Directors’ Duties: Contingency Plans

While the Government has introduced new measures to support businesses through the Covid-19 crisis, we are yet to see any adjustments being made to relax the existing regime for directors' duties. Directors seeking to access the funding support packages made available by the Government earlier this week will need to be mindful of their duties and responsibilities. It is worth noting that, the Government is currently in discussions and ready to overhaul insolvency laws in response to the crisis due to the risk of corporate failures, to assist the directors. Further alerts will follow on this point separately.

When a company is or is likely to become insolvent the requirement to consider and act in the interests of creditors is imposed on the directors. The duty to have regard to the interests of creditors is not one of the general duties of directors identified specifically in sections 171-177 of the Companies Act 2006 (the "2006 Act"), but the common law duty is preserved by section 172(3) of the 2006 Act, notwithstanding the directors' obligation to serve the interests of shareholders. In other words, in situations where a company is severely distressed financially, the director's duty towards the company requires him or her to have proper regard for the interests of its creditors and prospective creditors.

Where directors of a company conclude or ought to have concluded that there is no reasonable prospect of the company avoiding going into insolvent administration or entering insolvent liquidation, those directors who, on an objective and subjective basis, fail to take every step with a view to minimising the potential loss to the company's creditors (as ought to be taken by them), expose themselves to the risk of being liable for wrongful trading under section 214 of the Insolvency Act after the company has gone into one of those formal insolvency processes.

Whilst wrongful trading prosecutions are relatively rare in practice, directors need also to be mindful of the statutory obligation, imposed on office-holders upon insolvency, under the Company Directors Disqualification Act 1986, to submit a report to the Secretary of State on the conduct of any director if it appeared to that office-holder that such conduct made him or her unfit to be concerned in the management of a company.

Directors should remain mindful of these important issues in light of the availability of such Government schemes as the CBILS and CCFF (discussed above), which may result in a company taking on additional borrowing at a time when it may already be experiencing liquidity challenges. This is especially important where it later is shown that by doing so they failed to promote the success of the company or, worse still, failed to take account of the interests of creditors as a whole resulting in the company's formal insolvency because it is unable to service its debt obligations. Add this additional debt to non-payment of the March quarter's rent, deferral of VAT and amounts due and owing to potentially unsupportive suppliers and lenders, and the trading outlook, once the covid-19 pandemic passes and these temporary business support measures are removed, will look bleak for many companies. This is absent clearly defined contingency plans to implement at the end of the support period following negotiation with key stakeholders over the coming weeks and months.

In order to mitigate against these risks it is therefore imperative that directors of companies (a) seek to unlock the Government's funding support packages through engaging with their professional advisers; (b) assess the appropriateness, from a duties and responsibilities perspective, of incurring additional borrowing in the current crisis; and (c) ensure there is a sufficiently rigorous business plan in place for servicing the loan burden going forward. Failure to take these steps as a matter of good corporate governance, whilst trying to keep the business afloat in the short term, could result in serious consequences for the directors personally further down the track.

Some basic and effective "self-protection" measures can offset the risk of not complying with their duties and responsibilities. For example, some of these measures will include:

• ensuring there is a rigorous business plan in place
• holding regular board meetings and keeping accurate, in depth board minutes
• questioning whether taking on new debt will benefit the company and its stakeholders
• ensuring there is up to date financial information available for review
• working out how to manage suppliers appropriately and avoid the risk of antecedent transactions (such as preferences, transactions at undervalue and transactions defrauding creditors); and
• ensuring decisions are made on a reasonable, good faith basis exercising sound, commercial judgment.

Most importantly, taking appropriate professional advice and acting on it will go a long way to directors protecting themselves. Contingency planning is essential and we expect many companies with leasehold portfolios, restaurant chains and retailers in particular, to be thinking hard about implementing a company voluntary arrangement under Part I of the Insolvency Act 1986 in order to manage through the June quarter's rent day.

What seems clear enough, given the huge amount of turmoil created by Covid-19, is that those companies experiencing liquidity challenges pre-Covid-19 are in for a torrid time and even those companies with more robust balance sheets will find it extremely difficult over the next few months. Ensuring that decisions by directors are properly made and implemented, together with contingency planning (including the potential for going into a formal insolvency process to protect the interests of creditors as a whole), has never been so important.

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The views expressed herein are solely the views of the authors and do not represent the views of Brown Rudnick LLP, those parties represented by the authors, or those parties represented by Brown Rudnick LLP.  Specific legal advice depends on the facts of each situation and may vary from situation to situation.  Information contained in this article is not intended to constitute legal advice by the authors or the lawyers at Brown Rudnick LLP, and it does not establish a lawyer-client relationship.