The economic uncertainty for companies caused by the Covid-19 pandemic has placed a heavy burden on directors. That burden of responsibility is set to become even heavier as the temporary measures introduced in 2020 to support companies during the pandemic come to an end. Small and medium sized enterprises (“SMEs”) and those businesses operating in the travel, hospitality, leisure and manufacturing industries have been impacted in particular.
We consider what impact the lifting of the suspension on wrongful trading provisions on 30 April 2021, and the end to the furlough scheme on 30 September 2021, will have on claims against directors.
Wrongful Trading provisions are set out in the Insolvency Act 1986 (“IA 86”) such that directors can become personally liable for the company's debts if they allow the company to trade after the point at which they know or ought to know that the company has no reasonable prospect of returning to solvent trading.
The courts have wide discretion to order the level of compensation the director ought to pay to the company, but the typical assessment of compensation is based on the extent to which the deficiency to creditors increased between the date the company ought to have ceased trading and the date the company actually ceased trading.
The Covid-19 pandemic and subsequent restrictions gave rise to situations whereby the normal operation of these provisions would force many businesses to cease trading.
The Corporate Insolvency and Governance Act 2020 (the “Act”) was therefore introduced to provide what the business secretary, Alok Sharma, described as “much needed breathing space” for companies adversely impacted by the pandemic. This included the temporary suspension of wrongful trading provisions until 30 September 2020 and applied retrospectively from 1 March 2021. The suspension period was later extended from 26 November 2020 to 30 April 2021.
The changes implemented by the Act meant that, when considering the contribution that a director is required to make towards the company’s debts, the court is to assume the director is not responsible for any worsening of the financial position of a company or its creditors during the period of the suspension.
The removal of the threat of personal liability of directors for wrongful trading during the suspension periods do, on the face of it, assist directors when trying to navigate through the challenging economic climate resulting from Covid-19.
Impact on claims
The suspension of the wrongful trading provisions may not, however, provide the lifeline for directors as appears at first blush. Directors will not escape all personal liability and their actions will remain subject to scrutiny, most notably in relation to their statutory duties under ss171-177 of the Companies Act 2006. This includes a duty to promote the success of the company and to act with reasonable care, skill and diligence.
Claims against directors for wrongful trading are commonly made alongside claims of breach of fiduciary duties. The wrongful trading suspension will not preclude a claim being made for breach of fiduciary duties arising during this time. Liquidators may therefore still bring misfeasance claims against directors, rather than wrongful trading claims, based on their actions during the period of the suspension.
Remedies for fraudulent trading under s.213 of the Insolvency Act 1986 also remain in place and historically, during difficult economic times, the risk of fraudulent and dishonest activity is higher. In addition, directors may face claims under the directors' disqualification regime, where directors can be faced with a compensation order if their actions caused a loss to one or more creditors.
We do expect the courts to show leniency and not be unduly critical of directors where they have, in good faith, expected the company to return to full trading. While the decision to continue to trade during the pandemic will involve looking to the future, we also expect the courts to acknowledge that companies are operating in a highly unusual environment, with ongoing uncertainties around the easing of lockdown, both on a national and localised basis.
The suspension may cause administrators and liquidators to look more closely at whether the directors ought to have ceased trading before 1 March 2020 and/or immediately following the lifting of the suspension. However, there may be public policy considerations for the courts given the intention of the Act is to prevent large numbers of businesses falling into administration or liquidation. Having spent vast sums supporting many businesses through the pandemic, the government may still seek to introduce additional measures to ensure that large scale insolvencies do not occur when the support ends.
Ultimately, we expect that once the suspension of wrongful trading provisions is lifted, there will be an increase in insolvencies, which inevitably will lead to more scrutiny of directors.
It is likely we will also see an increase in shareholder actions challenging decisions made by directors during that time. Directors will need to show that they discharged their duties to their companies, by acting with reasonable skill care and diligence, and with a view to promoting the success of the company. With conflicting pressures during this time, with workforces on furlough or working from home, directors ought to ensure they retain focus on their key duties to the company and creditors.
The Coronavirus Job Retention scheme (more widely known as furlough) has further propped up companies whose businesses have largely ceased trading, and who would otherwise have faced the prospect of laying off staff and a depleted workforce when it recommences trading. However, furlough has been described by HMRC as “a magnet for fraudsters”. It is estimated that between 5-10% of furlough payments are fraudulently claimed, which equated to between £2bn and £3.9bn worth of fraudulent payments in October 2020. This figure will continue to rise until the scheme ends on 30 September 2021.
The Chancellor of the Exchequer recently announced that the Government will be funding a £100m ‘Taxpayer Protection Taskforce’ which will enable HMRC to investigate the misuse of support packages for businesses, including “furlough fraud”.
What is furlough fraud? It can occur in many forms, but some of the most common include where employers:
- deliberately claim wages under the scheme for an employee who has continued to work during the relevant period;
- claim for fictitious employees;
- manipulate salary details so that a company recovers more than it has paid out to staff in wages.
HMRC’s task force is expected to exceed 1,200 people, making it one of the largest in its history. In addition, the Finance Act 2020 bestowed greater enforcement powers on HMRC, enabling it to:-
- Claw back funds: companies found to have claimed fraudulently under the scheme will be required to repay the monies to HMRC.
- Issue penalties: of up to 100% if the act is deliberate and concealed. If remedial action is taken swiftly then this may be reduced, but the penalty will not be less than 30%.
- Hold directors/officers/partners personally liability: If these individuals have played any role in committing furlough fraud, they are at risk of facing charges under the Criminal Finances Act 2017.
- Impose criminal sanctions: The first reported arrest of an individual suspected of furlough fraud was made in July 2020.
Importantly, HMRC will not just pursue deliberate fraud, they will also pursue unintentional acts. To avoid penalties, companies will need to self-report within 90 days from when furlough payments are erroneously received.
Impact on claims
We also anticipate that there will be a considerable increase in regulatory investigations into companies and their directors. Such regulatory investigations will trigger many D&O policies.
It is also likely that a bi-product of such investigations will be an increase in claims against directors for breach of their duties to companies. Companies could pursue directors personally for their role in any furlough fraud that results in a fine or other loss to the company. The obvious claims against directors will arise where a director has either been complicit in, or instigated, the fraud. However, we expect to also see claims where directors have been negligent, including for administrative errors, failing to self-report, or to put in place remedial action.