What Is Wrongful Trading And Why Directors Need To Be Aware of Changes?

The Government have recently announced they intend to implement temporary suspension of the wrongful trading rules, as well as introducing a moratorium for businesses undergoing restructuring processes. This has not yet been put into legislation but is anticipated to apply retrospectively from 1 March 2020, once the legislation is passed.

By imposing these temporary suspensions of the current provisions relating to wrongful trading, the Government’s aim is to keep companies trading, by providing their directors with extra reassurance during these difficult times. The Government’s aim is that viable companies can continue to do so without fear of repercussions, once the COVID-19 disruption has eased.

So what is Wrongful Trading and why is it important to directors?

Under the current rules, if a company continues to trade after the company has become insolvent, that is where the company is unable to pay their debts as they fall due, then the director/s of that company may be investigated and could be held personally liable for ‘wrongful trading’. The test for wrongful trading is that the director/s knew (or should have known) that there was no reasonable prospect of the company avoiding insolvent liquidation or administration.

If the director/s are found by the court to have been ‘wrongfully trading’ and did not minimise losses to creditors during this time, then the court can order the directors to personally make a contribution to the company’s assets. This is obviously causing many companies great concern at this time, and in light of the current circumstances the government have advised that they will take steps to help businesses and those running businesses during these uncertain times.

What is the Moratorium that has been suggested?

In addition the government have also proposed that there will be a moratorium for businesses that will need to undergo a restructuring process or a financial rescue. This is intended to allow businesses to continue to trade for an extended period of time knowing that they will not be pursued by creditors during that time.

Currently only small businesses can seek a moratorium when proposing a Company Voluntary Arrangement (CVA), including those with 50 or less employees, turnover of less than £10.1 million and less than £5.1 million balance sheet assets.

Additional moratoria measures for businesses have been considered for some time, including guidance as set out in the Government Consultation on Insolvency and Corporate Governance in 2018. We will however need to await further clarification as to the measures that will be taken by the government during these difficult times. The Government is aiming to strike a balance when introducing these COVID-19 insolvency changes, with the aim of protecting companies from short-term liquidity challenges as well as ensuring that creditors get the best return possible in these circumstances.

So what is the current problem many businesses are facing?

Many businesses, especially small businesses, run on tight profit margins. Without a certain amount of turnover and trade, businesses will struggle to cover the required running costs. The ability of many businesses to trade was completely turned upside down however when the government put temporary restrictions on people’s movement and trade.

These restrictions will also affect and delay the ability of a business to act in the best interest of the business and their creditors. This is a highly problematic and deeply distressing situation for a number of businesses that were previously quite correctly trading within the rules.

Without a temporary suspension of these rules, it is arguable that every company that needed to furlough staff or claim govt support funds would potentially have been in a position that they knew or should have known that there was no reasonable prospect of the company avoiding insolvency, and therefore would classify as wrongful trading.

Where a business is not able to continue in a viable manner, the correct legal course of action would be to file for insolvency, however given the huge number of businesses in the same position at the current time, this would have resulted in a massive surge of businesses failing.

The temporary suspension of the wrongful trading rules therefore temporarily removes the threat of directors incurring personal liability during the COVID-19 pandemic. Directors of a company owe their duties to the members of that company as a whole. It is important to note however that all other checks and balances to ensure that directors continue to fulfil their legal duties and obligations, including those to creditors, will remain in place.

Any company that was potentially facing insolvency prior to Covid-19 is unlikely to see a benefit from these changes. Many businesses that were struggling pre-1st March may now have to take steps towards insolvency, and it is likely that the insolvency service will pay particular attention to the timings around when decisions were made by Directors when assessing when to file for insolvency.

It is critical that you should seek advice at the earliest opportunity when you have concerns about the solvency of the company and making sure that you have properly documented all the steps when your company faces the threat of insolvency. Holding regular board meetings, and preparing contemporaneous minutes to document any key decision made about the ongoing operations of the business may be a defence to your actions, so understanding the position as soon as possible is vitally important.

At Altion Law we can help by advising you from the outset on best practice of properly documenting paperwork and compliance procedures. We can provide clear, jargon-free explanations of directors liabilities and compliance procedures, as well as a review of any procedures and processes to avoid future problems.

Our team can assist you if you have concerns about liability as a director that may impact your business or future business opportunities. If you would like to have a confidential discussion with a member of our team, please make a Free Enquiry, and one of our expert team will call you back at a time that is suitable for you or you can contact us directly on 01908 414990.