Rising high up among the numerous risks that directors have to manage during the pandemic is insolvency
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The role of director involves extensive legal and regulatory responsibilities, which also carry the risk of personal liability. Under the wrongful trading provisions of the Insolvency Act 1986, directors owe duties to creditors in addition to any liability for breaches of duty to the company.
If a company goes into administration or liquidation, the court can order its directors to contribute personally to the company’s debts, should it decide that the directors continued to trade knowing the company had no reasonable prospect of avoiding insolvent liquidation and failed to take every step to minimise losses to the company’s creditors. Directors may also be disqualified.
With the effect of the pandemic creating doubts about the going concern of numerous hitherto viable companies, the government has taken extensive action to bolster economic confidence, including introducing an important piece of emergency legislation – the Corporate Insolvency and Governance Act 2020 (CIGA).
The legislation, which came into force in June 2020, represents a significant development of the UK’s insolvency framework. It aims to provide viable businesses with support to help them ride out the pandemic in two forms:
- temporary measures, giving breathing space to consider options
- permanent reforms, giving new tools to help them emerge ready to grow again.
The suspension of the wrongful trading provisions from 1 March to 30 September 2020 was perhaps CIGA’s most eye-catching measure. It mitigated the effect of the insolvency regime on directors’ responsibilities.
The aim was to allow directors to take difficult decisions on the viability of their companies during a time of great uncertainty about future trading, while free from the threat of personal liability – often the trigger for directors deciding to put their company into an insolvency process.
The suspension of wrongful trading law was not extended beyond 30 September. The government views restoring wrongful trading as a key protection for creditors. However, it also has the effect of increasing risk once again for directors.
Other temporary measures in CIGA designed to support businesses trading through the pandemic have been extended. For example, winding-up petitions and statutory demands will continue to be restricted until the end of 2020 to protect companies from aggressive creditor enforcement actions arising from coronavirus-related debts.
CIGA contains two significant long-term measures:
- Moratorium. Directors can apply for a moratorium (initially 20 business days, with extensions) whereby they remain in charge, but with a licensed insolvency practitioner appointed as ‘monitor’. The monitor reviews the company’s affairs to assess whether rescue is likely – this is vital because during the moratorium creditors are asked to stand still and refrain from enforcement action.
- Restructuring. Directors can propose a restructuring plan that compromises the claims of creditors. A key feature is the new ‘cross-class cram down’, which allows the court to sanction the approval of a compromise or arrangement without the unanimous agreement of creditors.
These reforms enable directors to remain in control. They give them the chance to rescue their business without resorting to insolvency.
Hitherto the UK’s insolvency regime has always been regarded as ‘creditor-friendly’ because the process emphasises the rights of creditors. These new measures move the UK towards a ‘debtor in possession’ restructuring process; one run by the directors and more akin to the Chapter 11 approach in the US.
Implications for directors
Many businesses remain in financial difficulty even as the economic recovery begins. The threat of wrongful trading may well increase as government support is withdrawn and Covid loans need to be repaid. Therefore, directors need to consider their responsibilities carefully, both individually and collectively as a board.
Accountants can help here. They understand the importance of cash and know that financial problems must not be ignored – short-term liquidity can be slow to improve and often deteriorates quickly. They should ensure that directors have both the information and awareness they need to manage the risk.
Steve Giles is a consultant and lecturer in governance, risk and compliance
CPD technical article
"The reforms enable directors to remain in control. They give them the chance to rescue their business without resorting to insolvency"