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Coronavirus and Directors’ Duties
26th March, 2020
The impact of coronavirus on company cash flows is extreme. With the increased restrictions on movement of people and non-essential economic activity, many well-run companies could be facing the possibility of insolvency.
In such circumstances, directors need to understand the nature of their duties and take appropriate advice. It is hoped that as many companies as possible survive the disruption to trading, particularly with the various support packages in place. Where a company’s continued solvency is in the balance, directors would ordinarily need to take care to avoid potential personal liability for wrongful trading. On 27 March, the laws in this regard were temporarily changed to support the survival of businesses.
Directors’ Duties
Directors have a duty under section 172 of the Companies Act 2006 to act in the way that they consider, in good faith, will promote the success of the company. In discharging this duty, the Companies Act sets out a number of factors that need to be considered.
Protecting the workforce through closure of premises and imposing homeworking where possible, and furloughing staff where appropriate, are measures that contribute to short term disruption, but may well support success over a longer timeframe. Directors are having to make decisions quickly, often within hours, that would ordinarily take weeks or months to consider. It is important that directors hold meetings regularly and properly minute, in detail, the rationale for decisions made. At this time, physical meetings should be avoided where possible to comply with the social distancing requirements. If decisions made with limited information in a rapidly changing environment turn out to be poor, being able to evidence that decisions were made in good faith is likely to mitigate the risk of claims being made against directors.
If the continued solvency of a company starts to look uncertain, the nature of directors’ duties change. In such circumstances, directors need to consider the best interests of the creditors of the company as a whole. Directors need to ensure that they protect themselves against potential personal liability by taking professional advice. This is often from insolvency practitioners and from lawyers.
Potential Consequences of Breaching Duties in Relation to Possible Insolvency
There are a number of possible adverse consequences in the event that directors fail to comply with their duties in the lead up to a corporate insolvency. On 27 March 2020, Business Secretary Alok Sharma announced temporary changes to the UK Insolvency Laws to support the survival of businesses. The proposals are intended to protect directors from a risk of personal liability in the event that they take advantage of government backed borrowing at a time when it is unclear whether their company can survive.
Below we consider the wrongful trading laws which have been temporarily amended, and some other insolvency related provisions which directors should also be aware of:
- Wrongful Trading: Ordinarily, the position under the Insolvency Act 1986 is that a director can be made personally liable for the losses of a company which continues to trade in circumstances where they knew, or ought to have known, that there was no reasonable prospect of avoiding a formal insolvency. The provision of Government backed financial support meant that some directors were facing very difficult decisions because increasing borrowings with a view to the company surviving could expose them to the risk of personal liability. The temporary suspension of the wrongful trading laws removes this risk. Importantly, it applies retrospectively from 1 March 2020. The threat of personal liability could have inhibited directors from taking advantage of the government backed lending schemes and it is hoped that the changes will encourage businesses to make use of the available support. Notwithstanding the change to wrongful trading laws, Directors must still act in good faith to promote the interests of the company, and other provisions of the Insolvency Act remain relevant.
- Misfeasance/Breach of Duty: We have highlighted above some of the duties that a director is expected to comply with in performing their functions as directors. In addition, directors face the risk of personal liability if they allow the company to enter into transactions, prior to a formal insolvency, that breach the provisions of the Insolvency Act 1986, most notably (a) allowing the company to pay certain creditors in preference to others with the intention of putting those creditors in a better position than the general body of creditors; and (b) allowing the company to transfer assets for less than their true value. In circumstances where the company is of questionable solvency, therefore, every transaction should be considered carefully as to whether it is in the best interests of the creditors of the company as a whole.
- Fraudulent Trading: Under the Insolvency Act 1986 anyone who is knowingly party to a Company recklessly incurring credit when there is no reasonable prospect of meeting the debt could fall foul of the fraudulent trading provisions. This can result in both civil and criminal sanctions. This may give rise to difficult issues in determining whether to take advantage of support measures which give rise to a indebtedness on the part of a company which has to be repaid in future. Providing that directors act with integrity and honesty, there should be limited risk in this regard. In no circumstances should directors fabricate any information forming part of the application for funding under a support scheme.
- Misrepresentation: Making a knowingly false statement can lead to liability for damages. Directors should take care to ensure that all information provided and statements made in relation to applications to access support schemes are made honestly and in good faith.
- Disqualification: Administrators and Liquidators are required to report to the Insolvency Service on the conduct of directors in relation to a corporate insolvency. This can result in disqualification proceedings.
Protective Measures
In addition to the changes to wrongful trading laws, proposals were announced to introduce:
- A moratorium for companies to provide protection against creditors taking action to enforce debts whilst they seek to restructure, or seek a buyer.
- Provisions ensuring continuity of supplies during a moratorium to ensure the ability to continue to trade.
- Provisions to implement restructuring plans that would be binding upon dissenting creditors (assuming that a sufficient majority of creditors approved the proposals).
The proposals will also include balancing measures to provide comfort to creditors and suppliers that they will not suffer increased losses during a moratorium.
Under the existing laws, a moratorium generally only applies after a notice of intention to appoint an administrator has been filed, and then only for 10 business days. It is expected that the moratorium that will be introduced in connection with coronavirus will be longer, possibly between 1 and 3 months. The Government intends to introduce legislation to implement these proposals at “the earliest opportunity”.
It is incredibly challenging for directors to make the best decisions for a company where the landscape is constantly changing in such dramatic and unexpected circumstances. There are nevertheless steps that directors should take to protect themselves:
- As noted above, directors should hold meetings regularly and properly minute, in detail, the rationale for decisions made.
- Directors should ensure that they have as much financial information as possible. Increasing the frequency of management information can help to avoid taking actions that could lead to personal liability.
- Taking professional advice from insolvency practitioners and lawyers. Together we may be able to help with survival strategies in addition to ensuring that directors avoid personal liability.
If you have any queries regarding directors duties, or are a director of a company facing financial difficulties during these difficult times, please do not hesitate to contact one of our team.
The information on this site about legal matters is provided as a general guide only. Although we try to ensure that all of the information on this site is accurate and up to date, this cannot be guaranteed. The information on this site should not be relied upon or construed as constituting legal advice and Howes Percival LLP disclaims liability in relation to its use. You should seek appropriate legal advice before taking or refraining from taking any action.