Restoring the wrongful trading waiver is a U-turn PSCs will welcome, but it far from cuts it

As the pandemic continues, so too do the government U-turns, notably with the reintroduction of the wrongful trading rules waiver -- a type of coronavirus insolvency aid which the government chose not to redeploy after letting it expire in September despite calls to the contrary, writes Gareth Wilcox, partner at Opus Restructuring & Insolvency.

Wrongful Trading: a potted covid history

In my last article designed to help you navigate the maze of covid-19 support available to limited company directors, we explored the re-introduction of the Coronavirus Job Retention Scheme which, in the face of a rise in infections, represented a swift and sudden U-turn. After all, the government said it would not extend on it, on a more than couple of occasions. The reintroduction of the furlough scheme came the very day before it was due to be replaced by the Job Support Scheme (now shelved).  

It will come as little surprise to some that there have been further developments which could be construed as further government U-turns. In particular, on November 26th 2020, the Corporate Insolvency and Governance Act 2020 (Coronavirus) (Suspension of Liability for Wrongful Trading and Extension of the Relevant Period) Regulations 2020, came into force. But all the legislative wordiness in the world still can’t cover up the fact that the substantive content of this new legislation is an extension to the suspension of the Wrongful Trading provisions.

Implications for contractor limited companies

The extension means that from November 26th and until April 30th 2021, contractors who are directors of limited companies (apart from certain limited exclusions), cannot be found liable for wrongful trading. Nor, therefore, can they be ordered to make a personal contribution to the assets of their company where they allowed their company to continue trading to the detriment of creditors where there was no reasonable prospect of their company avoiding liquidation. 

Given the ever-developing covid-19 situation, there may be a further extension of this wrongful trading rules waiver in due course. The converse is also true however, since it is a requirement of the legislation that the changes be kept under review and removed if no longer needed. So the protection may be removed prior to April 30th 2021. In the present circumstances, however, it would appear unlikely (notwithstanding the recent covid-19 vaccine developments) that this will be the case.

Retrospection? No, never when you want it

Rather oddly, the previous suspension of the wrongful trading rules expired on September 30th 2020, but there does not appear to be any retrospective effect to the new one. Accordingly, in theory at least, a director could be found liable for wrongful trading which took place between October 1st 2020 and November 25th 2020. While this is anomalous, it is probably of little consequence given the mechanism of how a Wrongful Trading claim is typically constructed. 

Specifically, in order for a Wrongful Trading application to succeed, the Insolvency Practitioner (IP) must identify the time at which the director knew, or ought to have concluded, that there was no prospect of the limited company avoiding insolvent liquidation. This is a conclusion for an IP to reach following a detailed analysis of the company’s financial records. 

Once the above is established, the next step is to ascertain the additional losses which were incurred from the relevant date, up to the actual date of insolvency, since that represents the quantum of the contribution which is to be sought from the director. 

Where us IPs come in (cont.)

As with any other litigation, the amount being claimed must be sufficient for it to make commercial sense for the action to be brought, as there will inevitably be costs to be borne by the insolvent estate. For this reason, and since an IP must have in mind that any application found to be ‘unreasonable’ could be thrown out by the court, ordinarily there must be a sustained period of continued trading before a claim will be made. 

In light of the above, it seems unlikely that a Wrongful Trading claim is likely to arise in isolation (particularly in the case of PSCs with limited asset and liability values), during the period that the suspension was not in place. 

It is worth reiterating that the suspension only relates to losses incurred in the relevant periods.  It does not prevent an IP from identifying and pursuing a pattern of Wrongful Trading which occurred prior to March 1st 2020. In theory, if an IP identified a claim for Wrongful Trading which started prior to March 1st 2020, they could include any losses arising from October 1st  2020 to November 25th 2020 as part of that claim -- and it would then be up to a court (in the absence of any prior settlement), to decide whether a contribution ought to be paid or not.

Defences against Wrongful Trading

To defend against such an action for Wrongful Trading, directors typically have to prove that they took every step to minimise losses to creditors. It may also be possible to challenge the IP’s conclusion that, on a certain date, the director knew or ought to have concluded that there was no prospect of the company avoiding insolvent liquidation. This is ordinarily done by reference to a director being able to prove that they reasonably believed that the circumstances would improve, or indeed that they did improve at some point. 

Ordinarily, if an improvement in the financial position can be evidenced since the date identified by the IP, the claim will either be defeated -- or reduced as arguably evidencing an improvement would move the date on which Wrongful Trading could be considered to have started, since it usually requires loss-making trade.

It is also worth limited company directors bearing in mind that while receipt of a Wrongful Trading claim is a serious matter, and can have significant consequences (as with all forms of civil litigation), agreeable settlements can be reached and are indeed encouraged by the Civil Procedure Rules to avoid the need for unnecessary court hearings.

Other pitfalls

But it remains the case that the suspension of the Wrongful Trading rules does not curtail all claims which can be brought where companies enter an insolvency process. There remains no impediment on IPs bringing actions for

• Unfair Preferences (where the director of an insolvent company treats one creditor – including themselves - better than others);
• Transactions at Undervalue (where company assets are transferred for no, or minimal consideration); or
• Misfeasance (a breach of a director’s duty to the company). 

Further, there remains no suspension of claims for Fraudulent Trading. As such, if a director can be proved to have intentionally continued loss-making trading to the detriment of creditors, claims can still be brought.

HMRC Preferential Status

Another point to keep in mind if you’re the director of a struggling company is that the reintroduction of the ‘preferential status’ of HMRC has now taken effect. Accordingly, the Revenue is a second-tier preferential  creditor for certain liabilities in relation to any insolvency processes commencing on or after December 1st 2020. 

The relevant rules apply to certain types of HMRC debt, owed to HMRC by the company subject to the process, regardless of when the liability arose. So directors of companies which are in financial difficulty should bear this in mind when making decisions regarding whether to introduce funds or obtain additional funding, since HMRC are likely to rank above such amounts for distribution purposes.

Clearly the reintroduction of HMRC’s preferential status could have a negative effect on any company’s ability to borrow money not secured on fixed assets. Additionally relevant, it is being widely suggested that a significant amount of funding will be withdrawn from the market, once CBIL and Bounce Back Loans are no longer available.

Will there be, or has there been a spike in insolvencies?

Clearly in the face of the significant economic disruption, many commentators consider that there is likely to be a significant upturn in insolvencies. There have been a number of high-profile retail failures in recent months and indeed, days. People often approach me and say: “You must be busy."

But actually, the truth is that there have been lower insolvency figures this year than last. It’s something chancellor Rishi Sunak pointed out in his 2020 Spending Review speech.

This downturn can be attributed to a number of factors. There has been an effective ban on winding-up petitions and landlord enforcement action, while HMRC allowed wide-ranging deferment of tax liabilities. Typically, it is creditor pressures which either prompt a director to consider, or forcibly cause, an insolvency process.

Companies have in many circumstances also had access to easily-obtainable BBLs, while the CJRS and local grant schemes have offered many businesses partial support for their most significant overheads (like rent and salaries). Each of these factors, as well as the practical difficulties of arranging an insolvency process and realising assets during lockdown, have caused the actual number of business failures to reduce.

The calm before the storm

Whether the present situation is the calm before the storm remains to be seen. Following the last significant recession, the effects proved not to be as significant as many had feared, although the present pandemic crisis is clearly of a very different nature. Plus, there is no real ability this time for the Bank of England to reduce interest rates to ease strain on businesses.  More positively, the present interest rates have contributed to the government’s ability to raise funding for the support packages.

My personal take is that the level of public borrowing being accrued to support the ongoing CJRS and other covid-19 support measures, is clearly unsustainable. As we all know, at some point it will need to be repaid. And companies have, in many cases, borrowed monies to ‘plug’ a gap caused by the pandemic or measures introduced by the government to tackle the pandemic. So it’s the same for firms as it is for Mr Sunak and his coffers -- this will necessarily need to be repaid at some point by returning to (or increasing) profitability in the medium to long term.  

As to the outlook, given that there are changes in consumer habits caused by the pandemic, rising unemployment, and uncertainty regarding the length of the ongoing restrictions on personal freedoms, some businesses are undoubtedly going to struggle to achieve a recovery.  Add to this a likelihood that taxes will need to be increased at some point to repay the recent borrowing, and the picture will undoubtedly appear bleak for some sectors.

Last resorts

That said, the government has repeatedly affirmed its commitment to continuing to provide support where required, so we may still not yet have seen the last announcement of business support packages. Limited companies (more so than any other entity perhaps), are hoping that the long wait is going to be worth it. One thing is for sure, most PSC directors won’t think that the reintroduction of the wrongful trading waiver comes anywhere near close to cutting it for them.

Finally, a less bleak point. Where there is future profitability in a company burdened by historic debt, there are various recovery procedures available for IPs to assist with restructuring debts and/or assets, to ensure that value is preserved wherever possible, and losses mitigated. It is incumbent on an IP to investigate all circumstances of a company and treat liquidation only ever as a ‘last resort.’ It is my hope therefore, that ‘if’  -- and  it is an ‘if’ -- there is an increase in insolvencies, that in many cases it will be possible for value, jobs, and businesses to be preserved.