Relaxing the insolvency laws

The UK Government has announced that it will introduce new measures to support businesses under pressure as a result of the coronavirus outbreak.

The Business Secretary, Alok Sharma, announced plans to make changes to enable UK companies undergoing a rescue or restructure process to continue trading, allowing them “breathing space” which may help them avoid insolvency. The detail of the relaxations is still unclear but it is understood that they will include:

• A temporary moratorium for businesses undergoing a restructuring process, during which time they cannot be put into administration by creditors.
• Measures to allow companies to continue buying much-needed supplies, such as energy, raw materials or broadband, while attempting a rescue.
• A new restructuring plan, binding creditors to that plan.
• The new legislation fast tracks proposed plans to change UK insolvency laws that were consulted on in 2018.

Further, it has also been announced that the wrongful trading provisions will be suspended for three months to allow companies to keep their businesses going and to protect directors against the threat of personal liability.

Wrongful trading ordinarily would arise where a director of the company knew (or ought to have concluded) at some point before the commencement of a liquidation or administration that there was no reasonable prospect that the company would avoid going into an insolvent liquidation or administration.

In these circumstances the liquidator or administrator of the company can seek a court declaration that the director make a contribution to the company’s assets.

The Business Secretary has said that the new legislation, which would retrospectively apply from 1 March, would be introduced at the “earliest opportunity”.

What this means for your business

Despite these measures, directors should still be careful about payments made to themselves. Payment of normal PAYE salary and benefits to a director (so long as at no more than a market rate) should still be appropriate (depending on a Company’s individual circumstances). However, payment of dividends and repayment of director’s loans could be more problematic, and care must be taken to make sure any such payments are lawful.

The Company must have distributable profits before paying dividends, and when repaying any director’s loans, the directors must have a mind to the position of the Company and its creditors as a whole, a director cannot prefer payment of their own loan at the expense of other creditors. Care must also be taken to properly document any dividend or loan repayment.

Whilst the detail of the Government’s new measures is limited at present, the announcement does provide some comfort to directors that the reforms will allow companies which are genuinely struggling as a result of Covid-19 sufficient time to help them “weather the storm”. However, it is important to remember that not all insolvency laws will be relaxed and general directors duties will remain in force.  Directors should therefore continue to act in the best interests of the company during this turbulent time and have regard to the interests of creditors.

Directors have been particularly concerned about the wrongful trading rules currently in place due to the risk of personal liability. The suspension is perhaps most welcome in light of the Government’s offer of financial support for businesses in the wake of Covid-19 as the decision to take on additional borrowing whilst a company is technically insolvent could mean that they are subject to a claim for wrongful trading if the business ultimately folds. This should therefore provide reassurance to directors that they are able to take advantage of the help on offer without those concerns.

Existing laws for fraudulent trading and the threat of director disqualification will remain in force as a deterrent against director misconduct.

Matthew Fell, Chief UK Policy Director, Confederation of British Industry, said of the reforms:

“The CBI welcomes these interventions at a critical time for business. The temporary suspension of wrongful trading provisions, along with other measures, will give much needed headroom for company directors to enable otherwise viable businesses to use the government’s support package and weather this crisis.”

If companies are concerned about their current trading position and the impact of Covid-19, the following practical pointers may be useful:

• Seek professional advice at an early stage.
• Keep up to date financial information.
• Hold regular full board meetings and ensure the commercial decisions of the directors are reported in full in the minutes at each stage of this crisis.
• Monitor compliance with financial covenants in arrangements with existing lenders.
• Where possible, treat creditors with parity, but if this is not possible then document carefully the reasons for such decisions.
• Properly document any dividend payment or repayment of any directors’ loans.

Moorcrofts will be keeping a close eye on further announcements but if you require support or assistance in the meantime, please contact a member of our corporate team.