In an unprecedented and dynamic situation, company directors need to be mindful of the law
Company directors, along with everyone else, are living in a new world. The global response to the coronavirus outbreak has reshaped the business landscape. Even once the immediate Covid-19 crisis has passed, no-one can be certain what the new-normal will be. However, despite the instability, we are all still required to abide by the law.
During this period of turbulence, rapid decisions are being made to deal with the impact of Covid-19 on businesses. Due to the frenetic pace of the response, directors are revisiting their duties to ensure they are not inadvertently exposing themselves through breaching these duties. Though the government has temporarily relaxed the rules surrounding insolvency, the potential for personal exposure is still much more acute.
The statutory duties of directors are enshrined in the Companies Act (2006) and are complimented by duties set out in their company’s governance documents. There will be additional duties dependant on the nature of the company and the sector it operates in. For example, directors of Financial Conduct Authority (FCA) regulated firms will have Senior Managers Certification Regime (SMCR) obligations. In certain companies, health and safety will present extra duties.
Directors have a duty to act within their powers, in accordance with the Act and their company’s Articles of Association. They also have a duty to promote the success of the company. This broad requirement is broken down into several implied duties.
Requirements on directors to promote the success of the company
Directors must have regard to:
- the likely consequences of any decision in the long term;
- the interests of the company’s employees;
- 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;
- the desirability of the company maintaining a reputation for high standards of business conduct; and
- the need to act fairly as between the shareholders of the company.
In order to carry out their duties and make decisions on behalf of the company, directors must be in contact with one another and communicating frequently. In the current circumstances you would expect them to be communicating more frequently than usual. If the company is in financial difficulties, full board meetings should be held weekly, or even daily.
When it comes to making these decisions, each director has the duty to exercise individual judgement. The yardstick this is measured against is a careful and diligent director in the same circumstances. They have a duty to exercise reasonable care, skills and diligence. This is tested objectively against the knowledge, skills and experience reasonably expected of a person carrying out a director’s functions. The subjective knowledge, skills and experience of the actual director is taken into account if their background is relevant to the decision; for example, if the director was a lawyer who possessed specialist knowledge.
The duty to act in a way that they consider, in good faith, will promote the success of the company (section 172 of the Companies Act 2006) and the duty to exercise reasonable care, skill and diligence need to be considered carefully at this time. Decisions are being taken in response to Covid-19 which have an immediate adverse effect on companies. For example, restricting foreign travel for employees will have a harmful impact. Could decisions which cause the company loss or, in the worst case, cause the company to fail be a breach of duty?
Directors are not being asked to ignore the bigger picture. Under section 172, a director must have regard to a number of factors, including the long-term impact of decision making in the interests of employees. It is therefore likely that prudent decisions making will align with the section 172 duty. Short-term harm is likely to promote long-term success or survival. However, the key to carrying out this duty is ‘good faith’.
It is not a breach of duty to make the wrong decision. If the actions directors decide on are driven by an honest aim of doing what is best to secure the survival of a company, the duty is not infringed even if the decisions are poor. The courts will not look to pick through the commercial judgement of directors (especially given the current, chaotic situation); they will look at the integrity of the decision-making.
If a company’s solvency is in question, the duty of a director shifts from promoting success for shareholders to acting in the best interests of creditors. Due to the coronavirus response, companies in exposed sectors are likely to face significant – and increasing – cash flow pressure. This may mean that previously financially stable companies are rapidly faced with the prospect of insolvency.
Codid-19 may force many companies over this line inadvertently. This is another reason why directors should be meeting more frequently than usual, however they choose to arrange it ‘virtually’. If this line is crossed then independent advice must be sought, as wrongful trading could make a director liable under the Insolvency Act (1986).
Wrongful trading – when a director knew, or ought to have known that there was no reasonable prospect that the company would avoid going into insolvent administration were it to continue trading – has been the one area where the government have stepped in. The rules on wrongful trading are going to be relaxed from the 1 March 2020 for a period of three months. Though a welcome step, it is worth remembering that a relaxation in this area does not mean that directors are released from any of their other duties.
Directors must not hide away from the current challenges, or the challenges yet to come. To fulfil their duties they must communicate frequently and, crucially, record their communication. Good decision making may save companies. Even if some decisions turn out to be poor, it will be how they were made and why that will be scrutinised. Ensure detailed minutes are taken and, if using video conferencing software, record the meetings.
They must be aware of insolvency and take immediate action if they believe it has become likely. If it has, they need to remember that decisions still need to be made – ceasing trading is the only course of action. There may be circumstances when a company should continue trading to improve the position for the creditors, even if insolvent liquidation or insolvent administration is unavoidable.
We are all living in a new world. But we are in it together. A helpful starting point is to remind directors of these duties and ensure everyone is on the same page. If it’s not already regular practice, produce a document setting out these duties and ensure they are discussed at the board meeting, especially in the light of the Covid-19 response. From there, directors can begin to make decisions without inadvertently exposing themselves to a breach of duty and reduce their personal risk.
Your team at Briars are here to help with any questions that you may have concerning these duties and the issues surrounding them; please do not hesitate to contact us here at email@example.com.