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Changes to Insolvency Rules – #coronavirus

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Under normal circumstances firms which are insolvent, that’s to say they are unable to pay their debts, should not continue to trade. If they do and the company goes into liquidation or administration, the directors may be liable for some or all of the losses under Section 214 Insolvency Act 1986.

This applies if a person knew or ought to have known that there was no reasonable prospect that the company would avoid going into liquidation or administration but continued to trade. They must also have neglected to take the necessary steps to minimise the creditor’s losses. Understandably the COVID-19 pandemic has forced many businesses into a position where they are technically insolvent by virtue of them having to cease or reduce trading during the lockdown.

As a result, the Government plans to suspend the director’s personal liability for continuing to trade during the current national emergency should the business ultimately fail.

However, this not a ‘get out of jail free’ card and does not apply to the director’s duties under the companies act or disqualification for malfeasance and misconduct.

Similarly, s213 Insolvency Act, where the company continues to trade fraudulently, that is to say where the directors knowingly or recklessly continue to trade with the intention to defraud creditors, remains unchanged.

In general, for behaviour to fall under section 213 of the Insolvency Act, there must be dishonesty, by incurring company debts. This being done by the directors in the knowledge that creditors or customers will not be repaid, or at least a high risk that they will not be. Indeed, Chadwick LJ accepted counsel for the directors’ submission of that.

To further assist companies, the government proposals include a pre-insolvency pause or moratorium which prevents creditors from issuing claims or winding up petitions against companies who have sought the protection of this specific measure.

However again, this is not intended to be a way for businesses to avoid paying their debts and is understandably subject to various conditions being met. It is intended to operate in a similar fashion to Chapter 11 in the United States, also referred to as ‘reorganisation bankruptcy’. This is where the directors remain in control of the business and are referred to as ‘Debtors in Possession’ while being supervised by an insolvency practitioner.

Make no mistake, despite the apparent benefits of Chapter 11 in putting worthwhile and viable companies on life support with intensive care supervision, the success rate or long term survival rate is depressingly low. While in fairness, the COVID-19 pandemic is far from the usual circumstances and is likely to have far greater success, many economists have been predicting and evidencing a global slow down over the preceding year and therefor corporate failures cannot entirely be held to have been caused in a vacuum by the pandemic.

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