Why COVID-19’s insolvency life-raft of measures isn’t designed to keep contractors afloat
These are rough, unchartered waters for contractors and the wider economy, but help is at hand from new insolvency measures aimed at helping contractors who are limited company directors navigate through the coronavirus pandemic, writes Gareth Wilcox, partner at Opus Restructuring & Insolvency.
What support from COVID-19 is available already?
But first, the Covid-19 support measures most of us know about already. As is being discussed on Contractor UK’s Forum with varying levels of enthusiasm, the government has delayed the introduction of IR35, introduced coronavirus-inspired cash packages such as Business Interruption Loans, and latterly confirmed that the Job Retention Scheme will let PSC contractors furlough themselves, albeit with some unbreakable conditions.
For both incorporated and unincorporated business-owners, payment holidays are also available in relation to HMRC liabilities, including a deferment of VAT payments and in the form of greater access to Time to Pay agreements to settle tax debts over an extended period.
Companies House has responded to Coronavirus too
Recognising also that directors of limited companies may have difficulties in accessing their financial records and contacting their accountants amid the UK’s current lockdown, directors can apply to Companies House for an automatic and immediate three-month extension to filing deadlines. This is easy and can be done online here. But it is important to note that applications must be made before the filing deadline, so contractors should not leave it to the last.
Insolvency fears now at fever-pitch
In wake of the outbreak of COVID-19, major legislative changes have also been proposed to the UK’s insolvency regime to lend support to affected businesses. And the sheer size of those enterprises ‘affected’ is remarkable. In fact, in a stark warning, 18% of Britain’s SMEs say they are set to collapse because of the impact of the coronavirus on their business – within the next four weeks. This is according to The Corporate Finance Network of accountants.
What insolvency aid has been proposed?
The government is seeking to bring forward proposed changes to the UK’s insolvency framework to add new restructuring tools including:
- a moratorium for companies giving them breathing space from creditors enforcing their debts for a period of time while they seek a rescue or restructure;
- protection of their supplies, to enable them to continue trading during the moratorium; and;
- a new restructuring plan, binding creditors to that plan.
It is not yet clear when these changes may be implemented, or indeed the level of consultation which will be possible. But the objective is that the reforms will enable profitable UK businesses (including those engaging contractors) to continue to operate beyond the current crisis.
What is of more direct relevance to contractors and their own contractor companies, however, are the proposed changes to Wrongful Trading.
What are the wrongful trading rules and what’s happening to them amid covid-19?
We have introduced the wrongful trading rules to contractors previously, and pointed out when there was a moving of the goalposts. So already, all limited company contractor directors (including those persons with significant control) ought to know that they must, at all times, be alive to the possibility of falling foul of the framework.
And you fall of the wrongful trading rules where as a company director, you continue trading to the detriment of creditors (i.e. allowing further losses to build up), beyond a point where you realise, or ought objectively to have realised, that there was no reasonable prospect of a company avoiding liquidation.
In normal times, the remedy where the above infringement has occurred is that an appointed liquidator can apply to court for an order that the director(s) be required to make such a contribution to the assets of the company as the court sees fit. The court can then order the director to make a personal payment into the liquidation to cover the losses incurred during the period when the company was trading wrongfully. This can lead to substantial sums being payable. Then, in order to defend against such an action, directors would have to prove that they took every step to minimise losses to creditors.
The proposed suspension of the wrongful trading rules during coronavirus
Well, limited company contractors can sweat a little less during this fever-inducing pandemic. The government has announced that it will temporarily suspend the wrongful trading provisions to give company directors greater confidence to use their best endeavours to continue to trade during this pandemic. There will be no threat of personal liability should the company ultimately fall into insolvency. This suspension and waiver are in force now, as they took effect with backdated effect from March 1st 2020. It is currently unclear when the suspension will end.
Although the finer details have yet to be circulated, the upshot of pausing the wrongful trading rules is that those directors whose (otherwise profitable) business suffer a sudden shock in the current Covid-19 crisis, and which ultimately results in liquidation, will be protected from personal liability being incurred for additional liabilities suffered from March 1st 2020.
What’s the catch?
As with many of the government’s coronavirus support measures, there are indeed several catches and caveats to beware. But we say necessarily so in this instance, to ensure that directors are not given ‘carte blanche’ to disregard their director duties entirely.
Firstly, there has been no abolition of the Fraudulent Trading provisions of the Insolvency legislation. A Fraudulent Trading action operates in a similar way to a Wrongful Trading one, but it is necessary for the claimant to prove that directors continued trading with the intent of purposefully deceiving and defrauding its creditors. Clearly this is a much higher burden of proof to discharge since it arises through a positive action rather than mere neglect.
Secondly, there has been no suspension of a liquidator’s ability to bring actions in relation to:
- unfair preferences (where the director of an insolvent company treats one creditor – including themselves better than others);
- transactions at undervalue (where company assets are transferred for no, or minimal consideration)
- misfeasance (a breach of a director’s duty to the company).
So should any directors be concerned about the solvency of their company, they still need to be mindful of these provisions, including the risk of them ‘preferring themselves’ (for example by repaying monies to themselves or settling debts they have guaranteed over those which they have not).
Another consideration is the other strand to liquidator investigations -- that being the director’s report which is delivered to the Insolvency Service. This report is used to determine whether disqualification proceedings ought to be brought. Currently and despite the pandemic, there is no suspension of the requirement of a report to be submitted. Likewise, no additional guidance has been provided regarding reports of conduct during the Covid-19 outbreak.
Will this insolvency-related aid make all the difference?
The suspension of the wrongful trading provisions will of course be welcome news for directors, as they can focus on continuing to pay staff, suppliers and the like even if they fear their business might fail. But in practice, we believe it is of limited significance given the mechanism of such actions being brought.
Where actions are being considered by a liquidator, they must always have in mind the fact that such claims will ultimately be brought before a judge, who has wide discretion as to the orders which can be made, including dismissing it altogether with a costs-order against the liquidator. As a result, a liquidator would have been unlikely to bring a claim in any event, where they would have considered there to be a risk of a judge throwing it out on the basis that a finding against the directors would be unequitable.
There is also a limited window to the suspension, and the measures are clearly not designed to protect directors of companies which had already incurred liabilities wrongfully prior to it. As such, these insolvency measures should not be considered as a lifeboat to keep afloat companies which were already in difficulty prior to the onset of Covid-19.
Finally pay high regard; beware if furloughing, enlist if unsure
Given the above, and the continuance of the other powers available to challenge the conduct of directors, it is still necessary for ‘Ltd’ contractors to pay a high regard to their duties in these challenging times. Arguably, this is of particular significance where directors have furloughed themselves – which is the centrepiece of another seemingly well-intended policy but also one where the execution and impact both look off, at least at this still potentially early stage of the pandemic. Further unifying the Job Retention Scheme and the suspension of the Wrongful Trading rules -- if in doubt, don’t act; enlist advice as early as possible.