Second suspension of wrongful trading

26 November 2020

The government has once again suspended wrongful trading, this time until 30 April 2021. The government had previously suspended wrongful trading for the period between 1 March 2020 and 30 September 2020. To the surprise of many commentators in the insolvency profession the government let the first suspension lapse at the end of September. Perhaps because of the "second wave" of Covid-19 the government has seen it fit to revive the suspension.

Wrongful trading is a provision under the Insolvency Act 1986 aimed at discouraging directors from unnecessarily prolonging trading to the detriment of creditors when formal insolvency is unavoidable. It applies to directors of a company that has entered into insolvent liquidation or administration. A director could be found liable for wrongful trading if prior to the liquidation or administration the director knew or ought to have known that there was no reasonable prospect of the company avoiding insolvent liquidation or administration. However, simply trading while insolvent is not sufficient for wrongful trading as the directors will not be liable for wrongful trading if they took every step with a view to minimising potential loss to the company’s creditors.

If a director was found liable for wrongful trading it was normally open to the court to order that the director make a contribution to the company’s assets to compensate the creditors for the deterioration in the financial position of the company after the point in time when the directors knew or ought to have known formal insolvency was unavoidable. The effect of The Corporate Insolvency and Governance Act 2020 (Coronavirus) (Suspension of Liability for Wrongful Trading and Extension of the Relevant Period) Regulations 2020 is that the court is now required to assume that a director is not responsible for any worsening of the company’s financial position between 26 November 2020 and 30 April 2021.

The reasoning behind the suspension is that with the financial pressures on business caused by Covid-19 the fear of personal liability for wrongful trading may cause directors to be too quick to place their company into administration or liquidation and so exacerbate the damage to the economy caused by the pandemic. It is difficult to tell if the first suspension of wrongful trading had this impact. The insolvency statistics for October 2020 (a month where there was no suspension of wrongful trading) shows that the number of formal company insolvencies was 42% lower than the equivalent figure for October 2019. It is likely that this is due to other government measures in response to Covid-19, notably the restrictions on presenting winding-up petitions and financial support through the Corona Job Retention Scheme and the various government backed loan programmes. Nonetheless, the suspension of wrongful trading may have the side benefit of allowing directors to obtain D&O insurance (or at least obtain it more cheaply) than would otherwise be possible in the current difficult economic climate.

The importance of the suspension of wrongful trading should not be overstated. Certainly, the risk of wrongful trading would normally be a factor that should be considered by directors when a company is insolvent or in the twilight zone of doubtful solvency. However, the court has discretion whether to make a declaration of wrongful trading. Successful claims against directors for wrongful trading are rare, particularly where the directors have been well advised.

Furthermore, directors should not interpret the suspension of wrongful trading as giving them carte blanche if their company is in financial distress. The offence of fraudulent trading has not been suspended, although unlike wrongful trading that involves showing that the directors had an intention to deceive and defraud the company’s creditors. Perhaps more relevantly for most directors, the suspension of wrongful trading does not relieve them of their directors’ duties. This includes their duty to act in the best interests of the company, which when insolvency is probable means taking into account the interest of the company’s creditors rather than its shareholders. If a company ends up in liquidation a director could be pursued for a breach of this duty by the liquidator.

Navigating through financial distress and insolvency remains a difficult task for directors. The suspension of wrongful trading does not change that.

directors should not interpret the suspension of wrongful trading as giving them carte blanche if their company is in financial distress