Covid-19 and wrongful trading

The impact of Covid 19 on businesses has already been significant, with several high profile businesses in the UK and the Channel Islands ceasing to trade or entering administration.  The sudden drop in custom as a result of restrictions imposed to protect the community from Covid 19 (the Restrictions) has resulted in businesses experiencing severe, if not crippling cash flow issues.

Although the current situation is novel and unprecedented, it is important to remember the duties and responsibilities of company directors in these circumstances under the Companies (Guernsey) Law 2008 (the 2008 Law), together with their duties under Guernsey common law, still stand.  This article is a reminder of some of those duties and how best to ensure compliance with them in the present climate.

Duties under common law

Covid 19 and the Restrictions do not change the fact that directors still need to comply with their fiduciary duties to the company including:

• the duty to act in good faith and in the interests of the company as a whole
• the duty to promote the success of the company
• a duty to exercise reasonable care and skill

Fundamentally it is up to each director to decide, in good faith, whether it is appropriate for the company to take a particular course of action. Such judgements will often be extremely difficult to make given the uncertainties around the pandemic, in particular the duration the Restrictions and the pandemic itself will last. Directors should have regard to a number of factors when making their decisions, including balancing the long-term interests of the company against the short-term interests based on the information available to them at the time of making the decision. Directors may, for example, seek to prioritise essential supplier payments, come to agreements with other creditors where possible, claim against any insurance policies from which the company benefits or claim under applicable government schemes.

Duties under the 2008 Law

As the Restrictions hit companies hard, companies will face significant and increasing pressure on their cash flows. Previously, financially stable companies may well find themselves facing insolvency.

The “zone of insolvency” affects directors’ duties.  Ordinarily, directors owe duties to the members and creditors of a company.  As addressed recently in the Carlyle litigation in Guernsey, when a company is “on the brink of insolvency”, the directors have a duty to give precedence to the interests of the company’s creditors where necessary.

During the imposition of the Restrictions, directors should keep a close eye on their cash flow and the company’s debtors.  If it is apparent that even the short term impact of the Restrictions will put the company in a position where it has no prospect of recovery then advice should be sought from an insolvency practitioner. This is to guard against the risk of potential personal liability under the 2008 Law for wrongful and fraudulent trading.

Wrongful trading

Under the 2008 Law, a person can be required to contribute to a company’s assets in circumstances where:

• there is an insolvent liquidation;
• the company continued trading when that person ought to have known that there was no prospect of avoiding insolvency; and
• the person was a director at the time.

Liability for wrongful trading can be avoided if they can demonstrate that they took every step to minimise the possible loss to creditors. In order to mitigate against the risk of wrongful trading, it is important to recognise the “zone of insolvency”.  The prospect of an insolvent liquidation is often obvious with hindsight but can be more difficult to see at the time.  It may be something as simple as losing a significant customer, when there is no prospect of replacing that business. 

Fraudulent trading

Liability for fraudulent trading arises where a business was carried on with the intention to defraud creditors or for any other fraudulent purpose.  Fraudulent trading involves the additional element of intent. 

Under the 2008 Law, fraudulent trading gives rise to a civil liability. The court can order a person to make a contribution to the company’s assets during the insolvency process. However, unlike wrongful trading, fraudulent trading is also a criminal offence.

Other jurisdictions

Several countries have announced temporary suspension or alteration to these rules to assist companies and their directors while the situation continues. 

In England and Wales they are introducing temporary legislation to suspend wrongful trading provisions and introduce a moratorium on creditor actions for some businesses which will need restructuring.  In Germany, the government has removed the requirement for businesses to file for insolvency in circumstances of indebtedness.  The States of Guernsey have put in place financial measures to assist struggling business, but at present there have been no changes to the 2008 Law which affect directors’ liabilities. 

Recommendations

The Restrictions have been imposed to keep people safe, but will have a far reaching effect on the viability and solvency of businesses.  The duration of the Restrictions is unknown, and therefore directors should take care in considering their company’s position and the likely prospects of recovery after the Restrictions in scenarios of different length. Directors should make decisions in a prudent and reasonable manner with the aim of securing the short and long term survival of the company. It is important to make careful contemporaneous records of any decisions, and take professional advice in relation to concerns over when the focus of the directors’ duties may change and which help mitigate against liability for wrongful trading and breach of fiduciary duties.