The Corporate Governance and Insolvency Bill, which is expected to become law at the end of June 2020, is supposed to give businesses flexibility and breathing space, and allow them to continue trading and comply with their legal obligations, during the Covid-19 pandemic. Under the Bill, amongst other things, there will be relief from parts of existing insolvency law, in relation to a director’s personal liability for wrongful trading, a new insolvency procedure, and limitations on the exercise of termination clauses in supply contracts.
Directors and Wrongful Trading
There will be a temporary lifting of personal liability arising from wrongful trading for directors who continue to trade a company through the pandemic with the uncertainty that the company may not be able to avoid insolvency in the future. Directors of an insolvent company will not be liable for losses to their company or its creditors where those losses result from continued trading while the wrongful trading rules are suspended (currently being between 1 March 2020 and 30 June 2020 or, if later, one month after the Bill becomes law).
The intention is to remove pressure on directors to close, what would otherwise be, viable businesses to avoid personal liability, and so allowing them, in those circumstances, to continue to trade, pay suppliers and staff, and incur additional debt (including under the government’s recent funding initiatives).
Directors will, however, remain subject to their other duties under insolvency law (for example, in respect of fraudulent trading and misfeasance), and under the Companies Act (in respect of their fiduciary duties).
New Insolvency Procedure (a new moratorium)
There will be a new moratorium to allow businesses to pursue a rescue plan for the payment of pre-moratorium debts. Throughout the moratorium, the directors will remain in control of the company, but the process will be administered by a licensed insolvency practitioner, known as a “monitor”.
During the moratorium, creditors will not be able to commence or continue any legal proceedings, or enforce any security, against the company, and the company will be prevented from making payments to creditors in respect of its pre-moratorium debts above a statutory maximum, unless approved by the monitor.
The moratorium will last for an initial period of 20 business days, and may be extended by a further 20 business days without creditor consent, and by further periods after that with the agreement of creditors or the court.
Subject to limited exceptions, the moratorium will not prevent a creditor from exercising any rights of set-off that do not require court action or the company to make a payment.
The new moratorium will not be available for certain types of financial services companies (for example, banks and investment firms) and, broadly speaking, financial and commodities contracts.
Unless there is agreement between the parties, or court approval (where it is satisfied that to continue with a contract would cause hardship to a supplier), a supplier will not be able to rely on any termination provisions, or right to modify terms, in a contract if the other party has entered into, or suffered, an insolvency event (including the new moratorium). And, whilst it is in an insolvency process, a supplier will not be able to exercise any rights of termination or modification under the contract that might have arisen before the start of the insolvency process.
It is not uncommon for contracts to contain termination and modification clauses that allow a supplier to terminate, and/or modify the terms of, a contract where the other party becomes subject to an insolvency event. They are designed to give a supplier options in the event that a customer is about to enter into insolvency, with the likelihood that it will fail to perform (for example, pay or take delivery). They provide a mechanism to help mitigate risk of further losses. The new provisions will significantly curtail a supplier’s protection in these circumstances.
For a temporary period, the new measures will not apply to “small” suppliers – generally speaking, these are suppliers who, during their most recent financial year, meet two out of three criteria, of having an annual turnover of not more than £10.2m, a balance sheet value of not more than £5.1m, and (on average) no more than 50 employees.
A supplier will retain the right to terminate contracts on other grounds permitted under the contract, except where the ground arises prior to the insolvency event (for example, for non-payment for supplies made following the insolvency event, or for breach of the underlying contract). Therefore, termination could be allowed if, for example, a customer failed to make payment for goods or services supplied following the insolvency event, or for breach of the underlying contract.
There will be exceptions to the new termination restrictions, similar to those which apply to the new moratorium. In addition, the new termination measures will apply only to contracts for the supply of goods and services to a company that becomes subject to an insolvency event, and not to (or for the benefit of) the supplier of those goods or services if it becomes subject to the insolvency event.
It will be important for directors, creditors and suppliers to know the extent to which the regulations will affect them and their businesses. Directors’ relief from personal liability for wrongful trading is temporary, in respect of debts accruing during a limited time, and will not relieve them of their other responsibilities as directors. Where the new moratorium is instigated, creditors will be subject to the new regime before being able to take enforcement action; and suppliers will need to be careful not to terminate, or modify, a contract where it has no right (in spite of the express terms of a contract), and give rise to a claim against them for breach of contract.