In light of the recent coronavirus outbreak, company directors should carefully consider how to manage their duties, alongside any specific coronavirus risks. For example, on top of the financial risks posed by COVID-19, there are a broad range of other matters that should be considered, including how to ensure the safety and wellbeing of employees.
Failing to comply with these duties can have serious consequences, including directors incurring personal liability in connection with any breaches. However, by complying with their duties and obligations and acting properly, directors can minimise the risk of facing such liability.
Below we have summarised some of the key statutory duties that directors should keep in mind throughout the COVID-19 pandemic, as well as some of the other potential avenues of liability that should be considered (and avoided).
Company directors are required to comply with certain statutory duties. These duties cover a broad range of areas, from promoting the success of the company and exercising due skill and care, to avoiding conflicts of interest and taking certain action if the company experiences financial difficulties. Below, we focus on the statutory duties that might be most relevant for directors of companies that are experiencing (or might later experience) financial difficulties.
Duty to promote the success of the company
When a solvent company is trading, directors must act in a way that he or she considers would be most likely to promote the success of the company for the benefit of its members as a whole. By way of example, during the current COVID-19 pandemic, it might be prudent for a board or directors to require employees to work from home (or to restrict the extent to which those employees travel for business purposes), as this could help to safeguard the workforce, which in turn will likely promote the company’s success (to the extent possible given the circumstances).
Directors’ duties in an insolvency
Broadly speaking, a company is deemed to be “insolvent” if it is “unable to pay its debts”. However, directors may face liability in respect of actions taken (or not taken) during the period before a company actually becomes “insolvent”.
As a result, directors should be particularly vigilant in connection with the risk of the company tipping into insolvency. This is now the case more than ever, given that COVID-19 has seriously impacted company cash flows as businesses become increasingly restricted in their abilities to trade and operate on a day-to-day basis. The travel, hospitality and retail industries have been hit particularly hard, meaning companies within these industries will likely face more financial pressure than most.
Directors of companies that are experiencing such difficulties can face a broad range of challenges and must balance a variety of competing interests, demands and obligations. Directors of start-ups and SMEs may be heavily invested in their companies, either personally, financially, or both and they can face a lot of pressure to lead their business through a constant upward growth trajectory. However, in some situations – including throughout the current COVID-19 pandemic – this may no longer be realistic, possible or sensible.
Duty to act in the best interests of creditors
It is important to note that in an insolvency situation, the duty to promote the success of the company transforms into a duty to act in the best interests of creditors. This means directors must take into account the interests of creditors, giving careful consideration to the potential impact on creditors of any business decisions they make prior to liquidation.
The standard against which directors are judged
When considering what is likely to promote a company’s success, directors must take a holistic approach and consider the long-term impacts of their decisions. However, directors generally have discretion when deciding what constitutes the “success” of the company and how to balance competing stakeholder interests.
For example, even if a director knew or ought to have known that there was no reasonable prospect that the company would avoid going insolvent, he or she will not be liable if that director took every possible step that he or she ought to have taken to minimise the potential loss to the company’s creditors.
When determining whether a director has breached his or her duties, a court will consider both: (a) the expertise of the actual director in question; and (b) the expertise that would more generally be expected of a director in the same position.
It is however important to remember that courts do not generally assess the commercial judgement of directors and that the current situation is unprecedented, meaning it can be difficult to assess whether or not a proposed course of action will result in liability. Notwithstanding this, taking professional advice at an early stage can be key to mitigating the risk of future claims arising.
Other potential claims against directors
In addition to the above, there are a number of other statutory and regulatory duties to which directors must adhere. It is important that directors are aware of how and why claims can arise in relation to these duties, as a lack of awareness may result in serious consequences.
Perhaps the most likely claim to arise against directors in connection the recent COVID-19 outbreak is a claim for wrongful trading. “Wrongful trading” essentially involves directors allowing the company to continue trading even where there is no reasonable prospect that the company will avoid insolvency.
If a company has become insolvent (under the “balance sheet” test) and it appears that at some point prior to the commencement of its winding up a director knew or ought to have known that there was no reasonable prospect that the company would avoid insolvency, that director may be ordered to make such personal contributions to the assets of the company as the court sees fit. Accordingly, any decision to continue trading should be made in conjunction with professional advice where possible.
Note that in the context of wrongful trading claims, “director” includes de facto directors and shadow directors (i.e. people whose instructions the directors of a company generally follow).
However, the government has reiterated that its overriding objective is to ensure that companies “emerge intact the other side of the Covid-19 pandemic”. To that end, on 28 March 2020, the government announced that the laws regarding wrongful trading would be suspended for the duration of the pandemic and that this would apply retrospectively from 1 March 2020. This measure is aimed at protecting directors who may be faced with a decision as to whether to continue paying their suppliers and staff when, technically, the company might be approaching insolvency.
Notwithstanding the recent changes, we would advise all directors to carefully consider and review any actions taken during this period of uncertainty, as the requirement to comply with all other directors’ duties will remain in force.
On a slightly related note, the Business Secretary also announced that businesses undergoing a restructuring would be granted a temporary “moratorium” (i.e. period of suspension), during which creditors will be precluded from forcing them into administration. Such businesses will also be allowed to continue accessing raw materials during this period.
If, during the course of winding up, it appears that a director or other person involved in the formation, management or promotion of the company has:
- misapplied, retained or become accountable for any of the company’s assets; and/or
- breached any fiduciary or other duty to the company (including statutory directors’ duties),
they may be ordered to personally repay or restore any money or property obtained as a result of the misfeasance and/or pay a sum to the company by way of compensation (to be determined in the court’s discretion).
If, in the course of a winding up, it transpires that the company has conducted its business fraudulently, including in a manner that intentionally defrauds creditors, any director (or other person) knowingly involved in the fraudulent business may be ordered to make such personal contributions to the assets of the company as the court sees fit. Owners of enterprises of all sizes should be aware that in the context of fraud, structuring a business as a limited liability company offers no protection against such an order.
A director may be liable for “deceit” if he or she affirms in writing that the company can pay a debt, despite knowing that it cannot. This can result in the director being held personally liable for that debt.
Consequences for directors following a breach
A director of a company that has become insolvent may in certain circumstances be held personally liable for the company’s debts. The purpose of this is to protect creditors from director wrongdoing, whilst also encouraging directors to comply with their statutory duties.
Disqualification of directors
Under certain circumstances, a court may order that a particular individual can no longer be involved with the formation, management or promotion of a company for a given period. This includes disqualifying directors of companies for periods ranging between two and fifteen years.
For example, the court may disqualify a director of an insolvent company if his/her conduct as a director renders him/her unfit to manage a company, or if he/she has been found liable for fraudulent or wrongful trading.
A disqualified director may also be ordered to pay compensation to a company’s creditors where that director caused/worsened the creditors’ losses.
Practical steps that directors should consider
If a director knew or ought to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation, he or she will not be liable if that director took every possible step that he or she ought to have taken to minimise the potential loss to the company’s creditors.
Simply acting “honestly and reasonably” however is not sufficient for a director to escape liability for failing to minimise creditors’ potential losses. Directors should therefore aim to take positive, practical steps in order to attempt to reduce such losses (and thus avoid liability), examples of which are given below.
- Regularly monitoring the company’s finances and management accounts so as to ensure that the company’s financial status can be properly assessed. This means that directors should ensure that they have sufficient access to information on the company’s performance.
- On the basis of such up-to-date accounts, directors looking to continue trading should continually check that there is a reasonable prospect that all debts can be repaid on time (and if the answer is “no”, stop trading immediately) and should avoid taking on further credit that cannot be repaid.
- In circumstances where cash flow has been (or inevitably will be) adversely impacted, directors should open transparent lines of communication with their lenders and creditors to understand whether payments can be deferred or payment schedules restructured.
- In light of the COVID-19 pandemic, the government has implemented a suite of wide ranging fiscal measures to support businesses, including offering to extend the payment deadline for VAT liabilities and requesting that banks allow borrowers to defer loan or interest repayments.
- For further information on the full range of government assistance available, please get in touch with your usual Ignition contact.
- Complying with financial covenants entered into by the company and monitoring loan facilities. If the company breaches a financial covenant (e.g. if the company misses a loan repayment) this could trigger a right for the lender to recall the entire amount of the loan that is outstanding (a financial obligation which the company may be unable to meet).
- Communicating regularly with the other directors, including promptly raising any insolvency-related concerns at board meetings (and properly documenting this communication, including any reasoning behind decisions made). This could help to demonstrate that the company’s solvency is being monitored and reviewed at board level.
- Note that resigning at the first sign of trouble is unlikely to constitute “taking every step to minimise losses to creditors”, so resignation should only be a last resort (e.g. if you have repeatedly raised insolvency-related issues, the other directors have continually refused to act, and the reasons for your resignation have been properly documented).
Seeking professional advice
- Seeking independent professional advice where necessary, including from an insolvency practitioner and/or accountant (if potential financial difficulties become apparent) and considering/acting upon such advice where appropriate. This includes taking advice if the company is considering entering into a contract with a connected party or a transaction that could be deemed to be a preference or at an undervalue.
- Although investing in professional advice may seem like an avoidable expense (especially for smaller companies), doing so can be crucial to safeguarding the business and protecting the directors’ own interests.
Avoiding certain actions
- Avoid taking any actions likely to further destabilise the company’s financial position (without first taking professional advice), for example declaring dividends or diverting business away from the company.
- In addition, company directors and officers, or the company itself, may hold directors’ and officers’ liability insurance (known as D&O insurance). D&O insurance policies can provide financial cover for company directors that face personal liability in connection with the decisions or actions they take in the course of their normal duties (although the specific terms of each policy should be properly analysed before drawing any conclusions).
How can Ignition help?
Ignition Law can advise companies before, during and after insolvency processes, administration processes, or company voluntary arrangements, including:
Advising on directors’ duties, potential claims against directors and the company, and the practical steps that should be taken to minimise the risk of liability arising;
- Advising companies on the specific measures introduced by the UK Government to help businesses that are experiencing financial difficulties amidst the COVID-19 pandemic;
- Advising companies at risk of insolvency on potential restructuring options;
- Introducing companies to insolvency practitioners or administrators;
- Briefing, preparing and liaising with insolvency practitioners or administrators; and
- Advising creditors in connection with their recovery of debts from insolvent companies.
This guide has been prepared for directors and owners of private limited companies to provide a summary of the key issues that may arise for directors in light of the COVID-19 pandemic. This guide is extremely short and pragmatic, does not constitute legal advice and should not be relied upon. For specific queries, contact Ignition Law for advice relating to your particular circumstances.
Cash flow and funding considerations in light of government guidance as of 1 October 2020