Abstract of machinery with blue tint.

COVID-19: Good news on wrongful trading provisions but why should directors tread carefully?

09 April 2020. Published by Tim Moynihan, Senior Associate

The Government has launched a number of initiatives to assist companies and businesses to trade through the current financial stress. But what should directors still be aware of as they steer their organisations through these unprecedented times?

The Government's measures were focussed on protecting directors from personal liability for wrongful trading and a proposed moratorium to allow businesses to refinance or restructure free from creditor action or enforcement. (Click here to see our update on these measures).

The policy objective of both these measures is to push back the point at which companies need to enter into insolvency either due to pressure on directors or from external sources.  While those steps are welcome, and should ensure that fewer companies enter insolvency procedures precipitously during the pandemic, there are still numerous other issues facing directors where boards are advised to seek professional support.

Liquidity

One of those will be liquidity, with companies still facing significant liquidity issues in the absence of trading or non-payment by customers facing their own difficulties and seeking to protect their own cash reserves.

The government has sought to address this through a number of financial support packages; most notably the Coronavirus Business Interruption Loan Scheme (the Scheme) aimed at SMEs. The detail of the Scheme, and recent action by the government to address market criticisms of it, can be found in this update from RPC.

In addition, many companies will have headroom within existing facilities so that additional funds can be drawndown to either fund operations or to hold as reserves. Any such further drawdowns will likely be subject to repetition of warranties and / or covenant assessments by lenders.

What do directors still need to be aware of?

While the liability for wrongful trading has been relaxed, the remainder of the directors' duties regime remains intact and must be complied with. In particular, when electing to access additional capital directors must be mindful of their duties to either the company's members or where the company is facing significant distress to its creditors as a whole. Taking additional borrowing and providing assurances to lenders are areas where directors will need to proceed with particular caution and seek legal advice. Also, breaches of duty can attract personal liability even with the relaxation of wrongful trading rules.

There will also be circumstances where affiliates may wish to allocate financial resources across a group. While directors will already be aware of the rules that apply to such arrangements, they will need to give careful thought to the following:

  • The appropriateness of paying intra-group dividends to move cash at a time of financial uncertainty and where operational revenue and expense may be difficult to project.
  • The avoidance of conflicts where directors sit on multiple companies within a group – a point that arises in "normal" times but one that will be in sharper focus now.

Ascribing appropriate consideration for any assets transferred intra-group. Again, this applies in all circumstances but must be carefully considered at the present time where there has been no relaxation of claw back rules on insolvency and where ascertaining the proper value of the asset(s) and the solvency of the transferor may be problematic.

Again, any breaches by directors can give rise to personal liability outside of the change to wrongful trading. On a practical level, directors should be taking proper advice on any of these actions and documenting carefully the decisions taken and the rationale for them.