The suspension of the Wrongful Trading provision – What is Wrongful Trading?
15 April 2020: The law states “where a director knew, or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation” (Section 214, IA86)
Simply put; Wrongful Trading is a way of holding directors personally liable for company debts incurred after a time when a reasonable person would have stopped trading.
How is Insolvency established?
There are two tests:
- the balance sheet test – assets exceeded by liabilities (especially if contingent and prospective liabilities are taken into account); and/or
- cashflow test – unable to pay debts as and when they fall due.
Alarm bells should be ringing for directors if company debts cannot be paid as they fall due or if upon reviewing their business strategy it becomes apparent that they will not be able to meet the contingent liabilities that would crystallise upon a cessation of trade (i.e. redundancy costs).
Why are the Government suspending this provision?
Given the COVID-19 pandemic, it is arguable that many directors might now be advised to “throw in the towel” if, by carrying on, they risk personal liability. Accordingly the Government have stepped in to relieve directors of this threat – albeit temporarily. It is intended that this suspension will take effect retrospectively from 1 March 2020 for a period of three months (although it wouldn’t be that surprising if they extend this period).
Open season; for now does this mean directors can do what they want?
No. The Companies Act 2006 sets out a number of common law fiduciary duties owed to a company by its director(s). When a company is insolvent, the directors’ duties are to ensure that they act in the best interests of the company’s creditors, a failure to do so may result in an action for misfeasance and potential personal exposure. Other existing insolvency laws remain in force (including Fraudulent Trading) and should still provide an effective deterrent against director misconduct.
What should I do?
This change is only relevant if the company enters into an insolvency procedure. Whilst this is rarely a directors’ intention, during these uncertain times it would be helpful if the board retained detailed notes to support their understanding of the company financial position and why the decisions that they are taking are considered appropriate.
We want what is best for you and/or your client. BRI will give you the full picture irrespective of the likely outcome for ourselves. Call one of the BRI offices and speak with any of the management team for a free, no obligation discussion.