Companies Provided Additional Protection from Insolvency

Companies Provided Additional Protection from Insolvency

Key Contact: Hugh Hitchcock

Author: Joe Smith

The measures introduced by the Corporate Insolvency and Governance Act 2020 (“CIGA 2020”) aimed to protect businesses from the financial strain of COVID-19 by introducing a range of different measures. Some of the temporary measures in focus in this note, which are very relevant to the rules on insolvency, have been further implemented by the Government: namely, the suspension of both wrongful trading and statutory demands and winding up petitions.  

Suspension of Wrongful Trading Provisions until 30 April 2021

Wrongful trading is governed by sections 214 and 246ZB of the Insolvency Act 1986. Under these provisions, where a director knows (or ought to reasonably conclude) that there is no reasonable prospect that a company can avoid insolvent liquidation or administration, they have a duty to ensure that steps are taken to minimise loss to the creditors of the company. If the company then enters into insolvent liquidation or administration and the court, on the application of the liquidator or administrator, concludes that the director has failed to comply with their responsibility by continuing to trade to the detriment of the creditors, the director may be ordered to contribute to the company’s assets. What the director ought to have known is judged on the basis of what a “reasonably diligent person” would have known having the general knowledge, skill and experience that both the director personally had and what is generally expected of a director in their position.

These provisions place a positive obligation on directors of struggling companies to ensure they are not undermining the company’s creditors; failure to do so could risk an application being brought by the liquidator or administrator against them. The emergence of Covid-19 and the various lockdown regulations has generally increased the financial pressure on companies, with directors facing potentially difficult decisions. However, under section 12 of CIGA 2020 wrongful trading provisions were suspended between the period of 1 March 2020 and 30 September 2020. During this period, the court was to assume that a director is not to be responsible for any worsening of the financial position of the company or its creditors.

This relevant period came to an end on 30 September 2020 but, unlike other provisions in CIGA 2020, was not extended at the time. On 26 November 2020, The Corporate Insolvency and Governance Act 2020 (Coronavirus) (Suspension of Liability for Wrongful Trading and Extension of the Relevant Period) Regulations 2020 (“the Regulations”) were introduced, with the effect of introducing a further suspension of the wrongful trading provisions up to 30 April 2021. It is explained in the explanatory memorandum to the Regulations that the original suspension could not have been extended, as the relevant period up to 30 September 2020 had already ceased. Therefore, the Regulations essentially mirror the previous suspension provisions under CIGA 2020 and introduce a new period.

The key takeaway from the Regulations is that the court will again assume that a director is not responsible for worsening the financial position of the company or its creditors by continuing to trade during the period of 26 November 2020 and 30 April 2021.

Interestingly, there is a two-month window of potential liability between 1 October 2020 and 25 November 2020, where CIGA 2020 ceased to have effect and the Regulations commenced. Without the Regulations being retrospective, the normal wrongful trading provisions under the Insolvency Act 1986 would apply during this period and directors could face applications from creditors for wrongful trading.

Extended suspension of statutory demands and winding up petitions

On 9 December 2020, the Government announced in a press release that it intends to extend current restrictions on the use of statutory demands and winding up petitions. Whilst this legislation has not yet officially come into force, it is expected to be unveiled in the near future.

A statutory demand is where a creditor presents the debtor with a formal, written demand requesting payment of a sum by the creditor. Before CIGA 2020, a creditor was able to bring a petition against an individual or a company under the provisions of the Insolvency Act 1986. As discussed above, CIGA 2020 hoped to ease the financial strain on companies struggling to pay debts by suspending these provisions and preventing creditors from bringing statutory demands and winding up petitions against them.   

Under schedule 10 paragraphs 1 and 2 of CIGA 2020, a petition for the winding up of a registered company cannot be presented with a statutory demand under section 123(1)(a) of the Insolvency Act 1986. This provision normally provides that a company is deemed unable to pay its debts by failing to pay a sum over £750 left at the company’s registered office and not paid within the required three weeks during the relevant period. The suspension will prevent these normal rules applying, unless the creditor has reasonable grounds for believing that Covid-19 has not had a financial effect on the company or that the company would have been in the same position even if Covid-19 did not have a financial effect on the company.

The initial relevant period was between 1 March 2020 and 30 September 2020. This was then extended to 31 December 2020. This period has again been extended, this time to 31 March 2020. Statutory demands and winding up petitions shall therefore continue to be suspended unless the fairly difficult test above can be satisfied.

If you would like any assistance, please do not hesitate to contact the Dispute Resolution team at Acuity Law.

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