COVID-19 Insolvency Law Changes

The UK Government has announced that:

• It will temporarily suspend the offence of wrongful trading by directors of English companies for 3 months
• Amend insolvency laws to bring in more debtor friendly style processes where English companies can continue to trade while negotiating a restructuring solution with their creditors.

As ever, we await full details and legislation.

Wrongful Trading Suspension

The UK Government wants businesses to continue running and keep people in employment while the COVID-19 uncertainty resolves itself. To help that it will suspend the wrongful trading offence for 3 months from 1 March 2020. 

Current trading uncertainty has made the wrongful trading offence a particular concern for directors. Under existing laws, if a director knows (or should have concluded) that there is no reasonable prospect of the company avoiding an insolvent liquidation or insolvent administration, they must take all the steps which a reasonably diligent person would take to minimise any potential loss to the company’s creditors.  

If the company goes into insolvent administration/liquidation and the English court concludes that the director did not comply with this duty, they can be liable to make a personal contribution to the company’s assets. 

It has always been a difficult balancing act for directors - continuing to trade while minimising loss for creditors. The current inability to trade or forecast when trading will start again means that thousands of directors of small and large companies feel exposed to this offence. This could force directors to put their company into an insolvency/administrative process now which would be seriously detrimental to the business’ value. 

This suspension gives businesses and directors some time to work things out. But it is just delaying the issue for a later date. If not extended, on 2 June there will be a sudden cliff edge for businesses that have not been able to shore up their financial position or restart trading when this and the moratorium on landlord evictions etc. immediately end. Unlike a more usual recession, all troubled companies would be tipping into insolvency/admin situations at the same time. So we hope the Government will continue these legislative suspensions until there is clear trading certainty following the end of the COVID-19 crisis.

Legislation is awaited, so the suspension is not yet in effect and the wrongful trading offence is still the law. But the Government hopes that this announcement is enough to allow directors to continue operating in the meantime. 

Protections for creditors and suppliers

This is an unprecedented suspension of a fundamental principle of English insolvency laws. Concern has been expressed that some businesses will exploit the current situation to avoid payments to creditors without genuine cash flow reasons.

To meet those concerns, the suspension may include “safeguards” for creditors and suppliers to ensure they are paid. While companies may be able to stop incurring new debts to suppliers while they are not trading, there are some creditors (like landlords and utilities) which will continue to accrue while the business is not trading. 

We hope any safeguarding will not cut across the practical application of the suspension.

The offence of fraudulent trading still continues.  So if a director knowingly allowed a company to carry on with the intent to defraud creditors of the company or anyone else or for any fraudulent purpose, they can still be liable to make contributions to the company and/or force disqualification.

The Government has also chosen not to amend or suspend the law on directors’ duties. Directors still need to act in the interests of the company. If the company is insolvent, that means acting in the interest of creditors, rather than keeping the business going for employees, etc.

New insolvency solutions

The Government was already planning to bring in substantial changes to the Insolvency Law regime following the 2018 consultation. These changes will create a much more debtor friendly environment than the current process which puts most of the negotiating power with creditors.

Those changes are now being accelerated and will come into force shortly.  The changes include:

• A new pre-insolvency moratorium to allow businesses to continue trading and keep purchasing needed supplies, while a rescue is negotiated.This will be similar to a US Chapter 11 process and will give businesses a period of time when creditors (including secured lenders) cannot take action. This allows the business to source funding or restructure without the constant threat of enforcement. But this is likely to still be an “insolvency event” with the stigma that brings for a business
• A new restructuring plan – like the existing scheme of arrangement but with a “cross class cram down” mechanism to bind out of the money minority creditors who disagree into the plan. This will be similar to existing court procedures but should be simpler for businesses to access and more efficient.
• Prohibition on suppliers terminating contracts just because a business has entered an insolvency procedure, a moratorium or a new restructuring plan

Under the original proposals, these new protections were only available for solvent companies. Many companies may already be insolvent.  So this requirement may have to be temporarily suspended to allow companies to benefit from the new tools

This is new and complicated legislation which the Government may not be able to bring in quickly enough to help businesses. They may be hoping that the 3 month wrongful trading suspension is enough of a sticking plaster for now – giving the Government until 1 June to bring in this new legislation.