COVID-19: The suspension of wrongful trading provisions and a moratorium for businesses in restructuring – what is the likely impact on your business?
COVID-19: On 28 March 2020 the Business Secretary announced further new far-reaching measures to help businesses combat the financial impact of COVID-19. What it the likely impact of the suspension of wrongful trading provisions and a moratorium for businesses in restructuring on your business?
In a welcome intervention, the Business Secretary declared it was the government's intention to suspend wrongful trading provisions and to introduce a moratorium for businesses undergoing a restructuring process. Both measures are intended to assist companies to trade through financial distress caused by the loss of business due to the COVID-19 pandemic.
At this stage there is little detail in respect of the proposed legislation with the Business Secretary stating that such legislation would be introduced "at the earliest opportunity". Nevertheless, RPC restructuring and insolvency partner Paul Bagon commented: "the government's intention to introduce new measures to suspend director liability for wrongful trading will be welcome news to boards of directors around the country who are faced with unprecedented difficulties in assessing the ongoing viability of otherwise financially sound companies that are faced with the unexpected prospect of significantly reduced revenue for an unknown period of time".
Temporary Suspension of Wrongful Trading
In these uncertain times directors have become increasingly concerned about the risk of personal liability that can arise in respect of wrongful trading. Under current legislation a director can be liable if they are found to have continued trading a business and did not minimise losses to creditors at a time when they knew, or ought to have concluded, that there was no reasonable prospect of avoiding insolvent liquidation or administration.
The Business Secretary announced new legislation would be introduced to grant a temporary suspension of the wrongful trading provisions, which would take effect retrospectively from 1 March 2020.
Prior to the announced measures, wrongful trading provisions provided protection to creditors by imposing personal liability on directors of insolvent companies that continued trading beyond a time at which there was no reasonable prospect of the company avoiding insolvency. The aim of the proposed temporary suspension is to allow directors to continue trading distressed companies affected by the COVID-19 crisis without the risk of personal liability even in circumstances in which there is little clarity about the future prospects of the company avoiding insolvency due to uncertainty regarding when the COVID-19 crisis will end. Consequently, the measures should reduce the number of unnecessary and likely terminal corporate insolvency filings and allow viable companies to trade through the COVID-19 crisis and recover once normal trading activities resume.
One of the most difficult directors' duties decisions faced by boards of distressed companies relates to whether to drawdown on unutilised headroom under revolving credit facilities to provide much needed liquidity at a time when there is uncertainty about a borrower's ability to avoid insolvency. The relaxation of wrongful trading provisions during the COVID-19 crisis should enable directors to more easily evaluate such decisions and in so doing reduce the prospect of large numbers of companies becoming cashflow insolvent. Each such decision, however, will remain highly fact specific and to mitigate potential liability boards should continue to seek professional advice. In addition, as the proposed measures are universal and do not distinguish between businesses that were struggling prior to the COVID-19 crisis and those whose financial performance has been affected only by the pandemic, it is likely that the suspension of wrongful trading rules will enable so called unviable "zombie companies" to continue to limp on fuelled by low interest debt.
The Business Secretary also announced a moratorium for businesses which need to undergo a financial rescue or restructuring process which would allow them to keep trading for an extended period free from creditor action. Currently only small businesses (with 50 or less employees, turnover less than £10.1 million and less than £5.1 million balance sheet assets) can seek a moratorium when proposing a Company Voluntary Arrangement (CVA) and no such moratorium is available for businesses seeking a Scheme of Arrangement with their creditors. The introduction of additional moratoria for businesses implementing turnarounds through restructurings has been mooted for some time and was considered in the Government Consultation on Insolvency and Corporate Governance in 2018.
We await the Government's legislation for clarity on the exact scenarios in which businesses will be eligible to benefit from the proposals and the length of time the moratorium will be imposed. However, we would expect this to be similar to those currently granted to companies in administration or proposing a CVA, and as a minimum, prevent creditors from independently taking action to place companies in to liquidation or administration while the financial rescue or restructuring is ongoing.
We are also expecting, following the announcement by the Business Secretary, that provisions will be introduced to ensure businesses are still able to gain access to essential supplies. The extent of these provisions is unclear however we anticipate that they may expand the existing essential supplier regime set out in the Insolvency Act 1986 under which essential suppliers, such as utility and IT suppliers are prohibited from relying on an insolvency event as a trigger to terminate the provision of ongoing supply.
The Business Secretary has reiterated that "all of the other checks and balances that help directors fulfil their duties properly will remain in force". While a temporary suspension on wrongful trading has been welcomed by both the British Chamber of Commerce and the Confederation of British Industry, the risk of personal liability to directors remains. In particular, directors must continue to act in accordance with their duties, both fiduciary and those codified in the Companies Act 2006. Those that do not, still face the risk of sanction and possible disqualification as a result of any misconduct.
Existing insolvency legislation, such as the rules around preferences and transactions at undervalue, remain. RPC restructuring and insolvency Partner Finella Fogarty commented: "The proposed changes may be welcomed but do they really change anything? Very few directors are actually found guilty of wrongful trading and it may bring a false sense of security. In light of the majority of the existing legislation remaining unchanged, directors will continue to need to consider and document very carefully decisions relating to creditor payments and asset disposals where there is a risk of the company entering insolvency and to seek relevant professional support to mitigate their risks in these areas."
If you would like some advice on this topic, please contact any member of our team: