Directors' Duties: A Practical Guide to trading during COVID-19 - Part 2 - Update July 2020

The Corporate Insolvency and Governance Act 2020 (Act) received royal assent on 26 June 2020.

The Act outlines certain insolvency law reforms in response to the COVID-19 crisis, including a temporary suspension of wrongful trading provisions for company directors. The suspension applies retrospectively from 1 March 2020 until 30 September 2020, and aims to encourage directors to continue to trade during the pandemic.

This change will not affect the directors’ duties regime. Directors must continue to comply with their duties, in particular those owed to the company's creditors where the company is, or is likely to be, insolvent.

It is therefore imperative that directors continue to take steps to avoid breaching their duties during such challenging trading periods. As well as undertaking a full business review to identify ways to reduce expenditure and encourage cash flow, directors should also explore the newly-introduced Government-backed options, such as the Coronavirus Business Interruption Loan Scheme (CBILS), Coronavirus Large Business Interruption Loan Scheme (CLBILS) and the Job Retention Scheme (JRS). Certainly, not all of those options will be applicable, and in fact some may be unsuitable for the circumstances. Nevertheless, a failure to explore such measures may well factor against directors when the freeze on wrongful trading laws thaws out.

Should directors have any specific concerns, then we would strongly recommend that they seek legal advice.

Directors' Duties in an Insolvency

Ordinarily, a director is under a duty to act in the best interests of the company and its shareholders. However, where a company becomes irredeemably insolvent, the interests of the company’s creditors take priority. At that juncture, directors have a legal duty to act primarily in the interests of the company's creditors, instead of its shareholders.

By failing to act in time, directors may expose themselves to the risk of incurring personal liability for company debts and/or committing an offence. It is therefore crucial to determine whether the company is in fact insolvent.

Establishing Insolvency

In practice, it may not be possible to identify a precise point in time at which a company becomes irredeemably insolvent (if, indeed, the company reaches that position) and should cease trading. In broad terms, a company is irredeemably insolvent if its financial position is such that any reasonable director would conclude that it has no reasonable prospect of avoiding insolvent liquidation.

Practical Steps

In light of the current mercurial climate, directors should bear in mind the following practical steps which may assist them in acting in a way which minimises potential loss to a company’s creditors:

Full business review: This should include, for example, a constructive and sensible programme to reduce expenditure, increase income and to ensure an adequate cash flow. A clear exit strategy should be set out and reviewed regularly at each board meeting to see whether it is still viable as circumstances rapidly change.
Frequent board meetings: The board should meet frequently (virtually, bearing in mind social distancing guidance) to review the company’s position. It should also ensure that there is a proper distribution of responsibility within the company, both at director level and below.
Financial information: Up to date financial information in respect of the company should be regularly produced and critically reviewed and analysed by the board.
Provision of information to key creditors: It is essential to keep major creditors (for example, secured lenders, key suppliers) regularly informed. As far as possible, creditors should be enlisted for the continued operation of the Company. In addition, where the business is reliant upon the support of material or essential suppliers/customers their continued support would be required in order for the Company to be able to continue to trade. The decision whether to inform creditors and also what they shall tell them and when is a balancing act for the directors, taking account of the need to keep major creditors informed and “on side” on the one hand and the potential impact on the Company and the business having done so.
Government-backed Schemes: as noted above, directors may wish to explore the considerable array of government measures now in place to support employees, businesses of all sizes, and the self-employed, such as CBILS, CLBILS, JRS and the business rates and VAT relief schemes.
Professional advice: It is recommended that the board continue to take professional insolvency advice. In general, the courts will take a sympathetic view of directors who have acted honestly, reasonably and sensibly, particularly if the board has been seen to be taking proper advice from accountants, solicitors and other professionals on valuations, figures and strategies for minimising loss to creditors.

Conclusion

In light of the exceptional circumstances we are living through, and the potentially long-term disruption to customer bases and supply chains, it is more important than ever that directors seek advice sooner rather than later, to ensure that they are acting in accordance with their duties.