Wrongful Trading – An Update and Analysis of the Recent Government Suspension

These are certainly unusual times and no doubt most businesses have been or will be affected by the effects of the lockdown caused by Covid 19. In the past three weeks the government has announced a plethora of measures designed to protect the economy, companies and workers.

As a part of those measures the government has recently announced a number of protective measures in order to provide some protection to companies and their directors that have been affected by Covid 19. A significant measure was that of the temporary suspension of wrongful trading provisions for a period of three months starting on 01 March 2020. Although the detail has yet to be revealed it is certainly some cautiously welcome news to directors at these difficult times. 

As you may know Directors can be held liable for wrongful trading by a court pursuant to section 214 and 246ZB of the Insolvency act 1986. This is triggered where prior to the commencement of insolvency of a company (liquidation or administration) a director knew or should have known that there was no reasonable prospect that the company would avoid going to into insolvent liquidation or entering insolvent administration and did not take every step with a view to mitigating and or minimising the potential loss to the company’s creditors. 

Although the suspension of the wrongful trading rules is generally welcome, directors should still remain cautious. There remain alternative ways that the wrongful trading rules can be triggered, these are:

  1. Section 172 (3) of the Companies Act 2006; and
  2. Common law duties. 

It must be remembered that these go hand in hand and the common law duty is preserved by section 172(3). This route to triggering a claim has not been suspended, can be triggered more easily than those entrenched in the insolvency act and care should be taken that you are not in breach.

The test under the s172(3) trigger is ‘is likely to become insolvent’ rather than ‘no reasonable prospect that the company would avoid going to into insolvent liquidation or entering insolvent administration’ making it less onerous than the wrongful trading trigger.

Further, the duty under s172(3) will be engaged where a director knows or ought to have that the company is or is likely to become insolvent on either the cash flow or balance sheet basis. Whereas under the wrongful trading trigger a company goes into insolvent liquidation if it goes into liquidation at a time when its assets are insufficient for the payments of its debts, other liabilities and the costs of the winding up; i.e. it is balance sheet insolvent. Once again the s172(3) trigger is an easier route to trigger a wrongful trading claim.

There are a number of other related areas that have not been suspended by the government that are of equal importance and these will be discussed in our blog over the coming weeks. 

What can you do?

  1. Ensure that you hold regular meetings with directors to discuss the financial position and viability of the company, this of course should be undertaken in line with the governments social distancing recommendations;
  2. Keep a close eye on the company’s financial position by regularly reviewing the state of affairs, keeping accurate records and by speaking to your internal and external accountants; 
  3. Keep records and meeting minutes of decisions made and why those decisions have been made, it would be a good idea to ensure that any evidence relied upon in coming to that decision is also kept.
  4. Talk to your creditors, this may well be to simply touch base with them so that they understand the position of the company, can alternative agreement be reached.
  5. Most importantly, you should take appropriate legal, financial and insolvency advice.

*This blog is intended to provide the reader with an understanding of things to consider and should not be relied upon as specific legal advice.

If you’re looking to understand whether this applies to you or your business, please don’t hesitate to contact our Head of Litigation, Jagdeep Sandher.