Director’s Duties and Coronavirus: How to Run Your Ship When a Tsunami Hits
Last updated 30 June 2021, 11:30
As the chaos caused by the coronavirus outbreak continues to impair global markets, creating unprecedented challenges that may prove to rival the 2008 financial crisis, directors are having to consider not only how to cope with the immediate effects on their business, such as supply chain disruption and employee retention, but also the potential long-term implications of their decisions. Indeed, with the economy journeying toward a steep downturn, in such uncertain times it is especially important for board-level decisions not to exacerbate deterioration.
The efforts of financial regulatory authorities to claw back an ever weakening economy are still ongoing. The Financial Reporting Council (the “FRC”) has followed in the footsteps of the U.S. Securities and Exchange Commission in encouraging publicly listed companies to disclose to investors the predicted impact of the coronavirus on company operations and share prices. The Financial Conduct Authority (“FCA”) is also grappling to stabilise the UK market and on 17 March 2020 published a temporary prohibition on short selling (a technique used by individuals in an attempt to profit from the falling price of stock). Since then further measures have followed, which include the European Securities and Markets Authority (“ESMA”) publishing a decision on 17 September 2020 renewing its June 2020 decision requiring holders of net short positions in shares traded on an EU regulated market to notify the relevant national competent authority if the position reaches or exceeds 0.1% of the issued share capital. The decision applied for three months (until 18 December 2020)and was then renewed until 19 March 2021. From 20 March 2021 onwards, positions holders will need to send notifications only if they reach or exceed the 0.2% threshold again, while any outstanding net short position between 0.1% and 0.2% will not have to be reported.
In March 2020, the Coronavirus Job Retention Scheme was announced (see Coronavirus: Job Retention Scheme for details). The Coronavirus Job Retention Scheme, was previously due to close on 31 October 2020, however it has since been extended to 30 September 2021.
A new ‘Bounce Back Loans’ scheme was then introduced by the Government in April 2020 to assist small business. The scheme was open to applications until 31 March 2021.
The Corporate Insolvency and Governance Act 2020 (“CIGA”) came into force on 26 June 2020 with temporary measures to assist companies in financial distress as a result of the Coronavirus outbreak. These included, amongst other things, a temporary suspension of the wrongful trading liability for directors referable to the period from 1 March 2020 to 30 September 2020. The Corporate Insolvency and Governance Act 2020 (Coronavirus) (Suspension of Liability for Wrongful Trading and Extension of the Relevant Period) Regulations 2020 (SI 2020/1349) (“the CIGA Regulations”) has recently introduced a second suspension of this liability for the period between 26 November 2020 and 30 April 2021. A third suspension of this liability was introduced for the period between 30 April 2021 and 30 June 2021. A fourth suspension of this liability was recently introduced for the period between 30 June 2021 and 30 September 2021. For these periods, the assumption is that any worsening in a company’s financial position was due to the effects of the coronavirus pandemic and not the actions of its directors.
It is however important to note that the CIGA Regulations do not have retrospective effect and that the wrongful trading liability for directors referable to the period from 1 October 2020 to 25 November 2020 has not been suspended. Decisions and actions taken by directors during this interim period are therefore subject to the ordinary wrongful trading provisions under sections 214 and 246ZB of the IA 1986.
Although this gives directors a much needed breathing space, the Secretary of State for Business, Alok Shama, has made it clear that all other checks and balances to ensure that directors continue to fulfil their legal duties and obligations remained in place.
In addition to considering the implementation and knock-on effects of the new measures and ensuring continued compliance with regulatory obligations, such as health and safety laws, directors should carefully reflect on how the Coronavirus outbreak may impact their duties as directors.
The Companies Act 2006 (“CA ‘06”) sets out in sections 171 to 177 the general duties owed by a director of a company which include:
- a duty to act within powers (section 171);
- a duty to promote the success of the company (section 172);
- a duty to exercise independent judgement (section 173);
- a duty exercise reasonable care, skill and diligence (section 174);
- a duty to avoid conflicts of interest (section 175);
- a duty not to accept benefits from third parties (section 176);
- a duty to declare interest in proposed transaction or arrangement (section 177).
The duty to promote the success of the company includes the duty to consider, amongst other things, (a) the likely consequences of any decision in the long term, (b) the interests of the company’s employees and (c) the need to foster business relationships with suppliers, customers and others.
This duty should be carefully borne in mind by directors during the pandemic. In times of crisis, it might be tempting to prioritise short-term goals over longer-term objectives or take rushed decisions. However, as shall be explained, it is important for directors to continue to hold a future-focused view.
(a) Long-Term Decision Making
Section 172 of the CA ’06 does not make express reference to the financial success of the company, which is somewhat of a relief to business owners. The interpretation of the term “success” and how this should be measured is in fact to a large extent uncertain. During the passage of the CA ’06 through Parliament, Lord Goldsmith (then Attorney General) has stated that although “success” would normally mean “long term increase in value” it could also relate to “achievement of a company’s objectives”.
Directors should therefore ensure that they carefully consider the company’s objectives when prioritising short-term profits, if they want to minimise the potential for liability claims arising out of the Coronavirus chaos.
(b) Interests of Employees
As previously mentioned, the Coronavirus Job Retention Scheme is currently in place until 30 September 2021. The Scheme was introduced to support employers whose operations had been severely affected by the coronavirus outbreak. For employees who were previously eligible for the Coronavirus Job Retention Scheme, the calculation rules will remain the same. For claims between 1 November 2020 and 30 June 2021, the Scheme provides for the Government to pay 80% of wages up to a cap of £2,00 for the hours the employee is on furlough and employers must continue to pay ER NICs and pension contributions. Employers will not be required to contribute towards 80% of the employees’ usual wages for the hours not worked. For further information regarding the scheme, refer to the Coronavirus: Job Retention Scheme as well as the regularly updated Coronavirus: FAQs for Employers article available on our website.
It should be noted that due to the extension of the Coronavirus Job Retention Scheme, the Government will no longer be offering the £1,000 Job Retention Bonus.
(c) Business Relationships
Under the CA ‘06, directors owe a duty to the company’s creditors if there is reasonable cause to believe that their company is, or is likely to become, insolvent. In this context, “likely” means “probable”. Despite Government measures aimed at reducing the potential for companies to fall into insolvency, it is inevitable that some companies will fail. Indeed, COVID-19 has been cited as a contributor to the high-profile failures of Arcadia Debenhams and Jessops to name a few; unfortunately, it is likely that other companies will follow the same course.
In practice this requires directors to at all times consider whether their duty to promote the success of the company has switched from the company and its members to best interests of the company’s creditors.
Where a company starts showing signs of financial distress leading towards insolvency, the directors should prioritise the creditors. If directors implement robust, forward-focused decision-making now, their struggling business may turn around once the pandemic has receded. Despite the need to think proactively and positively, it should be borne in mind that these are unprecedented times and there may be long-term disruption to supply chains and to client bases, resulting in a slow recovery of confidence and ‘business as usual’.
Wrongful trading proposal
As previously outlined, CIGA introduced a temporary suspension of the wrongful trading provisions for directors in the IA 1986 referable to the period from 1 March 2020 to 30 September 2020. The CIGA Regulations have introduced a second and third suspension of this liability which applies to the period from 26 November 2020 to 30 June 2021. A fourth suspension of this liability was subsequently introduced for the period between 30 June 2021 and 30 September 2021. During these periods, it is assumed that any worsening in a company’s financial position is due to the effects of the coronavirus pandemic and not the actions of its directors. As such the court will only assess the directors’ behaviour referable to the period before 1 March 2020 and between 1 October 2020 and 25 November 2020 as potentially objectionable.
Directors should note that this should not be seen as an excuse to relax their compliance with their duties and obligations as directors. Directors should also note that the fraudulent trading provisions under the IA 1986 continue to apply, in the event that a director carries on a company’s business with the intent to defraud creditors or for any fraudulent purposes.
The provisions under the IA 1986 relating to misfeasance (breach of fiduciary or other duty) and reviewable transactions, such as preferences, transactions at undervalue and transactions defrauding creditors, are also still in force. The same applies to the directors’ disqualifications rules.
In order to mitigate their personal liability in claims such as misfeasance, directors should consider taking the following actions:
- seek appropriate legal and financial advice;
- keep up to speed on the FRC and FCA guidance;
- hold regular board meetings of the directors in order to consider the company’s current financial position and to ensure that all financial information is up to date, accurate and reliable;
- monitor creditors closely and maintain clear communication streams with creditors;
- ensure that appropriate directors and officers liability insurance is in place; and
- if appropriate, liaise with lenders and other stakeholders, such as the Pension Regulator.
If you would like to talk through the consequences for your business, please email us and one of our team will get in touch.
The content of this page is a summary of the law in force at the date of publication and is not exhaustive, nor does it contain definitive advice. Specialist legal advice should be sought in relation to any queries that may arise.
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