As the economy bites down once again as a result of a wave in local lockdowns, a spike in coronavirus cases and fluctuating quarantine travel rules, it’s likely that businesses are due to experience another income drought. The furlough scheme and additional financial support measures are due to taper down in a bid to slowly wean businesses off emergency grants and brace the business for a period of turbulent trading if the economic pressure surrounding the pandemic surges.
As an early response measure to protect healthy businesses directly impacted by Covid-19, wrongful trading provisions were temporarily suspended until the end of September to give businesses which were otherwise strong and viable, the opportunity to seek recovery and facilitate business rescue. The magnitude of risk associated with the spread of the virus resulted in sectors to be forced into a slowdown or even halt trading, leading to businesses to endure prolonged financial decline.
What is Wrongful Trading?
Wrongful trading is when a business continues trading with prior knowledge that the business is insolvent and therefore acting against the best interests of creditors. By continuing trade when knowingly insolvent, you are intentionally worsening the position of the business, accumulating debts and further exposing your business to legal action.
Wrongful trading under the Insolvency Act 1986 requires the company director to seek an insolvency procedure if the business is in serious financial difficulty, unable to fulfil liabilities and experiencing pressure from creditors. As the company director, it is your legal duty to ensure that you are placing the interests of creditors first, protecting their position from further worsening.
What’s the difference between Wrongful Trading and Insolvent Trading?
Insolvent trading is when a business continues trading when it is unable to fulfil liabilities, deteriorating the position of the business and creditors, however, this can be done unintentionally. Wrongful trading is when you are aware that your business is insolvent and therefore unable to meet financial commitments, however, you knowingly continue trading.
There is a subtle difference between wrongful trading and insolvent trading, however, wrongful trading is classed as a serious offence as you are knowingly trading with the knowledge that your business is insolvent and therefore unviable.
What’s are the consequences of Wrongful Trading?
Once the moratorium on wrongful trading ends, if a company director is found guilty of wrongful trading, the consequences are likely to damage your prospects. You could be fined, disqualified as a director for up to 15 years and even be held personally liable for the debts of the business. This is classed as a civil offence which could hinder your reputation as a business owner and place you on a blacklist by suppliers and creditors.
Wrongful trading rules during Covid-19
On 28 March 2020, Business secretary, Alok Sharma, announced an unprecedented change to insolvency rules, including a temporary moratorium on wrongful trading rules applied retrospectively from 1 March 2020 for businesses undergoing a rescue process. This means that businesses which would otherwise fall foul of wrongful trading rules due to Covid-19 pressures would be allowed to continue operating without the threat of impending creditor or legal action.
The moratorium is due to end on 30 September, (correct on publication date), when businesses on the brink are likely to either fall into the red or continue trading after the suspension of liability ends. If businesses continue to struggle after the moratorium ends, it is instrumental to seek specialist advice to avoid an Insolvency Service investigation.
Future of financially distressed businesses after moratorium passes
Once the moratorium passes and government support is pulled, this is likely to open the floodgates to struggling businesses with no cash reserves, emergency funding or financial support. In the first instance, it is vital to seek urgent advice before the business drowns in debt and shuts off access to formal restructuring and rescue measures.
The full scope of the pandemic is yet to be assessed as the UK enters a second phase of local lockdowns and curfews to curb the spread of the virus. It’s vital to take note that a business in severe financial distress is not necessarily irreparable and may be recovered through the likes of a Time to Pay arrangement (TTP). A Time to Pay arrangement gives the business breathing space as it restructures liabilities into affordable instalments. There are formal rescue strategies which can help you open the possibility of negotiating with creditors to revaluate outstanding debt into affordable instalments.
Following the moratorium, businesses on the fence about their future will be required to act fast to avoid falling foul of wrongful trading rules as this is a serious offence. If the business needs a cash injection to stay afloat, there are several finance options which can help the business get back on track. This period of trading difficulty has illustrated the importance of a war chest to provide financial support in the event of turbulent trading, such as during the coronavirus pandemic.
After the moratorium concludes, company directors should watch their step as failing to keep creditors interests as the primary priority could result in being held personally liable for the debts of the business. Your reputation as a company director will hinge on the duties fulfilled, the financial health of the business and seeking professional advice when it is due.
As businesses worldwide prepare to set foot upon the road of recovery, it is vital to assess the viability of the business on an ongoing basis to prevent the health of the business from further escalating negatively. The pandemic has set a backdrop of unexpected twists and turns, further turbulent trading due to the changing landscape of the economy and changing public health guidance due to the coronavirus pandemic.
About the Author
Jonathan Munnery is a partner at UK Liquidators, specialising in providing company liquidation services to company directors in financial distress. Jon works closely with business owners fighting unmanageable levels of debt, creditor pressure and legal action, guiding how to make a cost-efficient exit and protect creditor interests, more information can be found on the UK Liquidators website.