.
A series of articles has been produced looking at the various measures introduced by CIGA 2020. This one focusses on the relaxation of the wrongful trading provisions.
Territorial extent, effective date and period of operation
This measure extends to the whole of the UK and commenced retrospectively from 1 March 2020.
This is a temporary measure due to expire on 30 September 2020. That period may be extended by secondary legislation for a further six months if the government considers it to be necessary and appropriate.
In trading conditions where the company’s solvency is not in doubt, the directors are acting for the benefit of the company and its shareholders.
However, where it becomes apparent that the company is insolvent or at serious risk of insolvency, the focus of the directors’ duties switches and their overriding responsibility is to act in the best interests of the creditors of the company.
If a company is insolvent and its directors know (or ought reasonably to conclude) that it cannot avoid insolvent liquidation or administration, they are under a duty to take every step a reasonably diligent person would take to minimise potential loss to the company's creditors.
Failing that, they risk personal liability for any worsening of the company’s financial position (known as ‘wrongful trading’ and covered by sections 214 and 246ZB of the Insolvency Act 1986).
What has changed?
Section 12 of CIGA 2020 (and section 13 in relation to Northern Ireland) temporarily suspends liability for wrongful trading for company directors so they can keep their businesses going without the threat of personal liability.
It does this by specifying that, in determining the contribution to a company’s assets that it is proper for a person to make, the court is to assume that the person is not responsible for any worsening of the financial position of the company or its creditors that occurs during the period this provision is in operation.
The objective of this measure is to remove the deterrent of a possible future wrongful trading application so that directors of companies which are impacted by the pandemic may make decisions about the future of the company without the threat of becoming liable to personally contribute to the company’s assets if it later goes into liquidation or administration. This will in turn help to prevent businesses, which would be viable but for the impact of the pandemic, from closing.
The provisions do not apply to certain financial services firms and public-private partnership project companies. That is a company that is, during the relevant period:
- a company specified in new Schedule ZA1 of the 1986 Act (banks, insurance companies etc.)
- a small Alternative Investment Fund Manager (AIFM)
It also has no effect in relation to:
- building societies
- friendly societies
- credit unions
What hasn’t changed?
When first announcing the change on 28 March, Alok Sharma stated that “all of the other checks and balances that help to ensure directors fulfil their duties properly will remain in force”.
It is therefore important that a careful balance is struck, and this change is not simply seen as a green light for directors to act in an irresponsible manner. There must still be a reasonable prospect of the company recovering post-crisis and it is vitally important that all decision-making is fully documented.
Directors must still ensure that they comply with their duties and act in the best interests of the company. Only the wrongful trading provisions have been relaxed so the law remains unchanged in relation to other possible offences under the Insolvency Act 1986, such as:
- Misfeasance (section 212) whereby a director has misapplied or retained, or become accountable for, any money or other property of the company, or been guilty of any misfeasance or breach of any fiduciary or other duty in relation to the company.
- Fraudulent trading (sections 213 and 246ZA) whereby the business of the company has been carried on with the intention to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose.
- Gratuitous alienations (section 242) essentially a transaction at undervalue – selling an asset for less than it’s worth at a time when the company is technically insolvency.
- Unfair preferences (section 243) where a particular creditor is favoured to the prejudice of the general body of creditors – often to reduce a liability that a director has personally guaranteed.
All these offences can result in the directors being held liable to personally contribute to the assets of the company or repay money or assets misapplied.
The general duties of directors, set out at sections 171 to 177 of the Companies Act 2006, also continue to apply. These include the requirements to promote the success of the company, exercise independent judgment and to exercise reasonable care, skill and diligence.
The manner in which legislation has been drafted leaves a number of questions unanswered. While the court is to presume that the person is not responsible for any worsening of the position, does this leave it open to an office holder to seek a contribution where they can, through led evidence, demonstrate that the person was responsible for the worsening position? Where it can be demonstrated that the worsening position was not related to COVID19 can a challenge be raised?
Wrongful trading however already has a relatively high barrier of proof, with very few cases ever taken forward. It already has safeguards which probably would, for most sensible directors, not leave them exposed to risk of personal liability in any case. It therefore remains to be seen whether this change will have any material impact.
Notwithstanding this change, for a business in distress or where there are concerns about its ultimate viability, directors should review their position carefully and consider taking professional advice to ensure that the right decision about the future of the business is made.
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