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Company directors are still prone to liability even if wrongful trading has been suspended

The recent implementation of the Corporate Insolvency and Governance Act, which came into force on 26 June 2020, has now extended the temporary suspension of wrongful trading provisions. Andrew Knowles, senior director – restructuring advisory at Duff & Phelps, writes


The Corporate Insolvency and Governance Act contains a number of permanent and temporary measures that address business challenges resulting from the Covid-19 pandemic.

One of the key measures of the act is the continuation of the temporary suspension of wrongful trading introduced at the beginning of the pandemic. Through the suspension, the threat of personal liability has been significantly reduced, however company directors must remain attentive to other considerations relating to the continued trading of their businesses, as they are still bound by directors’ duties as set out in company law.

Provisions of the new act

The Insolvency Act 1986 included a number of provisions that protected creditors from the actions of rogue directors. Specifically, section 214 on wrongful trading required company directors to assess the likely prospect of avoiding insolvency. Continuing to trade when there was no reasonable prospect of avoiding insolvency can have dire consequences including personal liability for debts and trading losses.

Furthermore, disgruntled creditors can commence direct action against the director and protection of limited liability would not apply. This is commonly known as ‘piercing the corporate veil’, thus ensuring that in distressed situations directors were acting in the interests of creditors, rather than shareholders.

Although the new Act provides some sort of relief to company directors, it does not entirely turn off these wrongful trading provisions. For directors who may have previously hurried to start insolvency proceedings, avoiding the possibility of any personal liability, the temporary suspension will help postpone many from triggering that process and assist them to emerge intact on the other side of the Covid-19 pandemic. 

Directors are still bound by their duties

With the UK economy enduring its worst quarterly fall in four decades, it is no surprise that the majority of UK businesses are experiencing some form of financial pressure. To help ease these challenges, the government has made changes to the insolvency law but has stopped short of providing company directors with complete immunity from liability and their duties.

From experience, the vast majority of directors understand the difference between steering the business through a challenging period and crossing the line into wrongful trading for which there remain severe penalties, including personal liability and disqualification. On a cautionary note, all other sources of risk and liability under the Insolvency Act 1986 are unaffected. For example, directors will continue to receive sanctions and penalties if they attempt to defraud the creditors or the company. This shows that directors are still bound by their fiduciary duties, and also by the fraudulent trading provisions of section 213.

In addition, directors will still have duties under the Companies Act 2006 and must continue to act and be mindful of interests of creditors if the likelihood of insolvency increases. Overall, this means that the temporary suspension of wrongful trading doesn’t change the attention that directors should be giving when evaluating the financial position of their company. Directors’ actions will remain subject to scrutiny, making it critical that they consider very cautiously whether to continue trading if there is not a realistic chance of their company avoiding insolvency.

Looking ahead

While lockdown measures begin to ease and shops and high streets begin to reopen, numerous challenges still lay ahead, particularly with the expected reduction in consumer demand and confidence. The coming months will likely see a large number of company directors face a challenging ultimatum—continue trading or instigate an insolvency process? 

Directors that are concerned about the financial difficulty they may find themselves in should continue to consider the needs of all key stakeholders and creditors in any decision. It is pivotal to maintain ‘good housekeeping’ in the form of board meetings and keeping records of actions taken with an assessment of the reasons for certain decisions.

Most importantly, it is recommended that directors seek appropriate professional advice and turn to outside parties for help wherever possible.

 

 

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