These are extraordinary times and there are significant challenges for all those running companies. Every company is affected to some degree.
Previously healthy companies are having to deal with the immediate problem of not being able to trade at all, or with difficulty, as a consequence of employee absence and postponed order books.
Directors of companies will therefore be faced with significant challenges. During these momentous times what legal issues do directors need to bear in mind?
The law places various duties on directors, the breach of which can have serious implications as personal liabilities can be imposed on those that fall foul of the provisions. In addition, proceedings can be taken against directors under the Company Directors Disqualification Act 1986 (CDDA).
The government is clearly (and rightly) concerned that the recent shutdown measures will have a drastic impact on many businesses. While the government has announced various measures to assist companies where they have to furlough employees, as well as other schemes to try to alleviate financial pressure, the speed and ability of the economy to ultimately recover will depend on businesses remaining in existence. The longer the shutdown persists, the harder this will be for many companies.
Being mindful of the potential pressure that will be put on company directors at these times, the government has recently announced that there will be changes to the law to try to remove some of the concerns and risks that directors otherwise face.
This Q & A summarises the position that many directors may find themselves in:
Q: What are my duties as a director and to whom do I owe them?
The Companies Act 2006 places certain duties on directors. These duties are owed to the company itself which means that, if they are breached, later action can be taken in the name of the company against its directors. This may be encouraged by disgruntled shareholders. Alternatively, a shareholder may bring a derivative claim against a director on behalf of the company for breach of duty if the company itself is not willing to bring a claim or is prevented from so doing.
The duties owed by directors include acting within conferred powers, avoiding conflicts of interests, exercising independent judgment and exercising reasonable care, skill and diligence.
Even in these difficult times these duties continue to apply to all directors, and directors should remain mindful of them.
Q: Do I owe a duty to creditors?
Not directly. However, directors of companies in financial difficulty face risk if they do not take appropriate steps at the appropriate time in relation to the decision whether to continue with the business of the company. If they fail to do so they may risk action from insolvency office holders, supported by creditors, in the future in relation to damage suffered by creditors as a consequence of the director’s action or inaction.
Q: What is wrongful trading?
A potential claim for wrongful trading against a director arises as a consequence of section 214 of the Insolvency Act 1986. This provides that a liquidator or administrator can seek an order from the court that the director makes a personal contribution to a company’s losses if a director knew, or ought to have concluded, at some point before commencement of an insolvency process that there was no reasonable prospect that the company would avoid going into insolvency – yet the director nevertheless allowed the company to continue to trade, thereby increasing loss to creditors.
Liability arises if it is shown that the company is worse off as a result of the continuation of trading - once the point of insolvency has been reached. There are often arguments as to when that situation arose, and what the later damage actually was. A defence may be available if a director took ‘every step’ with a view to minimising the loss to creditors.
This risk is one of the main catalysts for directors attempting restructuring of their companies. Its relevance to the present situation is clear. Many directors may consider that given the ongoing costs in their business with delayed or cancelled orders, and a possible slow-down in cash collection, the question of a need to consider an insolvency process looms large - and any decision to continue to trade potentially presents a personal risk in the event that it is subsequently determined that the director ought to have caused the company to cease trading.
A breach of this section can also be used as the basis of a claim under the CDDA to disqualify someone as acting for a director for a prescribed period.
Q: What changes are the government introducing?
The UK government has announced imminent changes so that the wrongful trading law will be suspended to protect directors during the pandemic. This legislation will apply retrospectively from the beginning of March 2020. It will be introduced shortly - but is not in force as at 30 March 2020. The full details of the change have yet to be set out.
The stated rationale is “to give company directors greater confidence to use their best endeavours to continue to trade during this pandemic emergency, without the threat of personal liability should the company ultimately fall into insolvency.”
While the detail is awaited directors should continue to proceed with caution. The change to the law has not yet been introduced and the difference between the existing position and the new position is unclear.
Presumably it is intended that if there is more latitude in judging the actions of directors, they will be less prone to push the button of placing the company into an insolvency process.
However, there may still be issues in the future as to whether problems within a company were truly caused by Covid-19 or whether there were underlying problems anyway. In practice therefore directors should still proceed with caution.
There is also still a risk of personal liability if personal guarantees have been entered into by directors.
Q: What steps should I take?
It is good practice, and will remain so, for directors to act with caution and to take the following steps:
- Call regular board meetings if the company is in financial difficulties, and report and record decisions in the minutes. Specifically record any special considerations that apply to the business as a consequence of the coronavirus pandemic.
- Ensure that you have up to date financial information, and consider it carefully. The uncertain length and effect of the current situation makes things difficult when predicting the future income into the business.
- Take advice as soon as it appears that there is no reasonable prospect of avoiding an insolvency process - and do not incur further credit once that conclusion is reached.
The ability to demonstrate these steps will be important in any later review of actions taken. Any such review would of course take place many months ahead when the present crisis is over, and the significance of current issues possibly overlooked.
Q: Is there a relaxation of other provisions?
The government has stated that all other checks and balances applying to directors will remain in force.
This means, for obvious reasons, that the provisions regarding fraudulent trading remain – where directors can be personally liable if they traded with an intent to defraud creditors.
It is important to note that the provisions of s172 of the Companies Act 2006 will remain in force which applies where a company is close to insolvency and requires directors to consider the interests of creditors. Directors cannot ignore creditors or prefer some over others.
The threat of director disqualification under the CDDA also remains, where a director can be disqualified from acting as a director for misconduct.
Q: What other changes has the government introduced?
The government has also announced a change so that there will be a temporary moratorium for businesses undergoing restructuring, so that creditors cannot force them into an insolvency process. The intention is to give companies extra time and space to weather the storm.
There has been a long held view that corporate insolvency needed reforming and it looks like the present crisis may advance some of those provisions.
Further that there is a protection of supplies to enable companies to continue trading during the moratorium and a new restructuring plan, binding creditors into that plan.
Again, the specifics remain to be seen.
Contact us for further guidance at firstname.lastname@example.org or call Nick Parker on 029 20 34 55 11.