Is the suspension of wrongful trading the right approach?
Michael Reid, managing partner, Meston Reid & Co
When the temporary suspension of wrongful trading rules for company directors was announced, the UK government commented that it was designed to help business owners combat the financial impact of COVID-19.
This move was taken to “give company directors greater confidence to use their best endeavours to continue to trade during this pandemic emergency, without the threat of personal liability should the company ultimately fall into insolvency”, according to a UK Government announcement at the time.
A statement from the Department for Business, Energy and Industrial Strategy (BEIS) added: “Current insolvency rules stipulate that directors of limited liability companies can become personally liable for business debts if they continue to trade when uncertain about whether their businesses can continue to meet their debts. Relaxation of these wrongful trading rules will reassure directors that the difficult decisions they have to make about the future viability of their business will not have to be unduly influenced by the exceptional circumstances which are entirely beyond their control.”
In summary, section 214 of the Insolvency Act 1986 can render a director liable for a contribution from personal resources to an insolvent company’s assets if it can be demonstrated that the director continued to trade while aware – or while they should have been aware – that there was no reasonable prospect of avoiding insolvency.
Lifting such a worry for directors at a time when the primary focus for many is on survival would – at first glance – appear to be a sensible course of action. However, there’s room for concern that, while this short-term suspension of legislation represents a well-intended ‘breathing space’ for many, it may create an opportunity for a few to abuse the insolvency framework further down the line. With the prospect of more people returning to work and a business resuming whatever trading activity it can, will some directors use this relaxation in the insolvency legislation to act in ways which do not respect the interests of all stakeholder groups?
Some might argue that a delinquent director would seek to take advantage of the relaxation of the rules surrounding personal liability and flout the rules e.g. use the current situation as an excuse to defer payment – which in turn would have a financial impact on the supply chain for others.
The wrongful trading provisions play a crucial role in protecting creditors from unnecessary losses. It’s important we don’t lose sight of this – even during these challenging times – otherwise other businesses may suffer. Perhaps the focus should be on avoiding any ‘domino effect’ in the wider business community; this temporary suspension should be a protective force for those acting in good faith, rather than a convenient cover for the unscrupulous.
In practical terms, this adjustment to the insolvency process applies retrospectively from March 1, 2020, and we await further detail on how this change will take effect, but company directors need to be aware that key obligations remain in place.
The wrongful trading provisions mean that courts can, in normal circumstances, order directors to contribute personally to creditor losses and this interim suspension could remove such power from the courts. The upside is that the new rules should allow a business that seeks to restructure to maintain ongoing access to supplies and raw materials.
However, every director should remember their fiduciary responsibilities and thus, other factors which broadly constitute a ‘duty of care’ framework remain very much in play.
For company directors facing the insolvency circumstances covered by these wrongful trading rules, ignoring the wider principles of good business governance could still mean they find themselves liable to contribute personally to creditor losses.
Directors should not over-interpret the suspension to act with carte blanche: they should act sensibly and cautiously, and carefully document business decisions and the reasons behind them.
If directors recognise that the survival of their business is no longer feasible – for whatever good reason – they should seek professional guidance and reputable advice from the outset.
Michael Reid, managing partner at Meston Reid & Co, is one of the country’s leading insolvency practitioners. Meston Reid & Co is an Aberdeen-based chartered accountancy practice with expertise in tax, audit, insolvency, corporate finance, business advisory, payroll and landed estates. The firm has a broad range of clients, from contractors in the oil and gas sector to large businesses with international operations.