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David Reade QC and Alexander Halban on Emergency Changes to Insolvency Law during Coronavirus Pandemic

17.04.20

On Saturday 28 March 2020, the Government announced significant changes to UK insolvency law to help companies and directors weather the economic storm caused by the Coronavirus (COVID-19) pandemic.

As part of a range of measure to help companies, the Business Secretary, Alok Sharma, announced:

  • There would be a new temporary moratorium for businesses undergoing a restructuring process, during which time they cannot be put into administration by creditors and will continue to be able to access supplies and raw materials.
  • There would be a temporary suspension of wrongful trading laws for the duration of the pandemic, so that directors would not face the risk of personal liability in continuing to trade their companies. This would be made retrospective from 1 March. However, all of the other checks and balances that help to ensure directors fulfil their duties properly will remain in force

The Government said that the emergency legislation would be brought forward at the ‘earliest opportunity’ but it has not yet been published.

David Reade QC and Alexander Halban examine these proposed changes and some of the issues which need to be worked out in the emergency legislation.

First, this temporary moratorium is a novel development in insolvency law. There are, of course, moratoria when a company proposes a company voluntary arrangement (CVA) or goes into administration, preventing creditors from taking other enforcement or insolvency processes (Insolvency Act 1986 (‘IA 1986’), sched. A1, and sched. B1, paras. 42-43 respectively).

This new moratorium applies when the company is being restructured before administration – the Government said that it applied when companies ‘need to underdo financial rescue or restructuring’. It remains to be seen precisely what forms of rescue or restructuring it will cover or how this moratorium will be triggered – since these will all be informal restructuring procedures taken out of court and not even necessarily with the involvement of an insolvency practitioner. In common with the other emergency schemes introduced, the Government has not suggested that the company need to show that its financial state was caused of the coronavirus pandemic; this would help companies already in financial distress for unrelated reasons.

Once the moratorium in place it will likely operate similarly to the administration moratorium: creditors’ claims and winding up petitions cannot be brought and pending actions are likely to be stayed or dismissed.

If the moratorium operates like an administration moratorium then it would also prevent the progress of claims by employees. However, one would expect that as part of the financial restructuring or rescue the company would have taken advantage of the government scheme to meet employee costs, by placing them on furlough rather than making them redundant or dismissing them. (Further information on the furlough scheme can be found on the Littleton Chambers website.) Certainly this would assist in placing a company’s workforce of a company in ‘mothball’ to assist with the rescue/restructuring process.

It is also unclear if there will be a discretion for the court to allow an action to proceed despite the moratorium, as there for CVAs and administrations. In these cases, secured creditors, such as landlords and hirers of goods, are often permitted to exercise their proprietary rights to repossess land or goods. However, in this new moratorium such repossession actions would likely hamper the company’s ability to be restructured, and so they may well not be permitted.

Secondly, the temporary suspension of wrongful trading laws during the pandemic is an unprecedented measure, which has been strongly welcomed by the business community.

Under wrongful trading provisions (IA 1986, s. 214) directors can be personally liable if they continue to trade a company once they conclude (or should have concluded) that the company has no reasonable prospect of avoiding insolvent liquidation or administration. At that point they should take every step possible to minimise losses to creditors. If they do not, a liquidator can claim a contribution to the company’s assets personally from the directors. The suspension of these provisions remove the threat of personal liability on directors. It will allow them to pay company staff and suppliers, without being accused of increasing losses to all creditors.

However, as the Government emphasised, ‘all the other checks and balances that help to ensure directors fulfil their duties properly will remain in force’. The most significant of these are directors’ duties under the Companies Act 2006 (‘CA 2006’).

In particular, s. 172 CA 2006 applies where a company is close to insolvency and requires directors to consider the interests of creditors. This duty will continue to apply, so that directors cannot ignore creditors in their decisions or prefer some over others. These duties can also be enforced personally against directors by the company or a liquidator and so directors still face some threat of personal liability. However, the focus there will be on particular actions by directors, not on the whole period of trading. Directors who take reasonable, good faith decisions to try to balance the interests of a company, its staff and creditors are unlikely to face claims.

Rightly, the suspension of wrongful trading provisions will almost certainly not apply to its more serious counterpart, fraudulent trading (IA 1986, s. 213), for which directors are also personally liable. There would be no justification for relaxing rules against trading with the intent to defraud creditors – in particular given reports of the emergence of Coronavirus-themed frauds almost as quickly as the virus itself.

These measures are a wide-ranging response to an unprecedented crisis. If they work as planned, they will allow companies to be rescued and still trade and obtain supplies, without the threat even of insolvency proceedings; and for directors to take difficult decisions in good faith to pay employees and suppliers without the risk of personal liability.

It remains to be seen how some of the issues discussed above will be clarified in the emergency legislation shortly. We will update this post when the legislation is published.

Relevant Members
David Reade QC Alexander Halban
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