Wrongful trading: relief for directors of distressed businesses

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In this, our second instalment in a series of bitesize updates on the new Corporate Insolvency and Governance Act, we examine wrongful trading and the new measures introduced.

Section 12 of the act temporarily relaxes the rules on wrongful trading. The changes apply from 1 March 2020 until 30 September 2020 and offer directors some relief from personal liability.

Wrongful trading – what’s new?

The threat of wrongful trading is usually a strong deterrent to directors who cause a company to trade on, even if they intend to take steps to minimise losses to creditors. The aim of the relaxation is to remove this deterrent to prevent businesses which would be viable, but for coronavirus, from closing.

How does it normally work?

Normally directors (including shadow and de factor directors) may be personally liable for debts and liabilities incurred after the director knew, or ought to have concluded, that there was no reasonable prospect that the company would avoid going into insolvent liquidation or administration and failed to act to minimise loss to creditors.

The onus is on the director to prove that she/he took every step possible to minimise the potential loss to the company’s creditors after they knew that company was likely to go into insolvent liquidation or administration.

The court will then decide how much the directors may be personally liable for, starting with whether there had been an increase in the net deficiency in respect of unsecured creditors after the company’s position (outlined above) became clear.

Temporary relief for directors

From 1 March 2020 until 30 September 2020, the court will instead assume that the director is not responsible for the worsening of the financial position of a company or its creditors, thereby relieving the director of any liability for wrongful trading.

Unlike many other temporary measures contained in the new Corporate Insolvency and Governance Act, there is no requirement for the company’s worsening financial position to be caused by coronavirus.

While this relief will end after 30 September, it can be extended for periods of up to 6 months.

Does your company qualify?  

While the new measures apply to most companies, they do not apply to certain specified companies including insurance companies, banks and investment firms, building societies and credit unions.

Risk free?

Kelly Jordan, partner and head of restructuring & insolvency, says: “Directors could be forgiven for thinking that this reprieve from wrongful trading relieves them of all risk of personal liability. However, section 10 only provides relief for wrongful trading; it does not affect fraudulent trading or misfeasance/breach of duty claims.”

“When a company is insolvent or likely to become insolvent, directors are dutybound to exercise their powers in the interests of creditors. If a director breaches that duty, they could still find themselves liable to contribute to the company’s assets by way of compensation for the loss caused.

“It therefore remains the case that directors should take advice from an insolvency professional whenever a company is at risk of insolvency and should record decisions taken by the board including the rationale for making those decisions.”

Next read

Our next update focuses on the new stand-alone moratorium – which gives eligible companies some breathing space to seek rescue – or click here to view all five updates.

For more help and specialist insolvency and restructuring advice meanwhile, contact Kelly Jordan on 0191 211 7899 or email [email protected] for a free consultation.