Directors' Duties during the COVID-19 Pandemic - Part 1

Last week, the Government announced a number of measures to provide financial support to businesses struggling with the impact of COVID-19, including two new Government-backed funding schemes.

Addleshaw Goddard is monitoring those measures closely, with our latest updates found here.

Notwithstanding, it is inevitable that we will see more companies collapse over the coming months, as they struggle to cope with the indefinite business disruption.  

Despite such turbulent and unparalleled times, as matters stand the law on directors' duties (and 'wrongful trading') remain unchanged, although some other countries have introduced temporary legislation (such as Germany and Spain).  Directors must therefore be mindful that their duties towards the company and its shareholders may switch to company creditors, and should therefore seek advice to avoid breaching those duties. 

Directors' Duties in an Insolvency

Ordinarily, a director is under a duty to act in the best interests of the company and its shareholders.  However, where a company becomes irredeemably insolvent, the interests of the company’s creditors take priority.  At that juncture, directors have a legal duty to act primarily in the interests of the company's creditors, instead of its shareholders.  

By failing to act in time, directors may expose themselves to the risk of incurring personal liability for company debts and/or committing an offence.  It is therefore crucial to determine whether the company is in fact insolvent.

Establishing Insolvency

In practice, it may not be possible to identify a precise point in time at which a company becomes irredeemably insolvent (if, indeed, the company reaches that position) and should cease trading.  In broad terms, a company is irredeemably insolvent if its financial position is such that any reasonable director would conclude that it has no reasonable prospect of avoiding insolvent liquidation.

Practical Steps

In light of the current mercurial climate, directors should bear in mind the following practical steps which may assist them in acting in a way which minimises potential loss to a company’s creditors:

• Full business review: This should include a constructive and sensible programme to reduce expenditure, increase income and to ensure an adequate cash flow.  Examples include limiting direct debits and standing orders to payments that are strictly necessary to continue the business, seeking rent payment holidays where possible and reviewing staff levels / working hours (after taking appropriate advice).
• Frequent board meetings: The board should meet frequently (virtually, bearing in mind social distancing guidance) to review the company’s position.  It should also ensure that there is a proper distribution of responsibility within the company, both at director level and below.
• Provision of information to key creditors: It is essential to keep major creditors (for example, secured lenders, key suppliers) regularly informed.  As far as possible, creditors should be enlisted for the continued operation of the Company.  In addition, where the business is reliant upon the support of material or essential suppliers/customers their continued support would be required in order for the Company to be able to continue to trade.  The decision whether to inform creditors and also what they shall tell them and when is a balancing act for the directors, taking account of the need to keep major creditors informed and “on side” on the one hand and the potential impact on the Company and the business having done so.
• Professional advice: It is recommended that the board continue to take professional insolvency advice.  In general, the courts will take a sympathetic view of directors who have acted honestly, reasonably and sensibly, particularly if the board has been seen to be taking proper advice from accountants, solicitors and other professionals on valuations, figures and strategies for minimising loss to creditors.

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In light of the exceptional circumstances we are living through, and the potentially long-term disruption to customer bases and supply chains, it is important that directors seek advice sooner rather than later, to ensure that they are acting in accordance with their duties.

Further guidance and commentary from AG on the impact of COVID-19 in different sectors can be found here.