As a direct result of the restrictions imposed by the Government on us all in response to the COVID-19 pandemic, many companies have suddenly and unexpectedly found themselves in a position where they are unable to pay their suppliers and are therefore insolvent on a cash flow basis.
The current unprecedented situation has brought the issues of directors’ obligations to their company’s suppliers, and the action that can be taken by unpaid suppliers, to the top of the agenda.
The government announced on 30 March 2020 that it would introduce legislation to temporarily suspend the wrongful trading provisions from 1 March 2020, for an initial period of 3 months, so that directors can keep their businesses going through this period without threat of personal liability. Of course this will have to be retrospective legislation.
This seems to put the needs of the directors above the needs of the creditors – the reason for the initial legislation – and this could be open to abuse.
It is important that directors continue to mind their obligations as directors and to the interests of creditors, despite the government’s intended relaxation of the law.
This is not entirely unexpected legislation as the government had previously proposed plans to introduce new restructuring procedures, with a short moratorium for companies in financial distress. Something along the lines of Chapter 11 in the United States.
When a company is trading properly, its directors are under a duty to act in the best interests of the company and its shareholders. As soon as the company becomes insolvent, its directors have a duty to act primarily in the interests of the company’s creditors.
Section 214 of the Insolvency Act 1986 provides that if the directors of a company continue to trade in circumstances where they knew or ought to have known that there is no reasonable prospect that the company would avoid going into administration or insolvent liquidation, they may be personally liable.
Directors can find themselves personally liable to contribute to the assets of a company if trading increases the net deficiency to creditors. In order to avoid liability for wrongful trading, the directors need to show that they took every step that they could have taken to keep losses to creditors to a minimum
Directors do not need to cease trading immediately when their company becomes insolvent. A company may be able to trade through its difficulties, or on-going trading may result in a better result for creditors than an immediate closure.
To protect themselves directors should as a minimum:
- Review the business and remove unnecessary expenditure
- Records must be kept. The company’s regular financial and operational records should be kept up to date.
- The directors should meet often and stay updated with management and cash flow information
- Treat equally all creditors and no creditor should be preferred over another
- Only in exceptional circumstances can payments be made to creditors whose supply is necessary for the continuation of the business to provide a better result for creditors as a whole. Professional advice should be sought before putting in place measures of this nature
- The directors should consider seeking appropriate advice.
- Talk with funders and key suppliers, and keep them informed of the company’s financial position.
- Ensure that you can explain the reasoning for the company’s continued trading with regard to the position of the company’s creditors.
The Insolvency and Companies Court has recently adjourned outstanding winding up petitions on the basis that the court cannot conduct the general winding up list remotely. Petitions have therefore been adjourned to a series of dates from mid June 2020 onwards.
Despite this the issue of a winding up petition will still have a significant impact on the company, and may by itself, bring about the collapse of that company.
Directors should treat the proposed suspension of the law relating to wrongful trading with extreme caution. The government has stated that the changes to the law will have retrospective effect, yet it may be some time before the changes become law.
There are no proposals to change insolvency law in other respects. The law relating to fraudulent trading (civil and criminal consequences), wrongdoing or misapplication of funds by company directors, and transactions at undervalue, and preferences, whilst a company is insolvent, will remain. There are also no changes to the circumstances in which company directors can be disqualified.