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COVID-19: Proposed reforms to insolvency laws intend to give companies breathing space

The Business Secretary Alok Sharma has proposed a relaxation to the current insolvency rules, in the hope that the measures will give companies some breathing space in the face of COVID-19.

Suspension of wrongful trading rules

The proposed changes include a temporary suspension of wrongful trading rules, which Alok Sharma suggested would apply retrospectively from 1 March 2020 for an initial period of three months.

Under the current insolvency rules, a director of an insolvent company can be personally liable for the company's debts if it is found that it continued to trade when the director knew (or ought to have known) that there was no reasonable prospect of the company avoiding insolvency.

The hope is that by suspending the wrongful trading rules, company directors will be able to keep their businesses trading without the threat of facing personal liability in the event of an insolvent liquidation or administration. Company directors should note, however, that all other checks and balances ensuring that they continue to fulfil their legal duties will remain in place.

Acceleration of reforms to insolvency rules?

Following consultation in August 2018, the government announced planned reforms to the corporate insolvency regime. A key theme of the government's response to the consultation was the desire to help businesses keep trading through the restructuring process.

The government made reference to these reforms at the same time as it recently announced the proposed three-month suspension of the wrongful trading rules. Therefore, whilst these measures have not yet been brought into force, it appears that the COVID-19 pandemic may hasten their implementation.

The suggested reforms include the introduction of a new moratorium for financially distressed (but ultimately viable) companies. During the moratorium, creditors (including secured creditors) will be prevented from taking action against the company. The intention is that this moratorium will give companies time to consider and implement options for rescue, such as undergoing a restructure or seeking new investment.

It is common for contracts to include a term permitting one party to terminate the contract on the insolvency of the other. Another suggested reform to the insolvency rules will prohibit an essential supplier from terminating a contract on the grounds that the purchasing company has entered into either a formal insolvency procedure, a moratorium or a restructuring plan. Preventing a supplier from enforcing such a term will enable a company in financial difficulty to carry on receiving supplies essential to its business and may, ultimately, aid its survival.

It now appears likely that the economic threat posed by the COVID-19 pandemic is to accelerate these planned reforms to the insolvency regime.

Law correct as at 8 April 2020.

8 April 2020

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