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COVID-19: The relaxation of wrongful trading rules

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By Will Macauley

The Coronavirus has caused many businesses to suffer significant declines in cashflow owing to mandatory closures, a cautious market and marooned workforce. Many management teams may feel that they should ‘fight through’, incurring debts and paying outgoings to enable their company to weather the crisis, but may be wary of potential wrongful trading liability. However, the Government has taken steps to remove such liability during this crisis.

Wrongful trading

Simply put, wrongful trading occurs when a director allows the company to continue to trade when it appears that insolvency is unavoidable. Wrongful trading will be determined once the company is in administration or liquidation and, where so determined, can allow the acting insolvency practitioner to seek a personal contribution by the director to the company’s debts.

However, on 28 March 2020, the Government announced that it would be suspending wrongful trading rules for 3 months with retrospective effect from 1 March 2020. The Government has reasoned that this would allow directors to take necessary steps to allow otherwise secure companies at risk as a result of the crisis to take steps to seek to endure it, including by utilising the Government’s support schemes.

While this should be welcome news for directors seeking to weather the crisis, it is a not an outright waiver of all the checks and balances which directors are subject to; there remain duties and fiduciary obligations which must be observed, along with other avenues to personal liability, for example, fraudulent trading and obligations under personal guarantees.

Fraudulent trading

Fraudulent trading rules remain in effect and are unlikely to change in the course of the Coronavirus crisis. Fraudulent trading differs from wrongful trading in that there is a requirement that the relevant person carries on business intending to defraud the company’s creditors or otherwise commit fraud. Like wrongful trading, however, the effect is that the guilty individual can be required to contribute to the company’s debts.

Fraudulent trading in the context of the Coronavirus crisis could arise where a director is proven to have made use of a Coronavirus Business Interruption Loan (for example) by supplying false information or representations about solvency and recoverability. In such circumstances, an insolvency practitioner asserting fraudulent trading would have to prove the director’s intention, which can be difficult, but the risk remains.

Personal guarantees

When providing loans or credit facilities, lenders can often require personal guarantees from the debtor business’s directors and/or shareholders. Though the specific effect of such documents will depend on their terms, broadly speaking, personal guarantees impose personal liability on the guarantor for all or part of the company’s liabilities to the lender in the event that the company does not fulfil those obligations itself, for example, where the company fails to make repayments.

Given the contractual liability under personal guarantees (contrasted with the statutory liability of wrongful trading), there is limited scope for the Government to step in and prevent this liability from arising. For this reason, while the Coronavirus crisis continues to hinder businesses’ ability to satisfy their liabilities, directors may need to stay cautious where a personal guarantee is in place, or where a creditor is requesting a new guarantee. However, directors should not seek to give preference to creditors to whom they have given a guarantee over other creditors, for the reason explored below.

Directors’ duties

A director operating a business which is insolvent or on the brink of insolvency can owe common law duties to act in the interests of the company’s creditors. This duty exists alongside directors’ existing statutory duties to their company. 

This means that a director cannot, for example, declare a dividend to the detriment of the company’s creditors, or make a preferential payment to a particular creditor to the detriment of the others. Where this duty is found to have been breached, the director at fault can be ordered to remedy the creditor losses they cause. Directors should, therefore, be very cautious when determining whom to pay and when if they believe that the company may be insolvent or close to insolvency.

Though the suspension of wrongful trading rules should be reassuring to directors, we are advising our business clients to maintain caution in this ever-changing environment; throughout this crisis period, directors should keep aware of their financial position, their legal position and the government support available.

If you are concerned about the legal implications to you and your business, please do get in touch and we will be happy to assist you during these challenging times.

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