Insolvency Law reform fast-tracked: substantive change ahead

Business Secretary Alok Sharma has announced (Department for Business, Energy & Industrial Strategy press release, 28 March 2020) the imminent introduction of substantive amendments to the UK’s insolvency framework. These amendments are intended to support business in the grip of an extraordinary set of circumstances but, also, see an early delivery on the government’s August 2018 response to a consultation process undertaken in 2016.

Headlines:

• A pre-insolvency moratorium, or breathing space within which creditors will be unable to take enforcement action
• Supply line protection facilitating trade during the moratorium
• A new form of restructuring plan
• Temporary suspension of wrongful trading provisions.

The business community is adept at spotting a market trend. This is useful in interpreting the political headlines written in the last week for unparalleled amounts of state intervention and support: rates holidays; the deferral of VAT and tax; employee furloughs. Significant market changing announcements, all forward-signalling as yet unwritten legislation. In the notes to the Business Secretary’s press release there is a reference to the 2016 consultation but it is clear that the immediate focus in this announcement is not the new moratorium, or the restructuring plan that may follow the US ‘Chapter 11’ model, but the existing law’s view on a director’s potential personal liability for wrongful trading: causing a company to continue to trade when he or she knew or ought to have known that there was no reasonable prospect of avoiding insolvent liquidation.

Separate legal personality, and the socialisation of risk, may well have been the nineteenth century’s legal gift to entrepreneurs but, in successive waves of legislation, the state has sought to hold to account directors who abuse that position. The power to make wrongful and fraudulent trading claims (ss 214 and 213 of The Insolvency Act 1986), the ability for creditors to make claims that they have been defrauded ( s423 IA 1986 ) and the state’s power to apply for directors to be banned from office (the Company Directors Disqualification Act 1986) are three of the significant weapons designed to promote good behaviour.

In practice, on the ground now, directors up and down the country look at the state aid presently on offer, whether their landlord is or is not engaged, and have to wonder whether the business of their company remains viable even though rates, tax and employee costs are theoretically the subject of massive assistance packages. Traditionally, the additional deficit to creditors caused by a decision to continue to trade could be the personal risk of the director(s), and this might well be an additional drag to the government’s attempts to keep business open. If anything, the Business Secretary’s announcement sets the tone now for proceedings that might otherwise have been brought by insolvency practitioners or creditors on the failure of the company.

The government will though need to consider how it will deal with the new contribution order adjunct to the disqualification process only just introduced. What good a moratorium and temporary suspension of a front door remedy if the contribution order remains available on disqualification, or is the government signalling the end of the very valuable wrongful trading tool currently held by the liquidator, in favour of a more narrowly focussed claim to be brought by the Official Receiver on disqualification?

And so back to separate legal personality. Whilst the state sought to dissuade patterns of abusive behaviour, the markets sought to circumvent the principle, or to create priorities or exceptions. The personal guarantee is a circumvention, a debenture or fixed charge creates priority over trade or involuntary creditors such as the state, and a retention of title clause in a contract seeks to create an exception to the principle of equitable distribution of an insolvent’s assets.

To succeed in keeping business open now, for the short term, and before the government’s proposed pre-insolvency moratorium and new Chapter 11 style rescue plan can be implemented, the government will have to look not just at enforcement against the struggling company but, also, the personal guarantees that directors of the UK’s SME heartland will inevitably have provided to the company’s bankers or credit suppliers. Whilst continuing to trade might not be wrongful, eventual failure will still engage a director’s personal liability. However, and unlike a wrongful trading claim, a call on a guarantee benefits one creditor and not the general body of creditors. Sharp elbows may prevail. It remains to be seen how the detail of the government’s announcement will deal with the tension between unpaid creditors and the desire to keep a failing company in business.

The devil is always in the detail. Whether the government has enough bandwidth to generate that detail in sufficient time to be of practical help is the question. In the interim, the landscape message may well be a director’s best hope against what would otherwise be a routine claim for a subsequently appointed liquidator.

To discuss any of the issues raised in this blog please contact Simeon Gilchrist or Ali Zaidi of Edwin Coe’s Restructuring & Insolvency team.

Further detail is available on the R3 website.

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