One of the questions for companies facing financial difficulties both in the U.S. and in the UK is the extent to which the boards of the companies owe duties to creditors to try to avoid creditors’ losses as the companies approach insolvency. I discussed the state of the law in Delaware regarding these issues in a recent post. In the following guest post, Francis Kean, a partner in the financial lines team at McGill and Partners, takes a look at the recent suspension in the UK of “wrongful trading’ legislation A version of Francis’s article previously was published on LinkedIn. I would like to thank Francis for allowing me to publish his article as a guest post on my site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly of you would like to submit a guest post. Here is Francis’s article.
The UK Government has just announced a three month retrospective suspension of the Wrongful Trading legislation from 1st March 2020. This unprecedented measure is designed to ease the pressure on company directors fearful of being held personally liable for continuing to trade in a period of heightened uncertainty created by the steps taken to combat Coronavirus. How far will it go in alleviating directors’ legitimate concerns? (The legislation which will be needed to effect this change to the law has yet to be drafted let alone passed into law). In trying to answer this question, it’s worth reminding ourselves about the range of powers available to insolvency practitioners to hold directors to account for their conduct in the period leading up to an insolvency of which the wrongful trading legislation forms part.
Section 214 of the Insolvency Act provides that a claim may be brought against company directors when a company has continued to trade past the point at which the directors knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation and they did not take “every step with a view to minimising the potential loss to the companies’ creditors.” This is a high standard but the courts have a wide discretion as to the amount of any award against the directors and are alive to the risks of exercising hindsight. That said, there is no doubt that the suspension of the legislation for this short period will give directors a measure of comfort that this particular form of personal liability will not be visited on them.
Nevertheless, in insolvencies threshold questions which liquidators (and sometimes courts) will wish to examine are (i) the extent to which the directors gave proper consideration to the relevant dangers and (ii) whether they had access to appropriate management information and professional advice in reaching their judgments. This type of investigation will still be necessary in relation to a range of other issues and the suspension of the wrongful trading laws is therefore unlikely to make much difference to the nature and extent of the fact gathering exercise which insolvency practitioners are still bound to carry out. The starting point here is that liquidators remain under a statutory duty to investigate the reasons for the insolvency. Wrongful trading is simply one of several activities which they will wish to satisfy themselves the directors have not engaged in. These include:
During the twilight zone when directors are required to apply their minds to the interests of creditors, they remain under a duty to exercise skill and care and to promote the success of the company. Some of the common claims against them for misfeasance which are often brought alongside wrongful trading claims might include:
- Concealing or removing company assets – This is when a director has tried to conceal particular assets from an impending liquidation.
- Preferential Payments – Here a director might transfer money to one creditor in particular, perhaps one to whom there is an existing personal guarantee.
- Transactions at Undervalue – Here a director may sell at an asset for less than it is worth, perhaps to a family member or friend, again to keep it out of the scope of the liquidator.
Fraudulent trading as the name suggests requires the company to have suffered loss caused by continuation of the business with the intent to defraud. The key difference between wrongful and fraudulent trading is that liability requires intent to defraud creditors. This test for dishonesty as clarified by the Supreme Court in Ivey and Genting Casinos is an objective one: was the director dishonest by the standards of an ordinary, reasonable individual (having the same knowledge as that individual)?
There are a range of reasons why directors can fall foul of the Company Directors’ Disqualification Act (CDDA) but being in breach of any of the Companies Act duties in respect of a company which subsequently becomes insolvent (i.e. misfeasance) is one of the most common. Periods of disqualification can be up to 15 years. While the suspension of the Wrongful Trading legislation temporarily removes this link between it and the CDDA it does not remove the threat of prosecution altogether. It remains an issue which liquidators will have to consider in each case.
The suspension of the wrongful trading legislation on its own does nothing to relieve directors either of their continuing fiduciary duties or the duty to exercise due skill, care and diligence imposed by the Companies Act . What this means in practice is that the costs associated with answering the questions posed by insolvency practitioners and participating in the post insolvency investigation process are not likely to be significantly reduced. The task of forensically examining what actions and decisions the directors took during the twilight zone will still need to be carried out. The need for D&O insurance to provide directors with the funds to pay for legal advice is likely to be just as acute. It that context it may be worth reviewing my earlier blog addressing some of the potential coverage issues to which this may give rise.