Wrongful trading provisions suspended3rd April 2020 - Published by Richard Palmer
We are still waiting for the government to set out the detailed proposals, but it has announced that it is temporarily suspending wrongful trading provisions, with a view to offering company directors greater confidence to trade during the current pandemic. What this means for directors is that there will be no threat of personal liability for wrongful trading if the company falls into insolvency. However, directors must be aware that other claims that may arise related to liquidation (such as misfeasance, fraudulent trading and director disqualification remedies) may still be pursued.
What is wrongful trading?
Wrongful trading is effectively a claim that an insolvency practitioner has against directors where they have traded on past “the point of no return” for the company. A liquidator would seek compensation for the benefit of the liquidation against directors who wrongfully traded by calculating the extra loss caused by trading beyond the point of no return. An action would look at:
1. the effect on creditors generally;
2. the effect on specific creditors.
A simplified example of wrongful trading:
- On 1 January 2019, a company that ran a number of shops was in a tight position but the directors were confident its January sales of surplus stock would get cash in to allow it to get back on track. The net loss to creditors at this time was £750k but forecasts showed that profit of £500k may be achievable in January.
- The sales were poorer than forecast and didn’t even cover overheads. The directors knew (or ought to have concluded) that the company would not avoid “entering an insolvency process” on 1 February 2019 when the January sales figures were poor. The net loss to creditors at this time was £1m.
- However, they traded on until 1 April 2019 incurring credit in buying supplies they couldn’t sell, with the overheads worsening. The company entered liquidation on 1 April 2019 with (because of the credit incurred) a net loss to creditors of £2m.
The liquidator can plead in a claim that the directors knew (or ought to have known) that the company would not avoid entering insolvency on either (a) 1 January 2019 or (b) 1 February 2019, and can claim that the directors should be liable to contribute a sum up to the difference between the actual loss and the loss at those times: applied to this example, that might be (a) as at 1 January 2019: £1.25m or (b) as at 1 February 2019: £1m. The court would consider the evidence available in making those decisions (it wouldn’t simply apply “hindsight”).
Because it also looks at the effect on individual creditors, if on 1 February 2019 sales were used to pay the older creditors but a new supplier was found and credit terms were agreed – that supplier was not paid at all. The effect on that supplier specifically may also be considered in assessment of any contribution the court orders.
Wrongful trading – The “new” position
The detail of the legislative changes has yet to be released, but from the government’s statement we can glean that they intend to remove the threat of directors facing wrongful trading actions should their companies enter insolvency for a period of three months from 1 March 2020.
These changes don’t address a number of the key concerns I’d have for companies generally which aren’t addressed by the statement as it stands:
- What if the relevant company is insolvent but hasn’t reached the “point of no return” as at 1 March 2020? I interpret that this company would be protected but it is difficult to be certain.
- Misfeasance remains a remedy and covers a wide ambit of potential misbehaviour by directors, particularly in any dealings with connected companies as defined by the insolvency legislation
- Antecedent transactions: in particular preferences (where a company pays some creditors to put them in a better position than the rest); many small companies have dealings with connected entities e.g. they rent premises off a holding company or SIPP for the directors. Is there a potential risk that continued rental payments to connected landlords will be reviewed under other measures in the current market?
- What about small companies where directors take loans and subsequently convert them to dividends for tax efficiency? There could be substantial cases of overdrawn director’s loan accounts as a consequence – the wrongful trading provisions do not affect this liability, although certain support may be available under the government’s scheme to help self-employed persons.
- With all companies, what about dividends generally?
- Director disqualification rights that the Secretary of State has are not affected.
Wrongful trading is a rarely-brought claim by insolvency practitioners; misfeasance and antecedent transaction claims are much more common and are not affected by the announcement.
At this stage there are more questions than answers, although one thing the government has done successfully is set the mood to encourage companies to try and stay afloat.
If you would like advice on anything mentioned above, please contact Richard Palmer on 0161 503 2996 or email firstname.lastname@example.org