Directors’ Duties: Contingency Plans – Update

The long-anticipated legislation to implement an update to the UK's wrongful trading regime received its second and third readings in Parliament yesterday, and it is expected that the assistance for company directors first trailed in March by the Business Secretary, Alok Sharma will soon make it onto the statute book. Our client alert published in March set out why we considered that a period of dispensation for directors from potential liability under the wrongful trading regime contained in section 214 of the Insolvency Act 1986, which enable a Court, on the application of a liquidator or an administrator, to impose financial penalties on a director who continues to trade a company beyond the point at which he knew or ought to have reasonably concluded there was no reasonable prospect of avoiding  administration or insolvent liquidation, having failed from that point onwards to take every step to minimise potential losses to creditors, would be gratefully received by directors of companies facing cash flow difficulties and uncertain future trading prospects as a result of the covid-19 pandemic.

When first announced by the Government it was envisaged that any suspension of wrongful trading rules would be a temporary three month suspension. However, the delay in bringing the Corporate Insolvency and Governance Bill (the Bill) before Parliament means that the suspension will initially last for just over four months, with retrospective effect from 1 March until one month after the Bill becomes law (the Suspension Window).

The Bill introduces measures which mean that in assessing what contribution a director must make to a company's assets in the event of wrongful trading liability being imposed, a Court "is to assume" that the director shall not be held responsible for any worsening of the financial position of a company or its creditors due to continued trading during the Suspension Window. This provides responsible directors with some certainty that they will not be held financially responsible for continuing to trade through this uncertain period. However, whether this lives up to the Government's initial claim that the new legislation would enable directors 'to keep their business going without the threat of personal liability' is not clear. The provisions of the Bill appear to fall short of fulfilling this claim for following reasons:

• Although directors should not face financial penalties for wrongful trading during the Suspension Window, the Bill does not prevent directors from being found to have traded wrongfully. Any future liquidator of the company could still pursue the directors on the basis of this wrongful trading, and seek to extract financial recompense on the basis of losses accrued just outside the Suspension Window. This concern may be made more acute, given the hard-stop date of the Suspension Window, following which the wrongful trading regime will immediately re-engage whilst directors may be dealing with very uncertain circumstances in which forecasting is difficult and with a company whose finances have deteriorated significantly beyond the point at which, absent the suspension, they would have ceased trading.
• The wording of the Bill provides that the Court should "assume" that the directors shall not be held responsible for the worsening of a company's financial position during the Suspension Window. Directors may be wary that this assumption may be rebutted on the submission of evidence to the contrary.
• Further, the Bill does not update directors' general duty set out in the Companies Act 2006 to act in the best interests of the Company, or their common-law duty to act in the best interests of creditors. Continuing to trade, and allowing the company to take on obligations, in circumstances where a director considers that insolvency is inevitable may well amount to a breach of these duties and could expose the director to breach of duty claims from creditors or shareholders, and the risk of misfeasance claims being brought against them by any future liquidator of the company. The provisions of the Bill, therefore, do not absolve irresponsible or reckless behaviour by directors in the management of a financially distressed company from potential future liability for their actions.
• Directors may also be conscious that wrongful trading (even where there is no financial liability) could be evidence of 'unfit conduct' in director disqualification proceedings under the provisions of the Company Directors Disqualification Act 1986.

In summary, whilst the suspension of wrongful trading liability during the Suspension Window is likely to be well received by directors, it is unlikely to have a significant practical impact on the day-to-day management of companies in financial distress where responsible decision making by directors remains critical to safeguarding the interests of stakeholders. Wrongful trading is not the only check on director's actions, and other avenues of recourse available to a company's members and creditors remain in full force during the Suspension Window. As ever, we recommend that any directors concerned about continuing to trade seek independent legal advice.

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The views expressed herein are solely the views of the authors and do not represent the views of Brown Rudnick LLP, those parties represented by the authors, or those parties represented by Brown Rudnick LLP. Specific legal advice depends on the facts of each situation and may vary from situation to situation. Information contained in this article is not intended to constitute legal advice by the authors or the lawyers at Brown Rudnick LLP, and it does not establish a lawyer-client relationship.