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Director's Duties and Liabilities Amidst the COVID - 19 Pandemic

Client Updates

 

1. INTRODUCTION

Being at the helm of a business during the coronavirus outbreak is a challenging time across many industries.  New insolvency legislation has been enacted by the UK Government to assist companies with navigating the pandemic and beyond.  The measures give companies some breathing space to consider next steps and / or rescue options, however directors should be aware – now more than ever – of their duties and obligations, and the potential liabilities they may be exposed to.

2. DIRECTORS' DUTIES UNDER ENGLISH LAW

Under English law, and under normal circumstances, the directors of English companies owe their duties to the company in question and not to the shareholders and creditors of the company, nor to the corporate group as a whole.  When insolvency is likely, English law requires a shift in these duties to consider or act in the interests of creditors of the company.  The global COVID-19 pandemic has affected a multitude of businesses in an unprecedent manner, such that they may have entered, or be entering the 'zone of insolvency'.

The directors of affected businesses are potentially personally liability when a company is threatened with insolvency.  Some insolvency law offences, such as fraudulent trading, involve an element of dishonesty / fraud / deception.  However, the offence of wrongful trading (i.e. the continuing of trading when there is no reasonable prospect of the company in question avoiding insolvency) does not involve any element of dishonesty, and the only defence is for directors to prove that they took "every step" (note: not "every reasonable step") to minimise losses to creditors.

Directors sitting on more than one board within the same group of companies must have regard to potential conflicts of interest in order to ensure compliance with their duty to avoid conflicts of interest and not put the interests of one member of the group ahead of their legal duties to another group company.  It should be noted that in the example of a subsidiary faced with a potential insolvency, if this subsidiary is controlled by a holding company, and the board of the potentially insolvent subsidiary is, in effect, controlled by the board of the parent company, the directors on the parent board could also be at risk of liability.  

3. NEW LAWS TO ASSIST DIRECTORS / COMPANIES DURING THE PANDEMIC AND BEYOND

Many aspects of the Corporate Insolvency and Governance Act 2020 (the "Act") were originally driven by a number of high-profile collapses of British businesses.  The timetable for enacting these changes to UK insolvency legislation has subsequently been accelerated, alongside the introduction of a temporary regime to stimulate recovery from the current public health emergency. 

COVID-19: Temporary Suspension of Wrongful Trading Rules

The Act implements a temporary suspension of the wrongful trading rules to remove the threat of directors incurring personal liability for wrongful trading resulting from the COVID-19 pandemic.  

This change in law applies retroactively from 1 March 2020 to 30 September 2020, but may be extended at the Government's discretion.  The overriding objective is to help companies to keep trading, by providing them with extra time and space to weather the current economic crisis. 

While the short-term removal of the wrongful trading regime is clearly a welcome development as companies navigate turbulent times during the pandemic, it is important for directors not to overlook the need to comply with existing laws when the suspension period ends and mitigate the risk of breaching their duties in future or when exploring options for corporate rescue.

Permanent Change to Insolvency Laws: Moratorium

For companies that can "likely" be rescued as a going concern, the Act also introduces a new option for an eligible distressed company to obtain a stay on legal action while it considers options for restructuring or rescue.  The purpose of the moratorium is to assist the rescue of businesses that would otherwise be placed into an immediately value-destructive insolvency process without, inter alia, the threat of winding-up proceedings being commenced or steps being taken by lenders to enforce security / crystallise charges.  

Directors may apply for a twenty business day moratorium to consider rescue plan options.  During this time, the directors continue the day-to-day running of a business (unlike during an administration when the administrator assumes control), but a 'monitor' will be appointed to ensure that the company complies with the conditions of any moratoria.  Due and careful consideration of directors' duties, and proper records of all decision-making (and the reasoning behind such decisions) will be especially important during this period, as this new 'debtor-in-possession' regime will mean that the actions of the board will be under even greater scrutiny.  

The directors may apply to Court (without the need for creditor consent) to extend this initial moratorium by a further twenty business days, subject to certain conditions being met.  However, the moratorium may only be extended beyond forty business days with creditor consent.  

COVID-19: Temporary Change to Eligibility Criteria for Moratorium

Subject to further extension by the Government, until 30 September 2020, the Act implements a temporary relaxation of the conditions required to obtain the aforementioned moratorium, specifically for companies whose financial positions have been worsened owing to the coronavirus outbreak.

4. PRACTICAL ADVICE FOR DIRECTORS TO DEMONSTRATE COMPLIANCE WITH THEIR DUTIES DURING THE PANDEMIC

If the business is experiencing substantial losses and / or trading performance is lower than required to meet debts as and when they fall due.

Professional advice should be regularly sought by the board.  If financial distress is a possibility, seeking advice early on can be a crucial step in preserving value in the business.  Board meetings should be held more frequently; directors should insist on regular management accounts and cashflow forecasts being prepared.  It is crucial that board minutes record how the creditors' interests have been duly considered, reasons why the board's decisions are in the interests of creditors, and any supporting evidence.  Directors should also review the D&O policy to ensure it is comprehensive, and to understand its limitations.  

The board should not be tempted to simply dispose of loss-making portions of the business, without proper professional advice.  Directors should be aware that if the company does subsequently become insolvent, such transactions can be reviewed and the directors could be personally liable if they are considered to have disadvantaged creditors.  Borrowing more capital and / or incurring more liabilities to make up for the shortfall is extremely risky; any decision to incur more debt finance in a company in the 'zone of insolvency' should be considered carefully in conjunction with professional advisers.

If the board is not in agreement with the strategy to deal with the company's issues?

Directors should ensure that comprehensive minutes are recorded of all meetings, and the key reasons for the chosen conclusion should be recorded (as well as the concerns of any dissenting minority).  Individual directors should also seek independent advice if they are not happy with the actions of the board, or if their concerns are not being heeded by the other directors, and the board's decisions are proving detrimental to the company.  A director should not resign from the board of a company in the 'zone of insolvency' without seeking proper legal advice beforehand, as this may increase, rather than reduce, their potential liability

Any decision to cease trading should be taken in conjunction with professional advice.  

If there is no hope of a successful restructuring / rescue of the business, trading may have to halt immediately, but a premature decision to stop operations could result in greater losses for the creditors.  Directors should be mindful of their duties and obligations at all times, and must be able to justify all decisions and actions taken (or not taken, as the case may be).  

5. PROPOSED LAWS OF WHICH DIRECTORS SHOULD BE AWARE

Directors should also be aware of the UK Government's further proposals for insolvency reform including:

(i) the proposal to give HMRC a new power to issue notices to make directors and certain others connected to a company, jointly and severally liable for the company's tax liabilities if the business is insolvent / potentially insolvent; and

(ii) the proposal to make directors of a holding company liable in relation to the disposal of an insolvent subsidiary – namely that liability would attach to a holding company's directors.

6. CONCLUSION

The temporary suspension of the wrongful trading rules and the temporary relaxation of conditions for obtaining a moratorium for coronavirus-impacted companies will provide much-needed headroom for struggling businesses and their boards, but it is important to note that those rules will (in the absence of extension by the Government) revert to the status quo ante after 30 September 2020.  Post-COVID-19, directors should carefully consider the impact of the permanent changes under the Act, including the enhanced spotlight on the role of directors (plus those in C-suite and management positions, plus their holding / portfolio companies) in the new regime.

All decisions in relation to a financially distressed business should be taken in connection with professional legal and financial advisers, and larger corporate groups should carefully consider who the true 'decision-maker' is, and decisions should be taken with careful consideration of the applicable duties.

To obtain tailored advice on any of the above issues, or for further information on directors' duties and liabilities and the insolvency law reforms, please contact SJ Beaumont, Stuart Blythe, Graham Brough or David Ramm. 

 

 

ABOUT BAKER BOTTS L.L.P.
Baker Botts is an international law firm of approximately 725 lawyers practicing throughout a network of 14 offices around the globe. Based on our experience and knowledge of our clients' industries, we are recognized as a leading firm in the energy and technology sectors. Since 1840, we have provided creative and effective legal solutions for our clients while demonstrating an unrelenting commitment to excellence. For more information, please visit bakerbotts.com.

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