Directors' legal duties and relaxing the wrongful trading laws to beat a Covid-19 world

Because of the new emergency measures announced by the UK’s business secretary, Alok Sharma, on 28 March 2020, UK company directors should no longer face the prospect of personal liability and/or actions brought against them by creditors, shareholders and others for battling to save their businesses, when many hundreds of thousands of them would otherwise be wrongfully trading and/or technically insolvent due to Covid-19’s horrendous impact.

These new temporary measures (not yet in force) are to be backdated to 1 March 2020 and are intended to be in force for at least 3 months, potentially longer.

If you’re a UK company director, protect yourself and give this a quick read to find out how this affects you and also what, as company directors, you still need to do to ensure you’re otherwise trading and behaving lawfully.

When we get through this extraordinary period, you’ll need to be fit to carry on running your businesses; and if you’re going to want funding (loans or investment), sales contracts, to bring in (or back) the talent that you need, the way that you’ve handled the business during this period will matter.

Understanding your position and enduring duties under the new emergency measures is therefore vital.

We grabbed a few moments with two of our favourite experts, Boffix’s head of accounting, Aaron Patrick, and 3D Solicitor’s founder partner, Dan Berke, to talk about the core essentials that directors must get right, even in Covid-19 times, and about the very welcome emergency measures to relax the wrongful trading and insolvency laws that the Government’s introduced.

And until these measures are captured in legislation and made law, both Aaron and Dan advise that company directors still need to be very cautious about their legal obligations and ensure they’re taking expert advice, where appropriate.

• The wrongful trading laws (described in more detail below) have been temporarily suspended, so that directors don't need to take the heartbreaking decision to close down their businesses prematurely because of Covid-19’s impact, rather than to continue, where reasonable and responsible, to carry on fighting to keep going

• The current rules state that directors of limited liability companies can become personally liable for business debts if they carry on trading when they’re uncertain whether their businesses can continue to meet its debts

• Temporarily suspending these wrongful trading rules means the difficult decisions directors are being forced to make about the future viability of their businesses, in exceptional circumstances that are entirely beyond their control, shouldn't result unfairly in legal actions against them

• There is now a 3-month (or more) moratorium for companies, giving them breathing space from creditors wanting to enforce their debts while companies seek rescue, undertake restructuring and fight to survive

• Companies can continue to source and take supply of vital materials to help them carry on trading (normally not permitted, as this would be incurring more costs/debt)

• Directors are still expected by law to use their best endeavours to trade and to make reasonable decisions about their businesses in these times. (Taking expert advice will help directors to demonstrate that they have fulfilled this legal duty)

• All other company director obligations remain in force; meaning that existing laws for fraudulent trading and the threat of director disqualification will continue in force, acting as a deterrent against director misconduct. So, directors must still ensure that decisions regarding:

  • financing decisions
  • loans
  • rent/rates/VAT deferrals/PAYE and NIC time-to-pay arrangements reached with HMRC
  • withholding rent/payment holidays/restructuring lease terms in agreement with landlords
  • restructuring or altering trading activities
  • headcount reductions and/or headcount terms alterations must still be made properly (raised and voted on, with the right quorum) in board meetings, recorded properly in board minutes and, where relevant, consented to by shareholders and filed properly; although for small businesses, all of these activities should be capable of being conducted remotely and online.

Check your articles of association and your shareholder agreements (if any) to ensure that you’re still getting these activities right. To find out more on what you need to do, access board minute templates and rapid guidance on what’s involved, see Farillio’s playbook for paperwork and filings, which contains the materials and support you need.

Companies whose annual accounts are due for filing with Companies House (not HMRC) during this period have also automatically been granted a 3-month extension (from 1 March 2020) to their filing deadline, using a fast-track online process. Find out more here.

Annual general meetings, for those obliged to hold them, can now be held online or by phone, using only proxy voting, so as to enable them to go ahead and observe the public health guidance.

More detail is expected as these changes are captured in legislation and the government determines how it will also legislate to include safeguards for creditors and suppliers to ensure they're paid and protected as far as possible during the Covid-19 emergency measures period.

No matter what challenges your business faces, if you’re one of its statutory directors and you’re acting in good faith and lawfully, then even if you can’t keep the business going, your personal assets and personal liability for are normally shielded and protected. And you can put in place tailored insurance as an extra, highly recommended precaution.

For many of us, that’s a bit of comfort, but not something that we’re really preoccupied with right now in Covid-19 world, as we literally battle to protect cashflow, get finance, take care of our workforce, agree rent payment holidays with landlords, or take other emergency measures to keep going.

But, and this is an important ‘but’, directors still need to protect themselves. Not just their health and mental health (this is brutal; there’s no sugar-coating it), but also, critically, their personal liability.

Because if we’re not running our businesses lawfully and responsibly, then that all-important limited liability ‘shield’ falls away.

This would be disastrous. And the reason it’s such a big deal is that many millions of businesses in the UK right now, because of Covid-19, are carrying on trading when according to the usual legal rules, they shouldn't be.

In fact, they’re potentially, if not actually, ‘wrongfully trading’: carrying on business when their cashflow has crashed, they can’t afford headcount – but they’re not making staff redundant to minimise the financial damage – and they’ve probably not gone through all the formal motions that the law typically mandates in these circumstances, in normal times, when a company is at risk of (or actually) falling into insolvency.

This means that the shield is technically down, placing directors personally accountable to creditors and shareholders.

And it also means that directors’ and officers’ insurance, which many businesses sensibly have in place to protect their responsible and compliant directors and senior decision makers from any financial impact to their personal positions, may – in normal circumstances – be invalidated.

These emergency measures, which the government intends to be in force for at least 3 months, backdated to 1 March 2020, ensure that in these unprecedented times, good, responsible directors aren’t under fire and accused of wrongful trading as they battle to keep businesses alive, contracts honoured, or at least salvaged, and staff in jobs.

All other duties that directors are legally mandated to carry out properly and reasonably, remain in force. We summarised what they are, and how Covid-19 affects them, below.

Directors of UK companies have the following legal duties as they manage the limited companies they’re responsible for:

• to act within their powers (these are the powers given to them by their company’s rule book: the articles of association, as well as any supplementary requirements or limitations that might be imposed on them by any shareholder agreement)
• to promote the success of the company (essentially meaning that they should be actively focused on ensuring that the company’s prospects and financial position are strong and thriving – and that where they're not, there's a clear, appropriate and responsible plan to get back on track)
• to exercise independent judgment (so, not allowing themselves to be pressured, cajoled or otherwise unduly influenced by people, events or other factors that might cause them to act contrary to their normal good and lawful judgment, and against the company’s best interests)
• to avoid conflicts of interest (to not allow a relationship, investment, management or other position, that they or a family member might hold, somewhere else, outside of the company, to influence their decision making and conduct within the company)
• not to accept benefits from third parties (similar to the above, directors must not permit themselves to accept incentives or other motivators in return for voting or behaving in a different manner to what would be expected of them in normal circumstances)
• to declare any potential conflicting interest (or possible bias) in a proposed transaction or arrangement

One of the duties most under scrutiny as a result of the current Covid-19 situation is the one to promote the success of the company. Covid-19 is really challenging for almost every company director right now. There are no real comparators for this kind of situation. So, knowing how to act in the best interests of the business and to promote its success may be daunting for some and the last thing on the minds of others. Keeping up with all the changes, reliefs, requirements and opportunities is a challenge that many of us are struggling with.

We still have to act in good faith

The legal provision setting this out under the UK’s Companies Act obligates directors to act in good faith to promote the success of the company for the benefit of its shareholders (owners) as a whole.

The rule states that acting in good faith means that, in carrying out their duties and making decisions, directors must carefully consider the:

• likely long-term consequences of any decision made
• impact of this on the company’s employees
• need to preserve good trading and business relationships with suppliers, customers and others
• consequences of the action/decision on the community and the environment
• desirability of maintaining a brand reputation for high standards of business conduct
• need to act fairly towards the shareholders (owners) of the company.

The law states that:

• this list of factors isn’t exhaustive and that there may be other relevant factors contributing in any particular situation to achieving the success of the business; and
• importantly, that each company director is legally required to act in this way, individually, as well as collectively with their fellow directors

It also requires each individual director to act with reasonable care, skill and due diligence when they make decisions and apply these factors – which in a number of circumstances, will mean demonstrating that they have taken expert advice to help them make decisions where they're not subject matter experts and/or experienced in handling particular situations that have arisen.

What does ‘promoting success’ mean?

This is largely for you, as directors to ascertain yourselves, relative to the business and sectors you operate in and the opportunities and challenges that you each individually encounter. Provided that you can evidence that you’re acting in good faith and reasonably, the UK law treats strategic and tactical decisions as matters that should rightfully be determined by the directors, and not dictated by law or the courts.

Where the evidence of director decision making and reasonable evaluation of a matter is not clear, then the proper test that the courts apply is whether an intelligent and honest person in the position of that director/group of directors would have reasonably believed that the activity or decision in question was taken and intended to benefit the company.

However, where the company faces severe financial difficulties, and potentially insolvency, the duty of the directors by law switches to acting in the interests of the creditors. And if the creditors don't believe that the company and its directors are acting in their best interests, they have the ability to ask a court to issue a winding-up order, essentially shutting the business down with near immediate effect and selling off assets/recovering as much money as is left, so that the creditors can minimise their losses as far as possible.

Covid-19 has placed many businesses in a position where the directors should, technically, under the current law, be acting in the interests of creditors, and prioritising them over staff, business opportunities and continuing to trade – and where creditors would rightly be justified in applying for winding-up orders.

This is why Alok Sharma’s announcement and the government’s intended emergency legislation to temporarily relax the wrongful trading rules and the insolvency position are so important.

Nobody wants UK businesses to go down. The fight to stay solvent is a critical one. And the silver-lining, at least, is that thanks to these imminent changes to the law, directors can hopefully carry on fighting to survive, acting in the best interests of their business, still accessing suppliers and raw materials, furloughing staff rather than making them redundant, and not having to prioritise creditors unless their advisers tell them it’s time to do so.

Any existing winding-up orders brought by creditors before this date are also to be suspended until (currently) 17 June onwards.

As directors, we must ensure we’re doing the following:

• taking the right advice, without delay: this may be financial and/or insolvency law-related. If the company ultimately can't be saved, the courts and creditors are likely to be far more lenient on directors if they sought timely and respectable advice on the reasonableness of continued trading and if they followed the advice that they received. Keep a clear note of all interactions with advisers, what was said, who this advice was reported to, and what action was decided on and taken

• cashflow and costs: urgently and regularly reviewing cashflow and making decisions that conserve it as far as possible (e.g. by furloughing staff and reducing any non-critical expenditure

• creditors: keeping all creditors informed of how the company is faring, what it is doing and treating all creditors equally, not preferring one over any other, except where it is critical to ensure business trading continuity (e.g. a supplier must be paid before more vital supplies are delivered)

• keep funders and investors informed: you have a legal duty to keep these stakeholders informed and up to date with what is happening

• put in place clear contingency plans and compromises with suppliers and distributors: suppliers and distributors will be experiencing the same crushing challenges as you are. Get agreement in writing wherever you can to reduce/delay payments, manage deliveries and keep going. Put these compromise solutions in writing, indicating:

  • what is being changed (e.g. payment terms, suspension of late payment interest obligation, delivery deadlines (including time-is-of-the-essence obligations), volumes of supply delivered (e.g. you may be reducing supply to manage costs and reflecting reduced headcount), suspension/alternation of liability and indemnity obligations, etc.)
  • why it's being changed
  • from when and to when these changes will take effect
  • that this is an exceptional waiver of the existing terms and not a permanent variation to your contract terms
  • when you'll both review the arrangements and decide next steps

You can adapt Farillio’s template letter to help you get started on this. It’s recommended that you get advice on this communication, however, so you can be sure you’re not missing anything fundamental in your trading terms, or trading practices that have essentially become part of your contractual relationship(s) with suppliers and distributors.

Many businesses are striking compromise arrangements with suppliers where they agree to pay/contribute to supplier overheads and delivery costs, but have reduced/discounted the full amount due, recognising the supplier’s reduced staff costs, where the supplier has furloughed staff and is operating only a skeleton staff while it continues to fulfil orders as best it can.

Logical, common sense and creative problem solving in reaching these arrangements will support directors in demonstrating that they're behaving reasonably and responsibly in the circumstances.

• decision making and record keeping: keep proper records, hold proper meetings (remotely – check your articles of association to check you can do this – if not, pass a written resolution to amend them), ensure decisions are made with the right quorum (minimum number of directors to pass a decision), get shareholder approval for any major decisions requiring their consent. See Farillio’s playbook on this topic, to check what you need for each and every activity. Hold regular and thorough board meetings to ensure the timely handling and escalation of issues arising

• notifying insurers, if needed: you may need to keep your insurer/broker informed – or at the very least, to keep an eye on your policy wording to check that decisions you’re making don't undermine or invalidate any cover you have in place (e.g. employer liability coverage where staff are working remotely, directors and officers liability where you’re trading despite cashflow difficulties, etc.)

Please note: The contents of this blog are not tailored business advice or legal advice. This is guidance and information, which we do our best to keep current, relevant and helpful. If you need business or legal advice, please use our Speak To An Adviser service or you can get in touch via our LiveChat