Walking the Tightrope of Wrongful Trading: Temporary “Suspension” of Liability in the UK Corporate Insolvency and Governance Bill
On 20 May 2020, the UK Government introduced the Corporate Insolvency and Governance Bill (the “Bill”) to the House of Commons. The aim of the Bill was temporarily to amend corporate insolvency laws to give companies the best possible chance of weathering the storm of the COVID-19 pandemic.
One of the significant measures can be found at clause 10 of the Bill. This is the temporary relaxation/suspension of liability for wrongful trading under sections 214 and 246ZB of the Insolvency Act 1986. The intention of this measure is to allow directors to ensure that their businesses continue through the COVID-19 pandemic without fear of personal liability for wrongful trading. However, wide drafting may have raised as many questions as the answers it provides.
This blog will focus on wrongful trading. A broader overview of the measures introduced by the Bill can be found here.
The Bill states that during the “relevant period”, in determining whether wrongful trading has occurred, the court will assume that a director is not responsible for the worsening of the financial position of a company or its creditors. This relieves the director of any liability for wrongful trading.
The relevant period in question is from 1 March 2020 until 30 June 2020 or 1 month after the Bill is enacted, whichever is later. It is also important to note that this period can be extended by 6 months at a time or shortened by secondary legislation.
A number of companies are excluded from these changes. Firstly, the new measures do not apply to companies listed in schedule ZA1 of the Insolvency Act 1986 such as insurance companies, banks and investment firms. Building societies, friendly societies and credit unions are also exempt, along with any company carrying out a regulated activity under Section 4A FSMA. Before relying on the Bill in respect of wrongful trading, directors should consider whether their company is among the excluded categories.
Interestingly, a guidance note provided alongside the Bill confirms that there is no requirement for the worsening of the financial position of a company to be attributable to the COVID-19 pandemic. This creates a very wide scope for potential application (and possibly abuse) of the new measures and it remains to be seen how this will be addressed.
Comments on the Bill
Many have noted that the broad drafting of the Bill to include companies that have not necessarily been directly affected by COVID-19 seems to leave potential for exploitation. However, it is important to consider whether there is a workable alternative. In order to ensure that the Bill distinguished companies that are affected by COVID-19 from those that are not, there would have been a requirement for some kind of test which would in all likelihood prove unwieldy. Given the number of companies facing financial difficulties as a result of COVID-19, such a test would need to be user-friendly.
It is entirely possible that the government has taken the view that it is better that all companies can benefit at the risk of exploitation as opposed to narrowing the test and risking companies that are affected by COVID-19 falling outside the criteria.
The flexibility of the “relevant period” may also be cause for concern for some directors. A shortening of the relevant period with relatively little notice may result in a director facing exposure to liability for wrongful trading. While it seems unlikely that there would be a shortening of the relevant period in the very near future, it is possible that a six-month extension may be shortened in the future. If a director has committed to a course of action that will take a number of months to be fruitful, a shortening of the relevant period could leave a director facing a decision whether to stop this course of action to the detriment of the company and its creditors, or continue and risk liability for wrongful trading.
The wording of section 10, which states that “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 relevant period.” will also raise questions for directors.
The fact that there is an assumption by the court that directors will not be responsible for any worsening of financial position creates a possibility that such an assumption may be rebutted. While the title of the measure is “Suspension of liability for wrongful trading”, the possibility of a rebuttable assumption suggests that it may be the case that in fact, the liability is being relaxed as opposed to suspended.
It is possible that this wording is intentional to cover the point raised earlier regarding the broad drafting and possibility of the measures being exploited by directors of companies unaffected by COVID-19. Nevertheless, a suggestion that there is still a possibility of liability for wrongful trading if irresponsible decisions have been taken by the director may mean that directors have not been provided with the reassurance that the government intended.
It is clear that a number of businesses are facing unprecedented financial challenges and that the government has sought to recognise this with changes in the law. However, questions remain as to how measures in relation to wrongful trading will operate and whether directors are actually being afforded the protection that is suggested at first glance. In the circumstances, directors should continue to take early advice and not treat the proposed new measures as a ”get out of jail free” card. In reality, there should be no change in the need for directors to exercise reasonable behaviour to ensure that they do not fall foul of the new legislation or incur liability for misfeasance or breach of duty under existing legislation.
The Bill may still be subject to amendments before it is enacted. This is an opportunity for the government to clear up grey areas; prevent legal ambiguity and the possibility of inconsistent application by the courts in the aftermath of COVID-19.
Trainee Solicitor Rory Thomas contributed to this article.