Temporary suspension of liability for wrongful trading

May 26, 2020

By Anja Lansbergen-Mills

On Wednesday of last week the Corporate Insolvency and Governance Bill received its first reading in the House of Commons. The Bill gives effect to a package of temporary measures, announced by the government in late March, that are intended to help businesses avoid insolvency during the economic downturn forced by the COVID-19 pandemic. The Bill also introduces a package of permanent reforms to insolvency and corporate governance previously set out in a 2018 government consultation response, along with some temporary modifications to them precipitated by the COVID-19 pandemic. The measures contained in the Bill are summarised in a news bulletin authored by Exchange Chambers’ Carly Sandbach and her pupil Katherine Traynor.

In a dedicated series of daily e-bulletins over the course of the next week, members of Exchange Chambers’ Restructuring and Insolvency team will consider the scope and effect of various reforms introduced by the Bill.

This first bulletin examines the temporary suspension of liability for wrongful trading. It considers the  justification for the measures, their scope and effect, and certain issues to which legal professionals and insolvency practitioners must be alive when advising and acting upon the suspension.

Background: wrongful trading

Section 214 of the Insolvency Act 1986 (“IA 1986”) renders the director of a company personally liable to contribute to the company’s assets in liquidation if, prior to the liquidation, the director knew or ought to have concluded that there was no reasonable prospect that the company would avoid entering into insolvent liquidation or administration. No liability attaches to a director who, after such time, takes every step to minimise the potential loss to creditors as she or she ought to have taken. A director is liable to equivalent extent to contribute to the company’s assets in administration pursuant to s.246ZB IA 1986 (in force since October 2015). The provisions apply both to appointed and to shadow directors.

A director may be personally liable under the aforementioned sections even if a company does not continue to carry on business, or accrue further indebtedness: any asset depletion of the company may constitute a failure by the director to minimise the potential loss to creditors.

The sections themselves are silent upon the issue of causation. It is however clear that an order for contribution will be made against a director only if and to the extent that the director’s acts or omissions caused the company and its creditors to suffer loss (see eg Grant v Ralls [2016] EWHC 243 (Ch)).

Temporary measures

Clause 10 of the Corporate Insolvency and Governance Bill  requires the court to assume for the purpose of sections 214 and 246ZB IA 1986 that a director is not responsible for any worsening of the financial position of the company or its creditors that occurs between 1 March 2020 and 30 June 2020. The section does not apply to certain specified companies, including insurance companies, banks, electronic money institutions, investment banks and firms, and payment institutions. Clause 39 of the Bill enables the period specified in clause 10 to be curtailed or extended by successive periods of up to six months by statutory instrument.

Scope and effect of measures

The description of the temporary measures as a suspension of directors’ liability is somewhat misleading: the Bill does not remove the statutory remedy available against the director of an insolvent company who fails to take steps to minimise loss to creditors. Rather, it precludes an applicant office holder from establishing during the four month period identified in the Bill the causative link necessary to obtain an order for contribution against the director.  The distinction is perhaps one more of symbolic rather than practical import, it reflecting the continued obligation upon directors to act in the interests of creditors when they know or should know that the company is or is likely to become insolvent (discussed further below), and it signposting the exceptional economic forces that precipitate the temporary measures.

The operative assumption is expressed in the Bill in mandatory language, and therefore does not appear to be rebuttable. That is to say, an office holder cannot defeat the benefit conferred upon a director by the Bill by bringing evidence to prove that losses suffered by the company are attributable to the conduct of the director and would have happened notwithstanding the COVID-19 pandemic (for example where the business conducted by a company was inherently loss making, or where a company had traded at a loss for a significant period before March 2020). Such position is perhaps reflective of the real difficulty in disentangling causative factors of loss during a period of such exceptional economic shock.

By temporarily shielding company directors from personal liability the Bill aims to encourage and facilitate the survival of companies that would be viable but for the impact of the pandemic. Such policy objective is predicated upon an assumption that the wider package of financial support introduced by the government will mitigate the economic impact of the pandemic, and secure the conditions necessary for companies to be able to trade their way out of difficulty in relatively short order. The avoidance of mass corporate insolvency is clearly adjudged by the government to outweigh the risk of prejudice to creditors in the event that that assumption should prove optimistic, and the measures seem to have been widely welcomed by business and industry. The Confederation of British Industry has reportedly hailed the protection as giving

‘much needed headroom for company directors to enable otherwise viable businesses to use the government’s support package and weather this crisis’

whilst the head of economics at the British Chambers of Commerce considers it to be

‘right that the rules on wrongful trading are temporarily suspended to ensure that directors are not penalised for doing all they can to save companies and jobs during this turbulent period. Companies that were viable before the outbreak must be supported to ensure they can help power the recovery when the immediate crisis is over’.

Notwithstanding the positive reception of the measures in many quarters, there remains an obvious concern that such blanket protection of directors dismantles important protection to creditors, and provides a carte blanche for errant directors to act with impunity. Such risk is analysed in the impact assessment accompanying the Bill in the following terms:

In isolation [the introduction of the temporary measures] increases the risk of reckless behaviour that can cause economic harm to others (in particular creditors). However, as evidenced, wrongful trading claims are currently already rarely taken forward. While one cannot rule out that wrongful trading is not widespread precisely because of the threat of legal action, the risks caused by the suspension are largely mitigated because other protections still exist in company law, insolvency and enforcement regimes. These include the more serious liability for “fraudulent trading” (Section 213 of The Insolvency Act 1986) and the fact that general director duties set out in company law and the director disqualification regime continue to apply as normal. Thus any increase in risk to creditors is judged to be very small compared to the support provided to many businesses and directors who cannot realistically make a sound judgment about the state of solvency of their business during these times, and who might thus otherwise close businesses and stop creating economic activity due to fear for personal liability.

The impact assessment thus highlights the continued availability of a s.213 remedy against fraudulent trading as an alternate mechanism for holding a director to account. Even absent any fraudulent intention there are remain circumstances in which continued trading to the detriment of creditors may result in a director being ordered to make a contribution to the assets of the company. Directors are under a duty to consider the interests of creditors when they know or should know that the company is or is likely to become insolvent (and in this context, ‘likely’ means probable: BTI 2014 LLC v Sequana SA and others [2019] EWCA Civ 112). Failure to do so constitutes a breach of statutory duty (in particular of duty under s.172 of the Companies Act 2006 to promote the success of the company, and under s.174 CA 2006 to exercise reasonable care, skill and diligence) and/or misfeasance for which the director may be personally liable on application by an office holder under s.212 IA 1986. A breach of duty actionable under s.212 IA 1986 may also arise if in the course of or in furtherance of continued trading a director causes a company to give a preference within the meaning of s.239 IA 1986.

The possibility that continuation of trading may thus render a director liable for breach of duty notwithstanding the measures introduced by the Bill begs the question of whether those measures lack any real bite: of what comfort to a director is the suspension of s.214 liability, when a contribution can still be sought against him or her on the same factual basis pursuant to s.212 IA 1986? The answer may lie in the availability of a statutory defence to a s.212 IA 1986 application that cannot be deployed in a s.214 action (Halls v David [1989] 1 WLR 745). Pursuant to section 1157 of the Companies Act 2006, the court may relieve a director for liability for breach of duty if it appears to the court that the director acted honestly and reasonably, and that having regard to all the circumstances of the case he ought fairly to be excused. The scope of that defence is potentially wide enough for a director to deploy as a relevant circumstance the period of uncertainty created by the COVID-19 pandemic, and the clear regulatory encouragement given to him or her to trade an otherwise viable company through it.

Summary

The temporary measures introduced by the Bill have been hailed as providing welcome breathing room during the COVID-19 pandemic to directors who would otherwise be deterred from continuing to trade. Such intervention is by necessity circumscribed, relying upon the continued availability of other avenues of redress against a director to protect creditor interests and to guard against abuse.  For those advising a director of his or her obligations during the period covered by the measures, the headline point must be one of caution: a director must remain alive to the possibility of action being taken against him or her by other channels, and be mindful that the statutory defence of honest and reasonable action is as yet untested in the particular context of the COVID-19 pandemic and the government response to it. Meanwhile, office holders will be eager for clarification from the courts upon the practicalities of assessing quantum in circumstances where a director possessed relevant knowledge under s.214 IA 1986 on a date before 1 March 2020, and where losses to the company commenced before and continue after the period identified in the Bill.