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Changes relating to Wrongful Trading and the Insolvency Laws

As they apply to companies but not self-employed and partnerships

In the latest announcements, the Government has announced that “Wrongful Trading” provisions have been suspended from 1 March 2020 and that it will also introduce a new restructuring plan and debt moratorium.

What is “Wrongful Trading”

Broadly, if a company continues to trade while the directors know or should have known that their company was insolvent, then the directors can be found guilty of Wrongful Trading. If found guilty of this offence, the directors can be held personally liable for any debts incurred by the company found to be trading while insolvent.

OK, so when is a company “Insolvent”?

Broadly there are two definitions for a company being insolvent:

  • Liabilities exceed assets
  • Inability to pay liabilities as they fall due

So, some companies having invested heavily in factory premises and having retained profits would have assets in excess of liabilities; and therefore, would not fail the first test.

However, we can see in the current Coronavirus situation that the lack of cashflow in a company could mean:

  • It is unable to pay trade suppliers on time
  • Its customers might not pay on time (if at all)

In these circumstances, even a profitable trading company could be deemed to be insolvent.

And the new restructuring plan and debt moratorium proposals?

At the moment, there are scant details on what the new rules will be and how this will impact on the ability of a company to trade out of the current adverse trading conditions.

We expect that there will be some amendments to the current rules regarding the use of Corporate Voluntary Arrangements (“CVA”).  

A CVA is designed to give a company protection from its creditors while it tries to agree a plan to trade out of the current position. The focus is to give the creditors of the company a better return on the money they are owed compared with a forced liquidation.

Historically, HMRC have been one of the major creditors of a company and have at times refused to agree to the terms of a CVA, even if it is in their best interests to do so - perhaps to stop other companies from not paying their debts to HMRC on time. It is possible the HMRC will be more conciliatory in agreeing any CVA proposals put to them.

We have also heard that some lenders, with the benefit of a personal guarantee from the directors, may refuse to agree to a CVA. These lenders, expecting that they will be better off receiving a smaller payment from the liquidation of the company (and then calling in the personal guarantee of the directors) may end up in a better position yet causing an increased loss to the other creditors of the company. 

Again, the legislation of CVAs may require lenders to be more accommodating to the needs of all creditors.

What is the purpose of the new rules?

These are aimed at giving directors breathing space, help get the company finances back in order and may require HMRC and other secured creditors not to act in a way that is prejudicial to the other creditors of the company (i.e. the trade creditors of the company).

So, while details are thin on the ground, what should a director be doing to take advantage of any restructuring under the new legislation?

In previous articles we have recommended that the company directors should be preparing:

  • Cash flow and profit and loss projections
  • A business plan

These would be needed for any application to a bank for funding under the Coronavirus Business Interruption Loan Scheme (“CBILS”).

We believe the same information will be needed as a starting point for any restructuring under the new proposals (at time of writing no detail is available).

Restructuring will take some time to arrange. It is important that directors are well prepared to take advantage of any options open to ensure the business survives.  

We expect that any restructuring will need the services of an Insolvency Practitioner. They are likely to become very busy with companies requiring their service. Getting to the front of the queue with a well prepared survival plan will be crucial.

Considering the support being offered to the self-employed, will the new relaxed rules on wrongful trading apply to them?

We believe the denial of support to the directors of businesses in the current crisis is unfair. We have made our views known to the chief executive of our Institute (ICAEW).  

We expect we will not be the only ones doing so and can only hope pressure from various groups will force a rethink on the support being offered to directors.

However, we believe the new rules will not apply to a sole trader (or a partner in a partnership) as they are jointly and severally liable for the debts of their business. This means that if they owe their suppliers, they will have to pay them in full - even if this means digging into their personal reserves. This could result in the remortgage of their home.

So while we believe the lack of support to directors is unfair, the protection offered by operating through a limited company may be worth more than the support being offered to a sole trader facing unlimited liability for the debts of their business.

It is possible for a sole trader to enter an Individual Voluntary Arrangement (“IVA”) with their creditors, but the terms of this would normally require a contribution from the individual and the payments could be spread over several years.

In the event that the IVA is not approved then the next stage could be personal bankruptcy (which could include a charge being placed on their share of jointly held property). 

And the question of overdrawn director’s loan accounts?

This will be covered in the next update; so please look out for this in the next day or so.

But, in the event of a liquidation of the company, the liquidator will look to recover from the director the balance on any overdrawn director’s loan account.

Need more advice?

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