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Wrongful trading is a term that has received quite a bit of press over the last few months, mainly through the headlines generated by the UK Government’s unprecedented amendment to the wrongful trading provisions contained within our insolvency legislation.
But what exactly is wrongful trading and what has changed?
Wrongful trading is the legal term used to describe the actions of a director of a limited company who has been found to have continued trading their company past the point of insolvency when they either knew, or ought to have known, that the company was insolvent. This continued trading normally worsens the prospect of a return being made to the company’s creditors or causes an overall deterioration in the company’s financial position.
When a company enters into a formal insolvency process such as administration or liquidation, the prior conduct of the directors will always be under scrutiny. If there is evidence of wrongful trading on the part of the company directors then it is likely that the Department for the Economy will take Court action against those directors. If the Court concludes that wrongful trading has occurred the directors face the worrying prospect of being ordered to make a contribution to the company’s assets out of their own personal funds as well as receiving a disqualification from being a director of any other limited company for up to 15 years in the most serious of cases.
With such severe consequences at the forefront of their mind it is little wonder that a responsible director will always want to have a prudent and cautious approach when running their company and take early and proactive steps to close down a company when they realise that its financial health is deteriorating towards failure. However, given that the majority of the country’s companies have recently experienced a dramatic commercial deterioration brought on by the unforeseen external forces of the current pandemic, the Government has sought to prevent an otherwise expected tsunami of company insolvencies by temporarily relaxing the wrongful trading provisions for a short period of time.
The Corporate Insolvency and Governance Act 2020 (“CIGA 2020”) came into force in Northern Ireland at the end of June 2020 and provides that in any future wrongful trading claims brought before the Court, the Court will assume that the directors were not responsible for worsening the financial position of the company during the relevant period which is currently 1 March 2020 to 30 September 2020. This effectively provides directors with a period of immunity during which they can afford to be more patient than usual to fully assess and understand what the future holds for their respective companies before deciding on the best course of action.
Whilst all companies will benefit from this change, it is specifically aimed at protecting those companies that would otherwise have been financially viable but for the impact of COVID-19. It is therefore hoped that this legislative relaxation will give directors a greater confidence to persevere through this economic storm and try to navigate towards hopefully calmer waters on the other side. Unfortunately it is inevitable that lots of companies will still end up in a formal insolvency process, however these temporary changes will no doubt help some companies from being wound up prematurely or unnecessarily.
Given that disqualification proceedings can be brought against company directors up to two years from the date the company became insolvent, it will be quite some time before we see any significant caselaw on how this particular change to the legislation has played out. The immunity period has not yet expired and wrongful trading claims are only brought after a company has been placed into a formal insolvency process such as compulsory liquidation, which for many companies is still a very long way away. That risk is potentially postponed further in light of other legislative changes recently introduced such as the hurdles creditors now have to negotiate in order to present winding up petitions against debtor companies.
The important message however is that wrongful trading is still very much something that directors need to be mindful of and the reality is that nothing has changed in terms of directors duties and their responsibilities in relation to their company, its shareholders and its creditors. The amendment to the wrongful trading provisions is only temporary and is clearly designed to help with the overall rescue of the economy. It will not protect directors in relation to wrongful trading that they may have overseen before 1 March 2020 or any wrongful trading that occurs after the relevant period ends. Similarly, it will not protect directors whose conduct falls below the expected standard.
Wrongful trading should not be confused with the entirely separate offence of fraudulent trading, this being where the directors ultimately set out to commit a fraud through the company’s trading activities. The provisions around fraudulent trading have not been relaxed and remain operational in full as do the general duties regarding the need to continue to exercise reasonable care, skill and diligence, to promote the success of the company and to exercise independent judgment and it is adherence to these duties that will continue to regulate the conduct of directors.
It is imperative that directors use the breathing space afforded to them under the relaxation of the wrongful trading provisions to fully explore all possible options for their company both in terms of exit strategies and cessation of trading. As always, early reliable advice is key and at TLT we have a team of experts with the experience to support local businesses in finding the right solutions by providing clear and practical advice.
If you would like to arrange a consultation with a member of our team please get in touch.
This publication is intended for general guidance and represents our understanding of the relevant law and practice as at August 2020. Specific advice should be sought for specific cases. For more information see our terms & conditions.
11 August 2020
Insights 18 JULY 2022