06.04.2020
By Doug Robertson
The issues faced by directors during this global pandemic are far reaching and are of course not confined to the hospitality and travel industries. The social distancing guidelines put in place by the Government in order to keep the population safe, mean that businesses from financial services, to hospitality, to construction are all being affected by the change. Businesses are creating innovative and effective ways of providing continuity where safe to do so and where possible, and the Government has issued proposals for financial assistance to support businesses with meeting their fixed cost liabilities during this difficult period.
It is expected that some businesses will suffer financial distress as a result of this difficult time, and the inevitable absence of cash flow. As a result, the directors of those companies will need to pay very careful consideration to their duties. Below, we outline some of the key issues and risk areas that directors should personally consider, and continuously review.
KEY ISSUES
Wrongful trading
Under the usual course, a company’s directors have a duty to promote the success of the company and act in the interest of the company’s members as a whole. When a company is financially distressed and likely to be considered insolvent (in that it is unable to pay its debts as they fall due or its liabilities exceed its assets) then this focus shifts. It is then necessary for directors to act in the interest of the company’s creditors as a whole. Directors must preserve the value of the company in order to maximise the potential return to creditors. Technically, directors may still be liable under the wrongful trading provisions even if the company is not physically trading due to the social distancing measures introduced further to COVID-19, but when losses continue to increase.
Company directors should take every step to minimise losses to creditors once they conclude or ought to conclude that there is no reasonable prospect of avoiding insolvency. In the event that they fall short, an action may be taken against directors. If this happens, the directors would be liable to make such contribution to the company’s assets as the court thinks fit. This is likely to be the increase in losses to creditors incurred from the onset of insolvency until a formal claim was commenced, which may be a significant amount if the situation continued for several months.
Potential good news for directors?
The Government has stated that it will introduce:
- A short business rescue moratorium (effectively a break / breathing space) to protect companies from creditor action while they consider their options;
- A new court-based restructuring tool modelled on the pre-existing English Scheme of Arrangement; and
- New rules to prevent suppliers from cancelling contracts with businesses in an insolvency procedure.
The Government has also announced that it will temporarily suspend the wrongful trading provisions in the Insolvency Act 1986.
Provisions in respect of misfeasance and fraudulent trading remain in place.
It is important to note that though the Government has stated that it will provide financial assistance to companies during the crisis, this is (for the most part) in the form of interest bearing loans and tax payment deferral. These liabilities will need to be repaid in the future, and it is worth taking professional advice prior to taking on any further financial liability.
Misfeasance
In the event of a company’s insolvency, as above, the directors’ duties shift to a requirement to act in the best interest of creditors. Failure to consider the interests of the company’s creditors will amount to a breach of the directors' duties and could result in personal claims against the directors.
Relevant examples include where a director has:
misapplied, retained or become accountable for any money or other property of the company; or
been guilty of any misfeasance (such as breaching the insolvency duties); or
breached any fiduciary or other duty owed to the company.
Action may be taken to recover unlawful dividends, transactions at an undervalue, preferences, damages and compensation for breach of fiduciary duty or tortious duties of care. A director may be required to restore the company property in question, pay compensation and / or make such contribution to the company’s assets as the court thinks fit.
Notably, these actions are not limited solely to directors, and include any person who is involved with the formation of and management of the company. Those involved in the management of companies should be mindful of this when transferring any property out of the company’s ownership, and should seek advice prior to doing so in the event of the company’s financial distress.
Fraudulent Trading
Care must be taken to ensure that transactions must not be entered into which may defraud creditors. An example may be ordering supplies or taking customer deposits knowing that the contract will not be fulfilled. A practical solution could be to potentially pay customer deposits into a designated trust account in order to ensure separation from general working capital, however this could potentially amount to a preference or transaction at undervalue so this is an area where specialist advice is recommended.
There is a requirement to show that, during the fraudulent activity or business, there was a knowing intention to defraud, and awareness (or recklessness) of the consequences. There must also be an element of dishonesty involved, such as deliberate trading in the knowledge that debts would not be paid. This is not limited to directors but could also include senior employees who have the power to make decisions for the company. Those involved may be ordered to pay compensation for the amount involved in the transaction.
WHAT YOU CAN DO NOW
- Be aware of the risks and pitfalls when dealing with a financially stressed company. It will help your position if you take appropriate professional advice and can show that you acted in accordance with this. Remember, you do not have to get it absolutely right or be able to forecast the future; you just have to be able to demonstrate that the action you took was reasonable in the circumstances.
- Hold regular board meetings and ensure that the minutes of those meetings are accurately recorded in writing. Record the reasons for any decisions made and be able to explain the same in the event that these should be scrutinised at a later date.
- Create realistic financial plans both current and forecasted, so that there is an accurate record of the company’s position.
- Keep discussions flowing with the company’s supply chain (please see Irwin Mitchell’s specific article concerning supply chain issues here and review the ability to achieve a continuous supply of goods / services during this period. Have discussions concerning payment terms and whether these can be temporarily altered.
- Check the terms of finance documentation and any contracts where the company may be at risk of breaching covenants and in respect of any force majeure and illegality clauses.
- Check the terms of any insurance policies to see if any cover is applicable. Some companies may have pandemic cover, but it is likely that this will be a small proportion.
- Have early, regular and transparent discussions with lenders.
- Consider utilising any financial assistance provided by the Government if necessary and if available. Please see Irwin Mitchell's articles on Government assistance here.
- Consider utilising any dispensation provided in respect of mortgage payment holidays, rental payment holidays, business rates holidays and furlough payments for employees where necessary and available. Please refer to our articles on employees and COVID-19 here.
- Contingency planning in the event that the situation should change or worsen.
In the event that you require advice concerning the above, please contact us. Irwin Mitchell also has a fixed price retainer for the provision of monthly and affordable advice from our experts to company directors during this difficult time.
