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Suspension of Wrongful Trading and the Corporate Insolvency and Governance Bill

The Corporate Insolvency and Governance Bill (“Bill”) was published on 20 May 2020. The Bill intends to provide businesses with the flexibility they need to continue to trade during the Covid-19 pandemic and ease the Read more...

Katherine Zangana

Senior Associate

Company & Commercial, Employment

The Corporate Insolvency and Governance Bill (“Bill”) was published on 20 May 2020. The Bill intends to provide businesses with the flexibility they need to continue to trade during the Covid-19 pandemic and ease the burden on businesses that may otherwise have found themselves insolvent.

One of the measures included in the Bill is the temporary and retrospective suspension of wrongful trading provisions announced on 28 March.

The wrongful trading regime

The wrongful trading provisions are contained within sections 214 (liquidation) and 246ZB (administration) of the Insolvency Act 1986. Under these provisions, directors and former directors of companies which have gone into insolvent liquidation or entered insolvent administration may be ordered to make a contribution to the company’s assets to recoup the losses caused by their decision to continue to trade after they knew, or ought to have concluded, that there was no reasonable prospect that the company would avoid insolvency proceedings.

The objective of the suspension

When the suspension of wrongful trading provisions was announced, the Government indicated that it was to allow directors to keep their businesses going without the threat of personal liability. The announcement generated much discussion around whether the suspension could achieve that objective, whether it was appropriate and whether it was needed at all.

Taking each of those in turn:

The wrongful trading provisions are not the only means by which directors may incur personal liability for their actions. Suspending those provisions alone will not therefore remove the risk of personal liability for directors.

The wrongful trading provisions are there to protect creditors by discouraging directors from incurring liabilities without reasonable prospect of paying them back and consequently any suspension risks abuse.

If directors obtain and follow the advice of an insolvency practitioner or insolvency solicitor the risk of a wrongful trading action being taken by a subsequently appointed administrator or liquidator should be removed.

The Legislation

Section 10 of the Bill provides that in determining the contribution (if any) to a company’s assets that it is proper for a person to make, the court must assume that the person is not responsible for any worsening of the financial position of the company or its creditors that occurs during the relevant period.

Various categories of company (including insurance companies, banks, investment firms and project companies) as well as those carrying on a regulated activity in terms of Part 4A of the Financial Services and Markets Act 2000, together with building societies, friendly societies and credit unions are excluded from the scope of the provision.

The “relevant period” is defined as the period from 1 March 2020 to the later of 30 June 2020 or one month after the coming into force of the Bill. This period may be extended for up to 6 months at a time or brought to an end by secondary legislation.

Other changes under the Corporate Insolvency and Governance Bill

Statutory Demands and Winding Up Petitions

A petition cannot be presented by a creditor during the period beginning 27 April 2020 to 30 June 2020 or one month after the coming into force of the Bill, whichever is the later, unless the creditor has reasonable grounds for believing that (a) coronavirus has not had a financial effect on the debtor, or (b) the debtor would have been unable to pay its debts even if coronavirus had not had a financial effect on the debtor.

So what is meant by “financial effect”? Coronavirus has a “financial effect” on a debtor if the debtor’s financial position worsens in consequence of, or for reasons relating to, coronavirus and should therefore be a threshold easily met.

In addition, no petition for the winding up of a company can be presented on or after 27 April 2020 on the ground that the company has failed to satisfy a statutory demand if the relevant statutory demand was served during the period beginning with 1 March 2020 and ending with 30 June 2020.

Restructuring

The Bill introduces a new restructuring procedure modelled on the existing scheme of arrangement procedure with additional flexibility. Unlike a company voluntary arrangement (CVA), it will have the ability to bind both secured creditors and unsecured creditors.

The removal of financial entry conditions means that both solvent and insolvent companies can propose the plan. Creditors will vote on the plan in separate classes, which will resemble those that feature in schemes of arrangement. The plan will require the approval of a minimum of 75% in value in each class of those voting.

The court will grant final approval to the plan if it believes it is just and equitable. The plan can be approved by the court even where one or more classes do not vote in favour.

Company Moratorium

Insolvent companies or companies that are likely to become insolvent can obtain a 20 business day moratorium period, allowing businesses with feasible prospects time to restructure or seek other means of avoiding creditor action. To benefit from this measure, directors will need to make a statement that the company is, or is likely to become, unable to pay its debts and the ‘monitor’ must make a statement that it is likely that a moratorium for the company would result in the rescue of the company.

Supplier Termination Clauses

Suppliers will often stop supplying or threaten to stop supplying a company that has entered into an insolvency process or restructuring procedure. The governing contract will usually provide the supplier with the contractual right to do this.

The Bill will prohibit suppliers from stopping supplies by reason of the company’s insolvency if the supplies continue to be paid for. It will also prevent suppliers from amending the contractual terms in order to force increased payment, though suppliers can be relieved of the obligation to continue supplies if it causes hardship to its business.