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Chris Tate

Directors will naturally be concerned as to their conduct during the current pandemic. Trying to do the right thing by the company’s employees, customers, suppliers and other stakeholders whilst ensuring ongoing compliance with their fiduciary duties will be challenging, however, changes are being made to the insolvency regime to provide directors with breathing space to explore their options, whilst protecting them from risk of personal liability.

Administration as a stability and restructuring mechanism
The Insolvency Lawyers Association (“ILA”) have been working to mobilise a fast-track ‘light touch’ form of administration to stabilise, protect, and, if necessary, restructure companies.

Administration is a rescue tool, which allows the company to continue to trade whilst providing a legal moratorium protecting it from creditor enforcement. Although relevant statutory provisions provide that an officer of a company in administration cannot exercise a management power without the consent of the administrator, the administrator can decide to delegate a whole host of management powers to the company’s directors. It seems likely that there are many cases arising out of the COVID-19 crisis where this would be appropriate.
This form of ‘rescue of the company as a going concern’ administration is not going to be appropriate in all cases, however, in the right circumstances can provide a company with additional breathing space to enable all of its options to be considered before implementing the most appropriate strategy.

New moratorium for companies
The government have announced emergency legislation to include a short moratorium preventing creditors from enforcing debts during that period. It is expected the moratorium will initially last for 20 days but could be extended for a further 20 days in certain circumstances. Further extension would require the approval of 50% of secured and unsecured creditors. These changes are not yet legislated but are expected to be fast-tracked and available shortly.

Whilst this is a welcome change the qualification criteria is restrictive. Only companies which are financially distressed but viable are presently set to benefit from the moratorium. A company must be able to demonstrate it has sufficient funds to pay creditors accrued during the moratorium period. It is expected the process must be monitored by an Insolvency Practitioner who will need to be satisfied that the qualifying conditions are met. Creditors will have the right to challenge on the basis qualifying conditions are not met or they would be unfairly prejudiced by the moratorium.

Exit from the moratorium is expected to be via an informal restructuring, Company Voluntary Arrangement, or liquidation.

Suspension of s214 Insolvency Act 1986 – Wrongful Trading

The Companies Act 2006 (CA 2006) codifies most, but not all, of the duties imposed on directors by case law and equitable principles. There are seven general statutory duties, of which three are most relevant to companies in financial difficulties:
  • the duty to promote the success of the company for the benefit of its members as a whole
  • the duty to exercise independent judgment, and
  • the duty to exercise reasonable care, skill and diligence.

When a company is financially distressed and becomes insolvent, or is unlikely to avoid insolvency, the directors’ duty to promote the company’s success (i.e. to act in the interests of the members as a whole) is replaced by a duty to act in the creditors interests as a whole (i.e. to preserve the value in the company in order to maximise the return to creditors).

The recent proposed amendment to the Insolvency Act will remove a director’s potential personal liability for losses in circumstances when, from 1 March 2020, they knew or ought to have known that the company could not avoid insolvency. This relaxation of the rules is currently due to last 3 months although it could be extended. As a result, this allows directors an opportunity to consider their options without the threat of becoming personally liable for the companies debts.

It’s important to note however that this temporary suspension of wrongful trading should not be interpreted as a suspension of fiduciary duties. Directors should use this time to ascertain whether a viable recovery plan can be implemented as an alternative to a formal insolvency procedure. It may be the case that the business is otherwise viable in which case a restructuring via an insolvency process may be appropriate.

Other government proposals
The government plan to legislate to prevent suppliers enforcing contractual termination clauses. Termination will still be possible on the grounds of non-payment and furthermore, suppliers can seek to terminate the contract is if can demonstrate “undue financial hardship”. Suppliers will have super priority for supplies made during the new moratorium process set out above.

The government have also announced a new restructuring procedure akin to a Scheme of Arrangement whereby smaller “out-of-the-money” creditors (amounting to less than 25% of overall liabilities) who are no worse off than in liquidation, can be crammed down and bound by an arrangement. Similar to a Scheme of Arrangement, the arrangement would require court approval. Further details of the mechanics of the process are anticipated shortly.

Ensure good governance
While the government has relaxed wrongful trading provisions, they have stayed silent on other parts of the Insolvency Act, so directors risk personally liability for other offences. These could include general misfeasance, preference payments, transactions at undervalue and fraudulent trading.

If a business is in distress, directors should seek appropriate professional advice; in the form of an experienced licensed insolvency practitioner or insolvency lawyer, and take practical steps to mitigate these risks and ensure they make the best and most informed decisions for their businesses, including:

  • Ensure all government mitigation measures, where appropriate, are implemented
  • Meet regularly and keep minutes of all meetings to support your decisions and thought processes;
  • Ensure financial information is up to date including forecasts to help assess the impact of Covid-19 on working capital;
  • Prepare a business strategy to document how the business will trade through the current disruption
  • Monitor financial covenants and consult lenders about existing debt and any future requirements.
  • Consider the impact of Coronavirus on the financial statements and extend the deadline for filing financial information, if required;
  • Review existing commercial contracts and establish whether contractual obligations can be met.
  • Care of employees and safeguard their health and wellbeing;
  • Satisfy obligations relating to the care of employees and safeguard their health and wellbeing;
  • Consult with suitable professionals such as an accountant or insolvency practitioner.
Consideration needs to be given by the board as to whether adequate business resilience plans are in place. Should directors be found to breach their duties, they could be personally exposed to claims  brought via civil and criminal actions.

Those involved in the running of a company should continue to seek appropriate professional advice if they are concerned about the viability of their business.

Please contact your local Moore South office for more advice.