Locke Lord QuickStudy: UK Government Announcement Regarding Changes to the UK’s Insolvency Regime ‎Prompted by COVID-19‎

Locke Lord LLP
April 1, 2020

On 28 March 2020 the UK government (the “Government”), following the lead of Australia ‎and Germany, announced plans to introduce a temporary relaxation of the existing wrongful ‎trading regime for company directors. Specifically, the Government has communicated its intention to introduce new legislation at ‎the “earliest opportunity” to suspend wrongful trading laws for a period of 3 months (with the ‎ability to extend this period if deemed necessary), to allow directors to continue to pay staff and ‎suppliers without risk of personal liability should their business later become insolvent. In the ‎same announcement, the Government indicated further-reaching insolvency law reforms. In this ‎QuickStudy, the authors consider the implications of that announcement. ‎

Current law on wrongful trading
The law on wrongful trading is contained in section 214 and section 246ZB of the Insolvency ‎Act 1986. Once a director or directors of a company conclude (or should have concluded) that ‎there is no reasonable prospect of the company avoiding an insolvent liquidation or, in relation to ‎business conducted on or after 1 October 2015, insolvent administration, they have a duty to ‎take every step which a reasonably diligent person would take to minimise potential loss to the ‎company’s creditors. If, after the company has gone into insolvent administration or liquidation, ‎it appears to the court that a director has failed to comply with this duty, the court can order the ‎director to make such contribution to the company’s assets as it thinks proper.‎

Covid-19 and Government proposals‎
In the current climate where, for example, directors will be grappling with issues such as incurring ‎further credit with a company’s supply chain and/or the continued payment of staff (and ‎associated PAYE/NIC liabilities to HMRC), directors will welcome the certainty of the ‎Government’s announcement that personal liability for wrongful trading will be temporarily ‎suspended. We understand that this extraordinary suspension will apply retroactively from 1 ‎March 2020 for an initial period of three months but with flexibility to extend that period if ‎needed.‎

The authors welcome, too, the Government’s statement, but in the absence of specific detail in ‎the Government’s proposals note that:‎

  • Successful ‘wrongful trading’ claims are, in the authors’ experience, relatively rare in any ‎event since the underlying legislation contains a mechanism to protect directors in special ‎circumstances provided that they “do the right thing” and take appropriate steps to ‎mitigate losses to creditors. Determination of wrongful trading requires the satisfaction of ‎an objective test around the director’s functions and a subjective test concerning the ‎general knowledge, skill and experience of that director. The authors query whether ‎current purposes might have been better served by clearer guidance on the underlying ‎legislation and its implications for directors.‎
  • Directors will also need to be mindful that the Government’s proposals only extend to ‎‎‘wrongful trading’. In its statement, the Government highlighted that “all of the other ‎checks and balances that help to ensure directors fulfil their duties properly will remain in ‎force”, by which the authors understand that laws in respect of  inter alia ‘fraudulent ‎trading’ and ‘misfeasance’ remain in place together with the threat of director ‎disqualification.‎
  • The reforms will be introduced in Parliament "at the earliest opportunity". In practice, this ‎will depend on whether Parliament is able to return from recess on 21 April. It is unclear ‎how these changes would be implemented in the event of an extended recess. ‎
  • On the possible negative side, the suspension of the wrongful trading rules could be open ‎to abuse by those at the helm of companies racking up debts that they have no hope or ‎even intention of paying. The devil of the new legislation will be in the detail. There will ‎doubtless be a call in some quarters to revert to the existing regime the moment the ‎Covid-19 crisis is behind us.‎

UK insolvency law reform
In addition and, in the authors’ view, with longer-lasting and more profound implications, the Covid-19 crisis has precipitated a fresh engagement by ‎Government with the plans of the previous government to reform UK insolvency law. These ‎plans were developed in the publication in August 2018 ‎of that government's response to its ‎consultation on potential reforms to insolvency law‎. Of the 2018 proposals, the Government's ‎announcement specifically references three:‎

  • a new restructuring moratorium for viable companies undergoing a restructuring process ‎to allow them time to negotiate an out-of-court restructuring; ‎
  • preservation of a company's ability to continue to access essential supplies such as energy, ‎raw materials or broadband while it undergoes a restructuring; and
  • a restructuring "plan" which will bind all creditors. ‎

The authors remain optimistic that, if implemented, these proposals will represent a considerable ‎reform to UK insolvency law not seen since 2002.  For the first time, assuming implementation in ‎line with government consultation, a restructuring plan will be capable of implementation without ‎the consent of each class of creditor through a cross-class cram-down mechanism subject to a ‎modified version of the US Chapter 11 absolute priority rule. ‎

Again, however, the authors sound a note of caution since the Government has yet to provide ‎specific details of how these changes will be implemented. For example, in granting a company ‎‎‘breathing space’ there are no further details at this stage on whether the measures will result in ‎some form of restriction on hostile creditor action. Similarly, in relation to access to essential ‎supplies it is unclear how legislation will manage the tension between allowing a degree of ‎forbearance for companies in difficulty without simply allowing bad debtors more time to pass ‎their liquidity difficulties on to suppliers, thereby pushing Covid-19 issues down the supply ‎chain.‎

Summary and next steps
In summary, the current circumstances faced by businesses are unique in living memory and ‎efforts by the Government to support businesses through the provision of additional liquidity ‎measures or a reshaping of the insolvency and reshaping ‎landscape are to be welcomed. The authors will follow with interest as the legislative framework ‎for these provisions takes shape.‎

Locke Lord’s London team has considerable experience advising on a host of ‎insolvency/restructuring and funding matters across all sectors in the UK and globally.‎

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