When a company is solvent, a director has a statutory duty to act to promote the company's success and the interests of its shareholders. However, if a company is struggling, is on the verge of insolvency or, is in fact insolvent, then this duty changes to become a duty to act in the best interests of its creditors (as a whole).
It can be a grey area as to precisely when the duty changes from one owed to shareholders to one of protecting creditors and as to what such duty might require of directors in particular cases. Directors need to be particularly mindful if the company finds itself in financial difficulty and is considering accepting new orders/new credit/government support in an attempt to stay in business. We would suggest taking legal advice in these circumstances, but directors may mitigate their exposure to liability by ensuring that they properly document their decisions and reasoning behind them – make sure you keep a good, defensible, audit trail.
Importantly, and recognising the fact that many more companies face an uncertain future at the moment, the government introduced a temporary suspension of the wrongful trading rules under the Insolvency Act 1986 (IA) (effective from 1 March – 1 June 2020) to give directors greater confidence to trade during this exceptional time. However, other statutory insolvency rules such as fraudulent trading (section 213 IA), directors' general duties in the CA and the threat of disqualification will continue to apply as a deterrent against misconduct.
A breach of directors' duties may result in a director being subject to civil and criminal liability as well as facing the risk of disqualification, so directors should consider taking legal advice if they are concerned.
Key issues for boards to monitor during Covid-19
In this uncertain and rapidly evolving situation, directors will need to manage their company's response to Covid-19. This is likely to involve them taking some tough decisions under time pressure. The relevant considerations will vary depending on the nature of the business but some of the key issues for directors to take into account are set out in the table below.
Employee and customer health and safety
Keep abreast of the latest government and official guidance and requirements and ensure that they are fully complied with.
Financial impact of Covid-19 and impact on cash flow
Regularly review the short-term and long-term financial impact of Covid-19 and preserve sufficient cash flow to trade.
The board should also discuss with the company's auditors if the company needs to make balance sheet adjustments or post balance sheet disclosures in relation to the impact of Covid-19.
Note that companies can seek a 3 month extension within which to file their accounts.
Oversee the management's attempts to identify, prioritise and manage the main risks to the company's business as a result of Covid-19. This includes getting more regular accounting and internal reporting updates from the management and monitoring the company's compliance with its banking facilities.
The company should have a business continuity plan in place and regularly review and refine it as the situation evolves. Such a plan may include:
- Reviewing existing contract terms to understand the impact of Covid-19 on the company's contractual obligations
- Assessing the effect on employee disruption and on supply chain and production disruption
- Assessing whether business interruption caused by Covid-19 is covered by existing corporate insurance policies. Check the terms of the D&O insurance and directors' indemnities to understand to what extent directors are protected from liability.
Consider directors' responsibilities to disclose the principal risks and impact of Covid-19 in the company's annual report.
Consider holding meetings virtually or by conference calls.
Maintain regular internal and external communication as well as keeping a good record of the decision-making process.
Key person risks
Ensure that the company has contingency plans in respect of key personnel
Review and consider executive remuneration and consider suspending incentive or bonus plans.
Beware though of taking voluntary pay cuts or giving up bonuses: strict rules have to be followed by both companies and employees (including directors) to avoid triggering a tax charge. These are especially important for directors of owner managed businesses as there are extra requirements for an individual who is a director.
If you require any assistance on the matters discussed in this article, or if you have any other queries on challenges your business is facing, please contact a member of the Corporate Department at Trowers & Hamlins LLP.