It is well documented and understood that directors have their basic statutory and fiduciary duties (such as under sections 171 to 177 of the Companies Act 2006 which include a duty to act in the company’s best interests, promote its success and act in the interests of its creditrs).
However, in considering their personal liability, directors also need to be mindful (especially when a company is financially challenged) of other statutory duties such as liability for wrongful trading (under sections 214 and 246ZB of the Insolvency Act 1986 (the “IA 1986”)), fraudulent trading (under sections 213 and 246ZA IA 1986), misfeasance (under section 212 IA 1986) as well as contractual personal liability (for example, under personal guarantees). In addition, a director can face disqualification under the Company Directors Disqualification Act 1986.
In this briefing we consider directors’ liabilities for wrongful trading, changes made to this potential liability as a result of the recent pandemic and the extent to which such liability may be covered by D&O Insurance.
Under the Insolvency Act 1986 (sections 214 and 246ZB) if, having concluded that the company can no longer avoid insolvent liquidation or administration, the directors of a company fail to take all steps to minimise the losses to creditors, the directors can be made personally liable for the consequent losses to creditors. This is known as wrongful trading.
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.
Under the Insolvency Act 1986, if a director is found liable for wrongful trading, they can be ordered personally to make a contribution to the assets of the company.
Wrongful trading came under the spotlight in 2020, driven by the challenging trading conditions experienced by many businesses due to the Covid-19 pandemic.
Accordingly, on 28 March 2020, the UK Government announced that (with retrospective effect to 1 March 2020) the statutory wrongful trading provisions would be suspended (initially for 3 months and later extended until 30 September 2020). On 25 November 2020, the government used secondary legislation (The Corporate Insolvency and Governance Act 2020 (Coronavirus)(Suspension of Liability for Wrongful Trading and Extension of the Relevant Period) Regulations 2020 (the “Regulations”)) to revive the suspension of liability for wrongful trading from 26 November 2020 until 31 April 2021 on the same terms as that originally introduced back in March 2020.
During the second reading of the Corporate Insolvency and Governance Bill (which passed into law on 26 June 2020), the UK Minister for Business, Alok Sharma, stated:
“It will allow directors of companies that are technically insolvent, but simply because of a temporary drop in demand caused by the covid-19 crisis, to proceed with the business without the threat of personal liability.”
CIGA 2020 (and more recently the Regulations) effectively suspend personal liability for wrongful trading by requiring the court to assume, in determining the amount (if any) that a director should be ordered to contribute to the assets of the company on a finding of wrongful trading, that the director was not responsible for any worsening of the financial position of the company or its creditors that occurs from 1 March 2020 until 30 September 2020 or from 26 November 2020 until 31 April 2021. Technically there is a gap from 1 October 2020 until 25 November 2020 when liability for wrongful trading remained live although whether this will have real impact remains to be seen.
In light of CIGA 2020 and the Regulations what has changed for businesses; in particular for the liability of directors and the liability protection that many think they have by virtue of CIGA 2020, the Regulations and directors and officers insurance policies (“D&O Insurance”)? There may well be corollaries to be drawn between claims under D&O Insurance and claims under business interruption policies where, as is widely reported, claims under those policies are now being refused by insurers and challenged through the courts.
Directors must be even more mindful of their wider statutory duties given that liability for wrongful trading is not the only liability directors face especially in these challenging trading times.
Many might assume that any risks are covered by their D&O Insurance but this should not be assumed until a thorough review of coverage has been undertaken – the fine print here is really vital.
The same forensic exercise must also be undertaken on any policy renewals or new policies being taken out as insurers seek to reduce their risk, with some insurers reportedly ceasing to write D&O Insurance at all. There are reports of many insureds not being offered renewal terms from their existing insurer or renewal on reduced coverage and/or on multiples of previous premiums.
Directors would be well advised to dust off their D&O Insurance policy and check that it does in fact give them the protection they think it does (notwithstanding the partial comfort provided by CIGA 2020 and the Regulations) as well as carefully scrutinising the terms of any renewal of cover/new cover they take out going forward (giving themselves plenty of time to do so).
With the difficult trading conditions from the pandemic still raging, changes to D&O Insurance availability, coverage and premiums are extremely unhelpful to directors at this time.
The breathing space that the UK Government is seeking to give directors may not, given their wider statutory duties, be the panacea the UK Government claims and directors wishing to ensure that they do not face personal liability (and consequently seeking to avoid uncertainty that their D&O Insurance may not cover their exposure) may well consider their only option will be to declare insolvency earlier than they might otherwise do.
A brief review of the recent changes to the law in respect of Directors’ liability and the extent to which such liability may be covered by D&O Insurance.