On 28 March 2020, the UK Business Secretary announced the intention to suspend wrongful trading provisions to help businesses combat the financial impact of Covid-19. The measure is designed to allow ailing companies to continue trading without directors facing the threat of incurring personal liability and was included in the Corporate Insolvency and Governance Bill published on 20 May 2020.
Below we examine the impact these measures are likely to have on creditor redress.
An overview of wrongful trading
When companies are solvent, directors have a fiduciary duty to promote the success of the company and exercise reasonable care, skill, and diligence. However, when a company is at risk of becoming insolvent, the interests of creditors are paramount. The wrongful trading provisions prioritize creditors’ interests and increase the accountability of directors. Directors can be held personally liable for business debts if they allow the company to continue to trade once they know or ought to conclude that there is no reasonable prospect of avoiding insolvent liquidation or administration. Any award is compensatory in nature and only arises if the company is worse off because of the continuation of trading.
The impact of the suspension
The temporary suspension of wrongful trading provisions and the imposition of a moratorium may be sensible in the current situation and welcomed by directors, but it is not a panacea. Although the suspension may limit some types of claim it will not absolve directors from other, overlapping claims, for example for breach of duty or fraudulent trading.
An unintended consequence of suspending the provision is that it will make it more difficult for insolvency practitioners to challenge the directors of businesses that would become insolvent regardless of the pandemic, and could unintentionally shield those directors acting in bad faith and looking to take advantage. Insolvency practitioners will need to bring their expertise to bear when navigating these additional hurdles to recover value for creditors.
Further, the defense of honest and reasonable action remains untested in the Covid-19 pandemic context and the level of protection afforded to directors is unclear.
Ultimately, there will likely be a rise in insolvency-related actions taken against directors, sponsors, and advisors in coming months as the economic downturn continues to take its toll and more companies go under. Regardless of any measures implemented by the government, creditors will still have access to a myriad of different ways to seek redress.
Legal finance allows insolvency practitioners to pursue valuable and meritorious claims that otherwise may have to be abandoned or settled for a value below the amount that could be realized with sufficient resources—thus maximizing recoveries for creditors. We anticipate that the global economic downturn that we are experiencing will result in a renewed importance for legal finance in the insolvency context.