While wrongful trading sleeps remember fortune favours the prepared
The Corporate Insolvency and Governance Act 2020 (Suspension of Liability for Wrongful Trading and Extension of the Relevant Period) Regulations 2020 (SI 2020/1349) (the “Regulations”) came into force on 26 November 2020. The Regulations require courts to disregard any worsening of the financial position of a company (or its creditors) that occurs from and including 26th November 2020 to 30th April 2021 when determining the amount its director would be required to contribute to its assets for wrongful trading. It is worth noting that the Regulations do not alleviate the fact of wrongful trading.
As we fast approach 30 April 2021, it is not clear whether the Government will introduce a further extension of the current protection. Company directors would be well advised to refresh their minds of wrongful trading liability and take this opportunity to attend to a few points of internal “house-keeping” so that they are in a position to properly deal with matters going forwards.
Wrongful Trading Refresh
Wrongful trading is explored when a company enters into an insolvent administration or insolvent liquidation. However, in determining whether there has been any wrongful trading activity, a liquidator or administrator (as the case may be) will look back in time to the conduct of the director(s) in the approach to such insolvency process. Therefore, the directors should be mindful of the potential for personal exposure for wrongful trading in every decision and each action (or any inaction) they resolve to take.
Determining whether wrongful trading has occurred is an assessment of whether a director knew or ought to have realised that there was no reasonable prospect of the company avoiding insolvent administration or insolvent liquidation (sections 214 and 246ZB of the Insolvency Act 1986 (“IA 1986”) and then whether prior to such insolvency, the director took every step with a view to minimising the potential loss to the company’s creditors such director ought to have taken (sections 214(3) and 246ZB(3) of the IA 1986).
If successfully pursued for wrongful trading, a director could be required to contribute towards the company’s assets. Such director may also be the subject of a disqualification order under the Company Directors Disqualification Act 1986.
Not a Statutory Director?
Proceed with caution because, whilst wrongful trading laws apply to directors, “directors” is widely interpreted and hence captures, not only a director whose appointment is registered with Companies House, but also:
- a person, who may not be actually or validly appointed, but who assumes to act as a director (a “de facto director”); and
- a person in accordance with whose directions or instructions the directors of a company are accustomed to act (a “shadow director”).
What can Directors do now?
The following list is not exhaustive. However, some practical steps worth taking now are:
Keep up to date
Regardless of the type of director you are and whether certain aspects of the company’s business operation have been delegated by the board of directors to a committee or sub-group of such board or committee, failure to keep informed of the company’s affairs is not a defence.
It is worth noting that directors meeting the furlough qualifications and placed on furlough leave are not exempt from the requirement to comply with their director’s duties. However, the balance between meeting the requirements of The Coronavirus Job Retention Scheme (“Furlough Scheme”) and enabling directors sufficient access to the company’s operation in order to allow them to discharge their director’s duties has been a delicate exercise for both companies and directors alike.
Businesses will be familiar with the overarching requirement of the Furlough Scheme that no furloughed director be permitted “to generate commercial revenue or provide services to or on behalf of a company”. However, this has not sat comfortably with directors’ fiduciary duties and their statutory obligation to act in a way they consider “in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole” (section 172 Companies Act 2006). Whilst HMRC guidance and Direction dated 15 April 2020 contain limited exceptions to the overarching term of the Furlough Scheme, such exceptions lean towards preserving the more administrative functions of a director. Advice should be obtained if in doubt of the current framework.
In the meantime, as we approach the 30 April 2021 deadline, companies should take this opportunity to ensure that they are and will continue to be in a position to produce the appropriate and regular reports, updates and trading information to directors. Directors should be prepared to come up to speed with such information in quick order.
Always have the latest financial information
Directors must ensure that they keep abreast with the financial information of the company at all times. Companies should work to ensure that trading performance statistics, management accounts and fiscal projections are prepared and distributed to the directors regularly.
Directors should closely monitor the company’s financial position and pay particular attention to:
- whether the company is experiencing increasing pressure from creditors;
- whether the company is unable to pay its debts – i.e. whether there is evidence of insolvency on the balance sheet basis;
- the frequency within which the company pays its creditors. Is it usually when proceedings or statutory demands have been issued and judgments entered into against the company?
- whether the company can pay and continue to pay its debts as they fall due; and
- the late filing of accounts, which do not fall within the scope of the extended filing deadlines introduced by The Companies etc. (Filing Requirements) (temporary Modifications) Regulations 2020 (SI 2020/645).
A liquidator or administrator who is considering whether to pursue a director for wrongful trading will investigate what such a director knows and what he/she ought to have known in the circumstances.
Financial covenants and reporting obligations
If the company has an arranged overdraft facility with its bank and/or any other lending or financing arrangements in place, directors should reacquaint themselves of the financial and reporting assurances the company provided in support of such financing. Has the company complied with such assurances?
Don’t underestimate the value of board meetings and keeping proper records
The importance of holding regular board meetings and keeping comprehensive minutes of such meetings should not be underestimated (see It may just take a minute to protect a director – RadcliffesLeBrasseur LLP for further information).
If it is not feasible or possible in the circumstances to hold physical board meetings, the company’s articles of association should be checked to ascertain whether they allow or prohibit the holding of electronic board meetings or written board resolutions. Check whether any amendments should be made to the articles of association and obtain legal advice regarding the implementation of any amendments required.
If the company looks as though it is in or heading towards financial difficulties, it is imperative that full board meetings are called regularly and that matters considered by and discussed between the directors including, but not limited to details of commercial decisions made and the reasoning behind such decisions are fully recorded in writing (usually by way of board minutes).
Directors are reminded that their commercial decisions at such meetings should be reached by them independently after taking into consideration the financial and any legal information and advice available to them. If the company is part of a group of companies and has one or more directors in common with another company within its group, directors should consider their position individually and be particularly alert to the possibility of conflicts of interest and how to address them. The matter of directors’ interests (particularly, in the context of those which conflict or may conflict with the interests of the company) is outside the scope of this article, but legal advice should be obtained in relation to the law in this respect.
In the case of companies with a single director, the sole director should also retain a full written record of all commercial decisions (including the reasoning behind such decisions) and noting the information and any advice considered in reaching such decisions.
In considering whether to pursue a director for wrongful trading, a liquidator or an administrator will investigate, not only what a director knew and should have known at the time of and in the lead up to the company’s financial difficulties, but he or she is also likely to explore the director’s thought process throughout. This is where the company’s ancillary documents play a very important role.
Directors should play their part to enable their company to act in accordance with its constitutional documents and hold regular board meetings. Detailed and comprehensive board minutes of such meetings or written board resolutions can be of crucial evidentiary value to the company’s directors in establishing their thought process in the company’s road to financial difficulties. Additionally, such documents can go a long way to show the regard paid by the directors to the fulfilment of their respective director’s duties and ultimately, in formulating a defence to any potential wrongful trading action.
It is important not to forget that board minutes and board resolutions are a contemporaneous record of the matters actually considered discussed and resolved. Therefore, board meetings (in the case of companies with more than one director) or written resolutions of the sole director (in the case of companies with a sole director) should be thorough and the corresponding written records must reflect reality.
Do not be purely reactionary
Directors should not wait for an event to occur (for instance, an application for administration against the company or a failure to reach a particular sales or cash flow target) before making the above preparations.
Be mindful, but try not to be afraid. It is understandable that the fear of wrongful trading may cause directors to consider initiating insolvency procedures early. However, premature action in this respect can potentially be as hazardous to creditors’ interests in some cases than simply waiting until the landscape becomes clearer.
Take this opportunity to get organised now and consider obtaining advice to help you navigate the road ahead.
Contact Sumaira Choudary, Partner and Solicitor, for more information.
This briefing is for guidance purposes only. RadcliffesLeBrasseur LLP accepts no responsibility or liability whatsoever for any action taken or not taken in relation to this note and recommends that appropriate legal advice be taken having regard to a client's own particular circumstances.