Wrongful trading

On 28 March 2020 Business Secretary Alok Sharma announced changes to UK insolvency law as part of the Government’s response to the Coronavirus pandemic. Announcing the changes Mr Sharma said they would give businesses “extra time to weather the storm” and “the government wanted to avoid companies going into liquidation or administration because directors feared claims from the current exceptional situation.”

One of the key proposals was that directors will not face claims for wrongful trading under the Insolvency Act. Since that announcement was made the Corporate Insolvency and Governance Bill has been published and is currently being debated in Parliament. It is expected to become law at the end of June or the beginning of July 2020. [Since this article was written, the Bill was passed as the Corporate Insolvency & Governance Act 2020 (CIGA).  You can read our further article on wrongful trading here together with articles on connected issues on our dedicated CIGA hub.]

If a company goes into administration or insolvent liquidation and it appears the directors knew or ought to have known there was no reasonable prospect of avoiding that, the directors can be ordered to contribute to the company’s assets.   Directors facing a wrongful trading claim will try to show they took every step with a view to minimising potential loss to the company’s creditors.   If the directors are unable to do so they risk being ordered to pay some or all of the increase in the “net deficiency” owed to creditors. 

Over the years, the Courts have recognised that directors often have to make decisions in difficult circumstances, and judges have been slow to find that, with the benefit of hindsight, the decision to carry on trading was wrong. That provided some, limited, comfort to directors.

According to initial announcements the proposed changes would remove the threat of wrongful trading altogether, suspending claims based on the 3 months from 1 March 2020. That addressed concerns that directors taking ‘every step’ to minimise potential loss would conflict with the Government’s encouragement to businesses to ride out the crisis. However the Bill, if passed by parliament, will not suspend claims for wrongful trading but instead the courts will assume the director is not responsible for the increase in the “net deficiency” during those three months. The word “assume” rather than “presume” has caused debate  – is there still an opportunity to argue suspension should not apply and the director still liable for wrongful trading?  Probably not but, for the moment at least, the position is not completely clear. The disadvantage of the proposed changes is that it risks cavalier or reckless decisions with apparent impunity.

Or does it? The temporary relaxation of the wrongful trading provisions does not give directors carte blanche. Directors retain their Companies Act 2006 and other legal and equitable duties, and must continue to act in the  best interests of the company and in some circumstances, its creditors, otherwise they may face  claims based on a breach of duty.   The court can reduce the claim or excuse the director altogether if s/he “acted honestly and reasonably” and “…having regard to all the circumstances of the case s/he ought fairly to be excused”.  It remains to be seen how the courts will deal with breach of duty claims based on the same 3 month period and may even decide that, in this exceptional period, there was in fact no breach of duty at all.

The fraudulent trading provisions of the Insolvency Act will also remain in force, and directors can still face disqualification proceedings. Allegations of unfitness are often the same or similar to wrongful trading. It is hard to see how a director could avoid a claim for wrongful trading yet still be disqualified for the same or a similar reason. Or face a compensation claim after a disqualification order has been made.  Only time will tell.   

At the end of March Mr Sharma said the changes should encourage directors to take advantage of the financial packages on offer, ensure that “when the crisis passes” companies are ready to “bounce back” and in the meantime can “keep their businesses going without the threat of personal liability”.   

For more information on this article please contact David Pomeroy

Please note that this article was originally published 18 June 2020 and was recently updated 22 April 2021.