Directors are often put under the spotlight in difficult times due to their management and decision making responsibilities.
In the face of Covid-19, and the uncertainty that lies ahead for all of us, directors should be aware of their statutory duties both generally and the changing scope of duty in the event of financial distress. Directors can be held personally liable for their actions, or failure to act, which cause damage to the company and/or is prejudicial to its creditors.
In the recent case of Re Systems Building Services Group Limited (In Liquidation) [2020] EWHC 54 (Ch), the Court held that a company director continues to owe general duties under sections 171 to 177 of the Companies Act 2006 even after a company enters into administration or liquidation (despite these events previously triggering a duty to minimise creditor losses).
We provide a brief reminder of directors' general duties under the Companies Act, how these evolve in an insolvency situation, and what steps directors should be taking now in response to changing economic environment triggered by the Covid-19 crisis.
Directors Duties
Pursuant to Sections 171 – 177 of the Companies Act, a director's main duties include an obligation to:
- Promote the success of the company
- Exercise independent judgment, reasonable care and skill
- Avoid conflicts of interest
General Duties
However, once a company becomes insolvent, a director's primary duty is then to act in the best interest of the Company's creditors.
Further, when there is no reasonable prospect of avoiding insolvency, the wrongful trading duty is engaged and directors must then take every step to minimise losses for creditors.
Creditor Duties
The Court has the power to order that a director personally contributes to a company's assets if it they are held to be in breach of its Creditor Duties. Accordingly, it is vital that directors recognise when a company is, or is likely to become, insolvent.
The Court has the power to order that a director personally contributes to a company's assets if it they are held to be in breach of its Creditor Duties. Accordingly, it is vital that directors recognise when a company is, or is likely to become, insolvent.
A company is generally deemed insolvent by reference to Section 123 of the Insolvency Act 1986 if it cannot pay its debts as they fall due (Cash Flow Test), or its total assets are less than its liabilities (both contingent and prospective) (Balance Sheet Test).
The reality is that it can be difficult for directors to identify when the transition from solvency to insolvency takes place – and with it the requirement to consider Creditor Duties. This is likely to be even more challenging in the current climate - when seismic changes are happening on a daily, if not hourly, basis.
Directors should consider that the balance between General Duties and Creditor Duties moves on a sliding scale:
If the probability of corporate insolvency is 50%, then both of these duties will sit alongside each other.
However, if insolvency becomes more certain, then the Creditor Duties must take priority, although it is important to note the Court's decision in Re Systems BSG that General Duties are not extinguished entirely.
What should directors do now
Regardless of the size and financial health of the business, our advice to all company directors is to:
- Maintain accurate financial reports about the performance of the business, its debtors and its liabilities;
- Hold regular meetings with fellow directors ((daily if circumstances require it) so that the risk of financial difficulty (and the threat of insolvency) is monitored and assessed;
- Carefully consider and evaluate any significant transactions to ensure that any board decisions can be justified in due course as having been in the best interest of the Company or its Creditors (as applicable). This is particularly important in respect of any lending facility that you may seek from your bank (or the Government).
- Seek professional advice if you are concerned that the company has become insolvent, or that it cannot reasonably be avoided in the future (note that this also applies to individual directors who may be worried about any decisions the board is taking - as this can potentially be relied upon in any defence to a wrongful trading claim).
- Maintain Directors and Officers insurance which can offer some protection against potential legal action, as can s1157 of the Companies Act 2006 in defending any breach of duty claim if the Court considers that the director has acted honestly and reasonably.
- Keep abreast of all Government updates, measures, guidance and any new legislation relating to COVID-19 – including any financial assistance (in the form of grants and/or loans) which may become available to businesses in the immediate future.
