The wrongful trading provisions suspended by the government at the start of the Covid-19 crisis came back into force on 1 October 2020. Tim Symes uses Cineworld’s situation as a useful case study to discuss the perils of wrongful trading.
Cineworld theatres are about to go dark across the UK and the US, with the loss of 45,000 jobs. Just like the British government depicted in the enduring Bond franchise, Cineworld was pinning its hopes on 007 to avert disaster.
The latest Bond film, No Time to Die, was supposed to be released in November last year but was postponed until this February, then April, then November. It has now been postponed until Easter next year. This latest delay has been, if not a mortal blow to Cineworld, a painful one indeed.
Cineworld’s announcement comes at a time when the suspension to a director’s liability for wrongful trading has been lifted. Its plight brings the relevance of these provisions sharply into focus for company directors.
The rules on wrongful trading say that if a director knew or ought to have concluded there was no reasonable prospect of avoiding insolvent liquidation (or administration), then they can be found liable to contribute to the assets of the company. That is, unless, the director can show they took “every step” to minimise loss to creditors. This is widely regarded as an almost impossibly high bar, and so not a defence to pin one’s hopes on.
The courts have clarified the “contribution to assets” element. It means the director can be found liable for the increase in the net deficiency generated in the period from the time the company should have stopped trading until it went into insolvent liquidation or insolvent administration.
The Cineworld board will have calculated that No Time to Die was critical to cash flow for their business after a prolonged period of little or no activity. They would have also calculated that this influx of cash would (albeit with possible other measures) help get it through a difficult winter to a hopefully rosier 2021. In essence, the board will have sought to satisfy itself that the business would remain viable for the foreseeable future based on the realistically anticipated levels of future trading, including the expected revenue generated by No Time to Die next month.
Then came the news of the delay to the film’s release and, at a stroke, the numbers didn’t work anymore.
These kinds of situations are faced by company directors all the time, where a hoped-for deal or revenue stream falls through or looks precarious. Sometimes, these anticipated deals are so important that the existence of the business depends on it.
As soon as the directors are faced with this prospect, they must consider the provisions of wrongful trading and whether they should continue trading. Or they may face personal financial liability.
If the directors do not have a viable plan B to the expected deal and simply press on hoping something improves the company’s position, then they are putting themselves squarely in the sights of a wrongful trading claim if the company later enters insolvent liquidation. This is because they knew, or at least ought to have realised, that without the expected deal or revenue stream, or any viable plan B, the company would end up in insolvent liquidation or administration.
There is no suggestion here that had Cineworld continued to trade on it would have ended up in a formal insolvency. However, it has been reported that the board accepts its loan covenants will be breached at the end of December but is negotiating waivers and exploring new funding, as well as extensions to its revolving credit facility and even a potential equity raise.
Directors will want to take urgent stock of their companies’ position in light of the wrongful trading rules becoming ‘live’ again from 1 October. They will need to be sure that if their business is in a bad place now, their plans to improve its fortunes are reasonably viable, rational and deliverable.
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