Suspension of wrongful trading provisions during COVID-19
20th April 2020
3PB barrister Cheryl JonesCheryl JonesCall: 1996 writes about wrongful trading and provides an update on what's changing in the light of the current COVID-19 pandemic.
What is wrongful trading and what are its consequences?
Wrongful trading takes place when one or more Directors knows or ought to have known that the Company had no reasonable prospect of avoiding going into administration or insolvent liquidation but continues to trade anyway, with the Company subsequently entering administration or insolvent liquidation [S214(2) & 246ZB Insolvency Act 1986]. The consequences for the Director can be swingeing, with orders against them personally to pay contributions reflecting the increase in insolvency during the period of wrongful trading, together with the never inconsiderable costs of the Insolvency Practitioner who brings the claim. The consequence of such orders is often the bankruptcy of the Director or Directors.
The Court will not make the order if, at the point when the Director knew (or ought to have known) that administration/insolvent liquidation was unavoidable, they took steps to minimise the potential losses to the creditors. That usually means they should seek advice from an Insolvency Practitioner about going into administration/liquidation.
Wrongful trading has been on the receiving end of justifiable criticism because, in the end, it is a question of judgment as to when a Company has no reasonable prospect of avoiding entering administration/insolvent liquidation, with that judgment being far easier for an Insolvency Practitioner making a retrospective analysis than for a Director in a fast-moving situation where the hope of rescue burns bright. Information presented and analysed in a dry and calculated manner at leisure after the event is very different from the piecemeal information tumbling through in no particular order to the pressurised Director or Directors of a Company which is clearly in trouble but for which there may be a prospect of a contract or payment which will turn things around, or a genuine hope of a sale or a white knight.
Why are there proposed changes now?
Well, the short answer is COVID-19. We are in a position where many Companies are being driven into a position whereby they cannot, in the short term, reasonably avoid administration or liquidation although they might be able to trade out of difficulties if they can weather the present storm. Even relatively strong Companies in some sectors (restaurants, for example) are likely to struggle with lack of cashflow whilst overheads remain relatively high. As things stand, the Directors of those Companies are personally at risk if they do not take the appropriate steps, despite the distant possibility or even probability of a brighter future.
The Government is anxious that Directors should not have to look over their shoulders and risk personal insolvency whilst trying to keep Companies going without hope of any income in the near future. If Directors can hold their nerve and allow an increase in liabilities in the short term, then at least some Companies which presently satisfy the definition of insolvency may survive and be able to continue upon the release of lockdown and renewed economic activities. If, in the longer run, there is no administration or liquidation, then the Directors will get away with having traded in the knowledge that the Company is actually insolvent. If, however, the Company does enter administration or liquidation in the future, then the Directors will have caused and allowed extra liabilities to accrue after what, in ordinary times, would be deemed the point of no return. Whilst s214 continues in force, therefore, Directors in these unusual times must act to minimise losses and cannot continue to trade in the hope of a turnaround if they are objectively insolvent now.