Business insolvency due to covid-19
New insolvency measures to support businesses under pressure as a result of COVID-19 have been announced. Many of these changes will be introduced by the Corporate Insolvency & Governance Bill, which is currently passing through parliament.
We explain what the new measures mean and how they are likely to work for debtors, creditors and directors.
We look at:
- Suspension of wrongful trading rules;;
- Moratorium for winding up petitions; and
- Temporary changes to Directors Duties
Wrongful trading rules
In normal times, the wrongful trading provisions allow a company’s administrator or liquidator to seek a court declaration requiring a director to make a personal contribution to the assets of the company, thereby benefiting creditors.
The court will grant this declaration if it believes that the director continued to trade despite the fact he knew or ought to have known that there was no reasonable prospect that the company could avoid liquidation or administration.
Often, it is the fear of personal liability for wrongful trading that convinces directors to wind up their businesses.
Suspension of wrongful trading provisions
On 30 March 2020 the government announced the suspension of wrongful trading provisions, releasing directors from personal liability for continuing to trade despite knowing the company had no reasonable prospect of avoiding insolvency. This suspension was widely welcomed, although there was little clarity at the time as to how the measures would be introduced. We now have some of that clarity.
These changes will come into force with the passing of the Corporate Insolvency & Governance Bill. While the government had announced that wrongful trading provisions were to be suspended, the draft bill instead modifies the rules which determine how much a director must contribute to the assets of an insolvent company.
The court is to assume that the director in question is not responsible for any worsening of the financial position of the company or its creditors during the period from 1 March 2020 to 30 June 2020 (or one month after the coming into force of the Act, whichever is later).
The intention of this change is to give directors of otherwise viable businesses the confidence to continue trading through the coronavirus crisis. However, the Bill does not release directors from the fiduciary duties to act in the best interests of their companies, which are discussed further below.
Moratorium on winding-up petitions
The business secretary also announced a moratorium for businesses which need to undergo a financial rescue or restructuring process. Again, the Corporate Insolvency & Governance Bill provides clarity which was not available at the time of the announcement. Rather than radically redrawing the insolvency landscape, the ‘moratorium’ is a set of proposed prohibitions and restrictions on the presentation of winding-up petitions during the period from 27 April 2020 to 30 June 2020 (or one month after the coming into force of the Act, whichever is later).
Once the Bill is passed, no winding up petition may be presented as a result of a company’s failure to meet a statutory demand served on them between 1 March and 30 June 2020. Further, a creditor cannot present a winding-up petition unless they have reasonable grounds to believe that coronavirus has not had a financial effect on the company or the ground for petitioning would apply in any event, regardless of coronavirus. The court will only make an order if satisfied that the grounds for petitioning would have arisen even if coronavirus had not had a financial effect on the company.
Director duties where a business may be insolvent
One thing the new COVID related insolvency measures will not do is release directors from their fiduciary duties to act in the best interests of the company or, in an insolvency situation, its creditors.
The general duties a director owes to their company are:
- To act within powers.
- To promote the success of the company.
- To exercise independent judgment.
- To exercise reasonable care, skill and diligence.
- To avoid conflicts of interest.
- Not to accept benefits from third parties.
- To declare an interest in a proposed transaction or arrangement.
Extension of the duties owed by directors
The courts have confirmed that these general duties owed by directors survive the company’s entry into administration and creditors voluntary liquidation. These duties are independent of, and run parallel to, the duties owed by an insolvency practitioner such as an administrator or liquidator. This raises the possibility that, where a director is in breach of their duties, the liquidators of a company can obtain a declaration from a court and receive damages on behalf of the company rather than needing to prove past breaches.
Liquidators will issue a questionnaire to directors
Typically, the first thing an insolvency practitioner does after being appointed is issue a questionnaire to directors asking them to explain their recent activities. This allows the practitioner to find out whether there are any historic breaches which give rise to claims they should pursue on the company’s behalf. However, directors shouldn’t think they are off the hook once the practitioner has been appointed and they have returned their questionnaires. If the directors decide, for instance, to sell off company assets at an undervalue while the company is in liquidation, they may have breached their directors’ duties and exposed themselves to a claim brought by the liquidator.
Directors should be aware that the appointment of a liquidator does not absolve them of their director’s duties, especially in the current climate where the suspension of wrongful trading means some businesses will continue trading longer than they normally would. Where continuing to trade is not in the best interests of the company (as they are spending more money keeping the business open than they are generating through trade, for example) then their director’s duties may require that they stop trading.
To avoid compounding business difficulties caused by the COVID, good communications, strategy and records are essential. Records can be easily overlooked as admin is tedious but they can save directors from difficulty. Good communication helps to avoid disputes and this ought to include communication between directors, communications between directors and shareholders and also with creditors. Strategy is also important – the terms of existing contracts should be considered, the possibility of renegotiating contracts and bank borrowing facilities and the viability of restructuring.
Practical actions to assess the solvency of your business and protect yourself as director
- Obtain legal and financial advice – this will demonstrate that you have taken prudent actions and sought external, professional advice to guide difficult assessment of whether your business is solvent and viable.
- Regular board meetings – document discussions and decisions and keep detailed minutes.
- Dialogue with creditors, lenders, suppliers and customers – review contracts, loan agreements and be proactive in determining whether your suppliers or customers might be likely to default on contracts or orders with your business or may be insolvent themselves.
- Be aware in more detail about the terms if your contracts.
Should you close down your company?
Getting good advice early can make all the difference in some scenarios. Whilst your business may not be technically insolvent today, it seems likely that the coronavirus crisis will impact business significantly for months to come.
The chances of suppliers or buyers becoming insolvent and not delivering or paying you may be high. Supply chain problems which you anticipate will happen could foreseeably make your business insolvent.
How to determine if your company is insolvent
There are generally 2 ways of determining whether a business is insolvent:
- the cashflow test
- the balance sheet test
Whilst it looks like the cashflow test will be relaxed by the Government during the pandemic, business owners would still keep in mind the balance sheet test and review on an ongoing basis considering whether present assets exceed present and reasonably expected future liabilities.
There may be some options to consider now such as pre-pack administration which might allow you to start up again. Such options are unlikely to be as practicable or possible without careful consideration now of your solvency position going forward and good planning. We can help.