COVID-19: directors' duties in testing times

7 minute read
23 March 2020

Healthcare workers are on the frontline of fighting COVID-19, but directors of companies have an equally important task, that of keeping the wheels turning and helping minimise the damage to the economy and the livelihoods of their employees, and keeping otherwise viable businesses intact for when the crisis passes.

How should directors respond to the fast-moving situation and the challenges posed by assessing and dealing with the impact on the business?

Company directors have a wide range of responsibilities under statute, regulation and the common law, and directors should already be familiar with these. The duty under section 172 Companies Act 2006 to promote the success of the company for the benefit of its members generally also requires a director to consider a non-exhaustive list of other matters, including the long term consequences of their decisions, as well as the interests of the company's employees, and business relationships with suppliers, customers and others. Directors will need to perform a careful balancing act, between the need to ensure the survival and long-term success of the company and the decisions needed in the short-term, such as cost reductions, prioritising critical payments over non-essential ones, and protecting their workforce, which may potentially have a short-term impact on the company's financial and trading position.

At this stage, the government's strategy is to provide liquidity funding to get the economy from A to B. Whether it will be enough and available quickly enough is an open question. So far, apart from perhaps residential tenants, the government does not appear to be looking to interfere directly in private contractual rights. So companies will need to seek to manage their liquidity, supply chains, changing consumer demands and hence their viability, using a mixture of the support available together with negotiated solutions, whilst also considering how best to adapt to possible future changes.

In some cases the impact of the crisis may quickly put the solvency of the company in question. Where the directors know or ought to know that the company is or is likely to become insolvent, their duties shift to a primary duty to protect the interests of the creditors. The two main tests of insolvency are:

  • The company cannot pay its debts as they fall due, i.e. the liquidity (or "cashflow") test.
  • The liabilities of the company (including contingent and prospective liabilities) are in excess of its assets i.e. the balance sheet test.

The directors of a company are at risk of personal liability to the company's creditors if they allow the company to trade whilst insolvent and the company ends in formal insolvency. They therefore need to keep the question of solvency at the front of their minds, and once they reach the position where ongoing solvency is in doubt, they must put the interests of creditors first. In addition to the directors' general duty to creditors when a company is insolvent, there are other areas of personal risk for the directors of companies in financial difficulties. These are wrongful trading, fraudulent trading, misfeasance and voidable transactions and disqualification from acting as a director.

In assessing the question of whether and how ongoing trading can be justified, directors need to take into account the availability of government sponsored support. However, this is not a blank cheque, and the directors need to act responsibly in taking that support and consider its terms and consequences carefully. They also need to consider what support they can seek and obtain from other stakeholders, such as changes to contractual terms with customers and suppliers, rent reductions or rent free periods, and reduction of pension contributions. Equally, such stakeholders will need to understand what other support is available to the subject business before they agree to concessions compromises.

It is inevitable that some businesses will fail as result of the crisis - we already have high-level examples in the case of FlyBe and Laura Ashley - but that does not absolve the need for directors to carry out their duties honestly and to the best of their ability. Their decisions will inevitably be judged with the benefit of hindsight.

What can directors do to mitigate the risk of personal liability?

It is vital to have a robust framework for decision making if directors want to do everything they can to keep the business going and preserve the jobs of their workforce. There are a number of key disciplines which should help:

  • Hold regular board meetings to discuss the financial and trading position of the company. Don't regard this as a formality - collective decision making will help share the stress and provide a forum for constructive challenge which should help ensure more effective governance. Decisions should be based on up-to- date and robust management information including daily cash receipts and payment requirements, longer-term cash-flow and trading forecasts, backed with appropriate risk analyses, and an understanding of the available government support.
  • Monitor and manage creditor pressure pro-actively.
  • Engage with lenders and other key-stakeholders. The latter may include key customers and suppliers, shareholders and pension trustees. Although interests may appear to diverge, all will have some common interest in seeing the business survive and may contribute to helping it do so.
  • Having engaged, keep the lines of communication going in an open and honest way.
  • Seek and act on appropriate professional advice, including legal financial and others appropriate to the business.
  • Ensure the business has appropriate insurance in place, including (but not limited to) D&O cover.
  • Keep (and preserve) detailed minutes of board meetings and notes of decisions taken and the reasons for taking those decisions.

There may be reasons to be more positive about the business outlook post-COVID-19. The UK government had already set out its willingness and readiness to stimulate growth through investment. A weaker sterling could help support exports when trade picks up, and low oil prices may help reduce price inflation. A rapid improvement in the economic position will bring its own challenges, including managing the need for increased working capital and investment, whilst unravelling and repairing the damage sustained in the short term. Good decision making and corporate governance adopted during the crisis will stand directors in good stead to manage the challenges which lie ahead.

We have put together a summary of UK Government funding measures to address the COVID-19 crisis and a COVID-19 online resource hub to help you manage the challenges and mitigate the risks for your business.

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