No more wrongful trading?

Andrew Studd, Partner in the Russell-Cooke Solicitors, charity law and not for profit team.
Andrew Studd
3 min Read

The Business Secretary has announced that the wrongful trading provisions in the Insolvency Act will be suspended retrospectively for three months from 1 March 2020.

Since the outbreak of the Covid-19 epidemic and the Government's subsequent lockdown, numerous organisations, including charities, have faced significant financial and cash flow difficulties. Many charity trustees worry generally about the risks of being a charity trustee, and in particular have concerns that arise from the potential insolvency of their charity. So the recent announcement from the Business Secretary will be comforting, albeit like many similar announcements, the details remain to be seen.

Trustees of charitable companies limited by guarantee and charitable incorporated organisations are subject to the insolvency laws and regime. In normal times a trustee's primary duty is act in the best interests of the organisation, which in the case of a charity is to seek to deliver the charity's objects. However where the charity is insolvent, or potentially facing insolvency, the trustees' duties shift.

Insolvency can arise on two bases – on a cash flow basis where the organisation cannot pay its debts as they fall due, and on a balance sheet basis where the organisation's liabilities, including contingent and prospective liabilities, exceed its assets.

Under the Insolvency Act, a trustee who allows the charity to continue to trade when they knew or ought to have concluded there was no reasonable prospect that the charity would avoid going into insolvent liquidation or insolvent administration may be held personally responsible for the increase in any losses suffered by creditors following the point of insolvency. Allowing the organisation to continue to trade in such circumstances is known as "wrongful trading". In such circumstances a liquidator or administrator can apply for a court order requiring the relevant trustees to contribute to the assets of the organisation.

A trustee will be judged by reference to the general knowledge, skill and experience that they have or the general knowledge, skill and experience which would reasonably be expected of a trustee. The court will not require a trustee to make a contribution if they took every step with a view to minimising the potential loss to the charity's creditors as they ought to have taken. 

This duty has in some instances encouraged worried trustees to close down a charity facing insolvency earlier than might otherwise be the case given the potential ramifications on their "day job" and the potential for personal liability for wrongful trading losses. Given the current situation, there is a real risk that otherwise viable organisations will close perhaps unnecessarily.

So the Business Secretary's recent announcement is helpful. This is a substantial announcement and, while its details are still unclear, it creates further space for organisations to manage during the current crisis and to hopefully thrive in the future.

In conjunction with this announcement there were a number of related announcements that had been under consideration for a while with a view to creating more of a "rescue culture". These include a moratorium on creditors enforcing their rights pending the development of a restructuring plan and permitting the organisation to acquire essential supplies to enable them to continue to trade (currently utilities). It also allows the proposed restructuring plan to bind creditors, although how this works is as yet unclear.

This announcement does not however relieve trustees of their other duties under charity and insolvency laws and is by no means a lifeline to struggling charities. The announcement just provides an incentive for trustees not to act overly hastily. However it may be that interruption to income generation during the lockdown has caused such a significant impact on the charity's future – loans will still need to be repaid at some point - that closure remains the only option.

Sadly this good news does not apply to unincorporated charities where trustees still face potential personal liability for losses suffered by the charity (which is why we urge any charity carrying out any sort of long term, risky or trading activity to incorporate).

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