Directors’ duties and managing your business during the COVID-19 outbreak
23 March 2020
The outbreak of novel coronavirus disease 2019 (COVID-19) has affected all aspects of life across the globe to a scale and extent that that would have been unimaginable to most only a few weeks ago. Although these are uncertain times, what is clear is that both the pandemic itself and the steps and measures taken by governments and their scientific and medical advisers will give rise to immense challenges for businesses and for society as a whole.
Directors are legally responsible for the management of a company’s business and its affairs. Being a director of a company can be very challenging at the best of times.Directors are subject to many duties under a wide variety of laws and regulations, such as health and safety legislation and employment law.Given the important role that directors play within an organisation, company law and insolvency law within the UK impose a number of duties on directors. The purpose of this note is to summarise some of the key directors’ duties and to suggest a number of considerations and practical steps that directors should bear in mind when considering how to discharge those duties in the face of the COVID-19 outbreak.
The Companies Act 2006 sets out the main duties to which all company directors of companies incorporated within Great Britain and Northern Ireland will be subject. In the context of COVID-19, we would highlight the following two overarching duties contained in the Act:
Duty to act in good faith to promote the success of the company
Section 172 of the Companies Act provides that a director must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. In so doing, the director must have regard to factors including, amongst others:
- the likely consequences of any decision in the long term;
- the interests of the company's employees (if any);
- the need to foster the company's business relationships with suppliers, customers and others;
- the impact of the company's operations on the community and the environment; and
- the desirability of the company maintaining a reputation for high standards of business conduct.
Duty to exercise reasonable skill, care and diligence
Section 174 of the Companies Act provides that a director must exercise the care, skill and diligence which would be exercised by a reasonably diligent person with both:
- the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company (the "objective" test); and
- the general knowledge, skill and experience that the director actually has (the "subjective" test).
So, at a minimum, a director must display the knowledge, skill and experience set out in the objective test, but where a director has specialist knowledge and/or greater experience, the higher subjective standard must be met. In applying the test, regard must be had to the functions of the particular director, including his specific responsibilities and the circumstances of the company.
What if my company faces insolvency?
For so long as a company is trading on a solvent basis, its directors owe their duties to the company for the benefit of its members (both present and future). In circumstances where a company becomes insolvent, however, or where there are reasonable concerns as to its continued ability to trade on an solvent basis, the directors' duty to promote the success of the company is displaced by a duty to act in the best interests of the company's creditors instead.
In this scenario, the duty of directors must seek to protect the value of the company assets and to minimise losses to creditors as far as possible. A failure to have proper regard to the interests of creditors of the company, or disregarding the commercial interests of a large creditor in favour of a course of action that would primarily benefit the shareholders, at a time when the company is insolvent, might very well constitute a breach of the relevant directors’ statutory duty.
It is outside the scope of this briefing to go into company solvency considerations in detail but a director should be aware of the following:
- A director may be personally liable to contribute to the company's assets for losses arising from his misfeasance or breach of fiduciary duty.
- As the law stands, directors run the risk of being ordered personally to contribute to the company's assets where they are held to have been engaged in “wrongful trading.” In essence, “wrongful trading” describes the scenario where a company has gone into insolvent liquidation and, at some point before the commencement of the winding up of the company, the director knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into such insolvent liquidation but fails to take all steps to minimise potential loss to creditors.The “chilling” effect of this on the willingness of directors of companies which are otherwise in reasonably good financial health to seek finance or incur further debt during the COVID-19 pandemic is easy to see.
- In response to the COVID-19 outbreak, however, the Government has announced that the “wrongful trading” provisions are to be temporarily suspended, with retrospective effect from 1st March 020, for at least 3 months. The rationale for this is to allow directors a little breathing space to make decisions that they might otherwise make for the benefit of the company were the threat of personal liability not hanging over them like the Sword of Damocles. It should be noted that other provisions under insolvency law (including director disqualification and fraudulent trading provisions) so the law continues to provide some measure of deterrent and protection for the benefit of creditors.
- Transactions undertaken when a company is insolvent or in circumstances where the transaction rendered the company insolvent may be unwound by the courts.
What does a director need to consider during the COVID-19 outbreak?
Directors are not expected to be clairvoyants or to possess all of the answers but they will still be required to discharge their statutory duties during the COVID-19 outbreak. The duty under section 172 of the Companies Act is not to guarantee the success of a company but to act in a way that the director considers, in good faith, would be most likely to promote the success of the company. How can a director seek to discharge this duty? The following considerations may be of assistance:
1. Regular communication and discussions between directors: It is extremely important that, despite the practical reality that, for the foreseeable future, physical meetings will be impractical or inadvisable, you and your fellow directors communicate regularly.
- Can you and your fellow directors hold board meetings by conference calls (whether audio-visual and/or audio only)? The standard position for companies formed under the Companies Act 2006 and adopting the model articles of association is that, in determining whether directors are “participating” in a directors’ meeting, it is irrelevant where any director is or how they communicate with each other. If your company’s articles of association do not permit this, you might wish to effect a change in order to facilitate decisions to be made through remote meetings.
- What are the quorum requirements for board meetings? Given the very real potential that one or more company directors might become seriously unwell or incapacitated during the pandemic. You should check your articles and/or shareholder agreements to ensure both that you know what the quorum requirements are and to ensure that any such illness (or illnesses) will not prevent board meetings from being quorate or from key decisions from being made.
- Do we still need to take minutes of meetings? Board minutes remain useful evidence that the directors have taken the appropriate factors into account in carrying out their duties.If your practice to date has been to maintain almost verbatim minutes of proceedings, that may become impracticable where remote meetings are being held and at frequent intervals but it is still advisable that a minute is kept of matters discussed where they are particularly relevant and the key actions and outcomes from the meeting. This is particularly important where the company is insolvent or at serious risk of insolvency.It is crucial that regular board meetings are called if the company is in financial difficulties and that the commercial decisions of the directors are properly recorded in the company's minutes.
2. Contingency planning in relation to key people: A company's board of directors has collective responsibility for managing the company, and the general principle is that decisions in relation to the management of the company should be made by board resolution. In reality, however, a board may delegate aspects of its functions to executive directors (for example, a managing director or finance director) or to a committee (for example, an audit committee or finance committee) provided that its articles of association permit them to do so. Given the very real possibility that, given the scale and pace of the COVID-19 outbreak, it is very possible that one or more executive directors or committee members may become incapacitated at the same time. To ensure that the relevant functions continue to be performed as far as possible it would be prudent to review your company's articles of association before such an unfortunate event occurs to understand the process by which such delegated functions might be performed in those circumstances and what authority or resolutions might be required to prepare for such an eventuality, even if only temporarily.
3. Take advantage external assistance, advice and resources where available: It is clear that no one person or organisation has all of the answers to the COVID-19 outbreak and the particular cocktail of challenges and issues it presents for each company is likely to be unique. Nonetheless, the likelihood is that there will be other external sources of advice, help and/or information who may be able to provide some assistance with some or all of those challenges and issues:
- Access support packages and reliefs: The fast-moving nature of the COVID-19 crisis has necessitated similarly quick responses from government both at the national and at the local level. We have already seen support packages, reliefs and other facilities announced, almost on a daily basis, with the intention of staving off the worst effects of the pandemic on the business community. At the time of writing, the fine print of these initiatives remains to be confirmed but we would suggest that it is incumbent on any board of directors to remain fully abreast of these initiatives, to find out the detail as soon as possible and, where available, ensures that they avail of such support as and where appropriate to do so.
- Seek professional advice: Companies and their directors should continue to seek professional advice from external experts where it would be prudent to do so. For example:
- The directors may wish to consider speaking to employment lawyers before undertaking any particular course of action in relation to its workforce in case there are potential pitfalls in doing so or a better way for the company to achieve its intended objective.
- Where the COVID-19 outbreak has an impact on the ability on the company or on its suppliers or customers to perform its contractual obligations, the directors may wish to speak to a contract lawyer to assess the options open to the company under the relevant contract.
- Where a company is insolvent, or where the directors reasonably perceive that the company’s prospects are sufficiently parlous that insolvency might loom, it would be sensible for the directors to liaise with an insolvency practitioner to ensure that they comply with their obligations and do not place themselves at unnecessary risk of personal liability. It is important, in order to escape liability for wrongful trading or breach of duty, that the directors reach their commercial decisions independently, on the basis of the financial and legal information and advice available to them.
- Take advantage of business representative and support organisations: The business community is supported by a host of representative organisations such as the Institute of Director, the CBI, the NI Chamber of Commerce, the FSB and the regional chambers of commerce. Many businesses are members of one or more of these organisations. It would be sensible for directors of a company to ensure that any expertise, knowledge and resources of any representative body of which that company is a member are accessed and utilised.It may be that organisation is able to provide the answer to a particular need or to put you in touch with someone else who might be able to address that need.
4. Don’t forget the “old” risks and threats: It is important that the directors and management of businesses do not lose sight of the continued importance of maintaining good corporate governance and robust financial systems and processes. It is clear that hackers and scammers are seeking already undertaking insidious and determined efforts to exploit the widespread disruption and distress caused by the COVID-19 pandemic. Directors should ensure that their staff remain vigilant against this risk and that any systems and processes adopted in response to the outbreak are designed and operated in a manner that does not allow scammers and fraudsters to slip through the cracks.
5. Are you covered by business interruption insurance? Many companies will have the benefit of business interruption insurance cover.It is very often the case that this cover will only apply to interruption where it results from material or physical damage. It is possible, however, that a company’s business interruption provides cover in circumstances of a disease or pandemic. It would be advisable for company directors to carefully consider the business interruption cover in place and to speak to the company’s insurance brokers to assess the recoverability or otherwise of the company’s loss under your policy.
6. Importance of up-to-date financial information: It is very likely that COVID-19 will have a significant impact on businesses and their financial position.It is not hard to see that there may be cash flow bottlenecks with customers or suppliers and that these might very quickly create issues for you and the company’s own cash flow. Directors must ensure that they have up to date financial information at all times and should not have to wait for a creditor's claim, winding up petition or failure to meet sales or cash flow forecasts or the quarterly debiting of bank interest to alert them to problems. Directors should also be careful to monitor compliance with financial covenants contained in any arrangements with lenders.
It is hard for anyone, let alone company directors, to quantify the full extent on the wider economy of the impact of the COVID-19 outbreak, and the measures taken to stave off, delay or prevent it worst effect. Discharging your statutory duties and responsibilities against such the background of the COVID-19 pandemic may seem daunting.If you have any queries, or if you would like to discuss directors’ duties with us in more detail, the Corporate team at Carson McDowell would be happy to help.
*This note reflects the position as at 1st April 2020.
*This information is for guidance purposes only and does not constitute, nor should be regarded, as a substitute for taking legal advice that is tailored to your particular circumstances.