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Corporate insolvencies and D&O risk

Rapid rise in insolvencies expected at the end of March 2021. What do you need to know and how to prepare?

Following a significant rise in 2019, corporate insolvencies have fallen by 27% following the onset of the pandemic in early 2020 (Quarterly Company Insolvency Statistics) due to the introduction of Government support measures such as the Coronavirus Job Retention Scheme, Coronavirus Business Interruption Loans,  Bounce Back Loans and the temporary suspension of various insolvency laws. However, we expect a rapid rise in insolvencies when restrictions on issuing statutory demands and presenting winding up petitions are lifted at the end of March 2021.

The twilight zone

During the period between the onset of insolvency and the commencement of the insolvency process, the focus of a director’s duties shifts from the company’s shareholders to the company’s creditors (West Mercia Safetywear v Dodd (1988) 4 BCC 30; Jetivia SA v Bilta (UK) Limited (in liquidation) [2015] UKSC 23). It is during this period that the actions of directors come under closest scrutiny.

When appointed, it is the duty of an Insolvency Practitioner (“IP”) to investigate the affairs of the company leading up to its insolvency and to realise any assets for the benefit of creditors, including recovery via any potential claims against directors for breach of their fiduciary duties or the provisions of insolvency and company legislation.

Wrongful trading suspension

Once the directors of a company conclude (or should have concluded) that there is no reasonable prospect of the company avoiding an insolvent liquidation or administration, they have a duty to take every step which a reasonably diligent person would take to minimise potential losses to the company’s creditors (Ss.214 and 246ZB of the Insolvency Act 1986). Directors who fail to discharge this duty risk personal liability and may be ordered to make such contribution to the company’s assets as the court thinks proper. This is known as wrongful trading.

The wrongful trading provisions were suspended initially following the introduction of the Corporate Insolvency and Governance Act 2020 (“CIGA”) retrospectively from 1 March 2020 to 30 September 2020. The suspension was re-introduced from 26 November 2020 to 30 April 2021 and at the time of writing has not been extended further. This measure allows directors breathing space to make commercial decisions and carry on trading during the current period of unusual economic instability without the fear of personal liability. However, directors should proceed with caution since the suspension does not apply to other actions that an IP can pursue, such as a misfeasance claim under s.212 of the Insolvency Act 1986.

Implications for directors

Directors should therefore continue to act reasonably, seek to minimise any potential losses to creditors and take professional advice as appropriate according to the circumstances in which they find themselves. Directors should ensure that all of their decisions are cautious, justifiable and properly recorded with regard to the entirety of the company’s creditors. It is the time to be more vigilant than ever, especially when a company is entering the twilight zone. 

Implications for D&O insurance

While the temporary suspension afforded under CIGA may avoid or delay wrongful trading claims, directors should maintain a coherent risk management strategy which will usually include suitable D&O insurance, especially since the rate of insolvencies is expected to rise in the medium term. Directors remain exposed to misfeasance actions for breach of duty, fraudulent trading and other actions under the Insolvency Act 1986 and should ensure compliance with policy terms and conditions, including prompt notification of claims and relevant circumstances.

Management liability insurers should be alive to the fact that the Government’s support is currently propping up a number of businesses which would otherwise have been rendered insolvent. Once the restrictions on insolvency processes are lifted, creditor losses may be far greater than they would have been ordinarily due to rolled-up debt, increasing the potential exposure of directors.

The future of D&O policies

Given the uncertainty surrounding the extent to which CIGA has merely delayed company insolvencies rather than averting them and the scale of potential insolvencies ahead, many commentators are predicting that Insurers may look to introduce exclusions for losses related to COVID-19 in D&O policies, especially as they come up for renewal. However, it is too early yet to state whether such practice will be widely adopted or how the market will react, but it’s definitely an area to keep a close eye on.

When approaching the renewal of D&O policies, directors should ensure that they start the process early and provide detailed proposals, including up-to-date financial information. This will allow time for negotiations on the policy terms and exclusions, including those related to insolvency and COVID-19, to avoid disputes later down the line.

For advice on any issues relating to insolvency, contact our insolvency lawyers.