The recent news that the UK government is relaxing its wrongful trading rules is to be welcomed.
The proposal to temporarily shield directors from liability when their companies do business while having negative balance sheets is set out in the Corporate Insolvency and Governance Bill, which is currently going through the UK parliament’s legislative process and is expected to be passed into law imminently.
Under the proposals, the government will temporarily suspend wrongful trading laws as one element of a package of measures intended to assist UK businesses coping with the coronavirus pandemic.
Wrongful trading is governed by s.214 of the UK’s Insolvency Act 1986. Existing case law on wrongful trading already provides some protection to directors where unforeseen economic circumstances have a profound effect on the market (see Nicholson v. Fieldings All ER (D) 156). The outright suspension of s.214 for the three months commencing March 1, 2020 (to be extended if required) will remove any doubt in the minds of directors on this important issue.
If the letter of the law were to be applied, how many company directors would be guilty of wrongful trading by the end of this Covid-19 lockdown?
The answer is “significant.” With interruptions to cash-flow, supplies, and access to customers, the truth is that there are many companies before Covid-19, which have been technically insolvent for short periods. But directors usually risk-manage this position; they “trade-thru” and emerge with the firm intact. This may be based on a reasonable expectation that, as a going concern, a business can and will likely make it through bumpy or seasonal times.
The Covid-19 crisis has greatly complicated the trading positions of an increasing number of companies. Many, if not most, are struggling with cash flow issues. It is an unavoidable consequence of lockdown.
It is highly likely that we will see an increase in the number of corporate frauds once Covid-19 is confined to history. During a recent interview with a London-based think tank, my UK-based investigator – who’s been investigating corporate frauds since 1998 – explained that the vast majority of companies he investigated had been legitimate enterprises at their inception. However, some had fallen into disrepute when the company had hit hard times. He added that only a small number of companies he’d investigated had been specifically set up as vehicles for fraud. This perspective mirrors my own experiences to some degree.
For the vast majority of companies, the changes to wrongful trading legislation will bring a sigh of relief. Some may remain afloat but overstep the mark, and in doing so, find themselves in trouble.
As with all these situations, it is always the minority that adversely affects the majority. So, the UK government must prepare itself not only for the plaudits linked to its common-sense approach but ultimately, the inevitable criticism when frauds are subsequently identified and reported.
Will a greater number of companies survive the Covid-19 crisis as a result of the UK government’s directive? Almost certainly. Will we see an increase in the number of directors who pushed their luck a step too far and found themselves in hot water? Inevitably. Will they be prosecuted? That’s debatable.
One of the new guidelines states it will assist matters by: “Temporarily removing the threat of personal liability for wrongful trading from directors who try to keep their companies afloat through the emergency.”
Time will tell if this move to protect directors from being accused of wrongful trading is a success. But time will also tell if the UK government’s intervention can also save directors from themselves.
With thanks to Tony McClements, Senior Investigator at Martin Kenney & Co, for his assistance with this post. He served for 33 years with UK police forces and has specialized in Fraud & Financial Investigation since 1998. He is also a lecturer in these subjects at the University of Central Lancashire (UCLAN).