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Coronavirus - Directors’ Duties: Changes to Personal Liability for Wrongful Trading - UK

  • United Kingdom
  • Coronavirus
  • Insurance and reinsurance
  • Litigation and dispute management
  • Restructuring and insolvency

14-10-2020

The Insolvency Act 1986 (the “Act”) introduced the concept of Wrongful Trading (s214 of the Act); if the directors of a company, having concluded that the company could no longer avoid insolvent liquidation or administration, fail to take all steps to minimise the losses to creditors, they can be made personally liable for the consequent losses to creditors.

The steps which the directors should have taken and the facts on which they will be judged are those of a reasonably diligent director, having both the general skill and experience that may reasonably be expected of a person carrying out the director’s function and the actual skill and experience of that director. Intentional fraud or dishonesty is not required to be found liable for wrongful trading. However, a director can only be found liable if it is found that the company is worse off as a result of continuing to trade.

If a director is liable for wrongful trading, they will be required to make a contribution to the assets of the company and may also be subject to disqualification of between 2 and 15 years under the Company Directors Disqualification Act 1986.

From 1 March 2020 to 30 September 2020, the Corporate Insolvency and Governance Act 2020 (“CIGA”) temporarily suspended some provisions of UK insolvency law to help companies cope with the COVID-19 pandemic. In particular, CIGA altered the liability of directors for wrongful trading.

CIGA said that if a company went into liquidation or administration and a director was subsequently found liable for wrongful trading, the Court would presume that the directors were not liable for any worsening of the company’s financial position during the period 1 March to 30 September 2020, as it was presumed those losses were due to the pandemic.  In effect, the amount by which a director could be ordered to contribute to the assets of the company was to be determined without taking into account losses in that six month period.

Whilst not absolving directors from liability for the period before 1 March 2020 or after 30 September 2020, it was expected materially to reduce that liability, and therefore encourage directors to look for solvent solutions rather than rush to insolvency to avoid personal liability.

These adjustment applied to directors of all companies, except financial services (e.g. banks, insurance companies, building societies etc.). Companies with permission to carry on a regulated activity under part 4A of the FSMA 2000 and who are not required to refrain from holding client monies were also excluded from the adjustment

Whilst some of the temporary changes to insolvency law introduced by CIGA have been extended to 31 December 2020, the changes to wrongful trading have not. Creditors are not able to force an insolvency by issuing a winding up petition so the pressure is now back on directors to protect the interests of those creditors. Directors are at a renewed risk of personal liability where they continue to trade a company which cannot avoid insolvency.

D&O Insurance

With the temporary protection for wrongful trading having expired, but with the pandemic showing no signs of abating, directors must continue to ensure that they are acting in line with their duties.

Many directors will rely on Directors and Officers (D&O) insurance to cover their risks. However, capacity within the insurance market for D&O insurance is  reduced, with some insurers ceasing to write this insurance. Insurers are particular wary of shareholder and third party actions in assessing whether to provide D&O insurance.

The result is that we are seeing insureds not being offered renewal terms from their existing insurer and brokers struggling to find other insurers willing or able to provide the insurance. Where terms are being offered, we have seen these at many 100% multiples of prior years’ premium, and at reduced indemnity limits.

We therefore stress the need for early engagement with your insurance broker in advance of your D&O renewal.

Coverage Issues

Directors also need to take note of the scope of their D&O insurance. All policies typically exclude cover for (i) fraudulent, dishonest or deliberate acts or omissions (ii) litigation which was prior or pending prior to commencement of the policy and (iii) circumstances known at inception of the policy.

Whether a “fraudulent/deliberate acts” exclusion will in fact apply to a wrongful trading claim depends on the nature of the findings of a court and the wording of the relevant exclusion. If a director is found liable for wrongful trading without a finding of deliberate or fraudulent misconduct, the exclusion in some policies may not bite. However, some exclusions are broader and exclude cover where the director or company has gained a profit or advantage to which it was not entitled. There may also be factual circumstances when this exclusion may apply.

It is therefore imperative that directors have a clear understanding of the scope of their D&O policy to seek to avoid any coverage issues if a claim is made on the policy. 

Considerations for directors

For directors, the re-imposition of liability for wrongful trading and the tightening of the market for D&O insurance creates a perfect storm.  At a time when trading conditions remain difficult for many sectors, directors take comfort from the protection from personal liability which D&O insurance  can bring.  If that safety net is gradually being removed, or made unaffordable, directors will need to look to other ways to protect their personal positions which may lead to more insolvencies at an earlier stage. This  is bad news for the economy and employees.