6 May 2020 - by Clifford Chance LLP

The Impacts of COVID-19 on Insolvency Law Processes and Reforms

A survey by the National Lottery Heritage Fund found that “around a third of charity/third sector organisations and around a third of community and voluntary groups said they could not exist beyond July.” The COVID-19 pandemic has sadly made this the new norm. For many organisations, insolvency is now of real concern and so understanding the changing insolvency landscape is key.

This update is intended as a guide only and reflects the current position in the UK at the date of publication. It is particularly relevant to companies and incorporated charities and social enterprises.

The first part of this update discusses Her Majesty’ Revenue and Custom’s (HMRC) new temporary guidance when acting as a creditor in insolvency proceedings. The second part briefly looks at some of the proposed (but as of yet unimplemented) changes to UK insolvency law, with a particular focus on the proposed temporary suspension of wrongful trading liability.

Part 1: HMRC’s New Temporary Guidance on Insolvency

To support individuals, companies and partnerships affected by the COVID-19 outbreak, HMRC issued temporary guidance on 27 March 2020. The guidance focuses on HMRC’s approach when acting as a creditor in new and existing insolvency proceedings.

The guidance addresses (1) HMRC’s enforcement activity and (2) existing voluntary arrangements (VAs).

We recommend that any organisation affected by either issue stays in contact with HMRC and seeks further guidance from HMRC on their individual case where necessary.

HMRC’s Enforcement Activity

HMRC has “paused the majority of all insolvency activity for now”. It will not petition for bankruptcy and winding up orders unless it is deemed essential to do so, i.e. where fraud or criminal activity is present.

HMRC will continue to consider new Company VAs, Administrations, Individual Voluntary Arrangements and Trust Deed proposals. This should ensure that businesses facing financial difficulty can still access the appropriate insolvency regime.

Existing Voluntary Arrangements

NGOs facing financial difficulty can enter into a VA or may be subject to an existing VA. This is a legally binding agreement which allows organisations to pay off their debts over a fixed period of time. The VA is a critical aspect of the rescue process, providing the breathing space needed to tackle operational and management issues to turn a business around. However, failure to pay the agreed contributions under the VA can jeopardise the arrangement, often leading to liquidation.

Where organisations owe significant tax arrears, HMRC is often an influential creditor in the VA. In its guidance, HMRC recognised that, as a result of the impact of COVID-19, organisations in existing VAs may struggle to meet the required contributions or post-arrangement tax obligations. Therefore, HMRC has relaxed its approach to such defaults under VAs:

  • HMRC expects supervisor discretion to be “exercised to its maximum, with reference to creditors only if essential”
  • HMRC will “support a three-month break from contributions from customers impacted by coronavirus”, with there being “no need to contact HMRC to request this deferment”. Further guidance, which will depend on the COVID-19 situation, will be issued on conclusion of the initial three months

Part 2: Proposed UK Insolvency Law Changes

The changes outlined below have not yet been implemented. This section will be updated if such measures are introduced or important clarification is provided.

On 28 March 2020, Business Secretary Alok Sharma announced the following intended changes to UK insolvency laws. The proposed new insolvency measures include:

  • a temporary suspension of wrongful trading provisions
  • the implementation of the proposed August 2018 insolvency framework, which includes a short moratorium from credit action to give companies breathing space to explore rescue or restructuring options

Overview of Suspension of Wrongful Trading Provisions

This is relevant to incorporated charities and companies which have or may enter into insolvent liquidation or insolvent administration. In such a case, a charity trustee or company director may be liable for wrongful trading if they continued to trade when they knew or ought to have known that there was no reasonable prospect of avoiding insolvent liquidation (Insolvency Act 1986, section 214). A judgement of wrongful trading is serious, potentially leading to fines, being held personally liable for company debts, penalties and disqualification for up to 15 years.

The proposed legislation would temporarily suspend liability for wrongful trading for three months, taking effect retrospectively from 1 March 2020.

The proposed suspension should allow charity trustees/directors to continue to trade without the risk of personal liability for wrongful trading.

However, there is no proposed change to other offences such as fraudulent trading. Therefore, it is important that directors/charity trustees still carry out their duties properly and in good faith to ensure they do not fall foul of other offences or in breach of their other duties.

Implementation of a New Short Moratorium

The proposed additional moratoria mechanism will likely protect companies against creditor enforcement while the company considers options for rescue and restructuring. Whilst we must await further clarification from the UK government, this measure would clearly benefit organisations as a short-term measure.

Concluding Thoughts

Organisations should continue to closely monitor their own financial situation, which may have been detrimentally impacted as a result of COVID-19 and plan for their projected financial situation going forward. Other options which organisations may wish to consider include:

  • merging with another organisation where synergies are present
  • considering eligibility under public funding schemes, such as the government’s £750 million fund to support some frontline charities and social enterprises during the COVID-19 crisis

Further Reading

On company VAs:

On the new laws:

Information in this update has been provided by A4ID’s Legal Partner Clifford Chance LLP and does not constitute legal advice. If you require specific legal advice arising from the matters outlined in this update please contact the Pro Bono Legal Services Team at [email protected].