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Directors' Duties in light of COVID-19

20.03.2020 Business Recovery, Restructuring & Insolvency

Alex Rogan

Alex Rogan Partner

Julie Killip

Julie Killip Partner

Rebecca Ferguson

Rebecca Ferguson Head of Capital Markets

COVID-19 represents an unprecedented challenge to people and their businesses, the like of which has not been seen before in modern times. There is no doubt that almost all sectors will face significant challenges as both the supply and demand side of the economy grind to a halt. Certain sectors will benefit as the world moves on-line due to travel restrictions but for the large part this will be a very difficult trading environment which will be challenging for businesses to navigate.

Directors will need to carefully consider the scope of their duties and take action to ensure that they minimise the risks of continuing to trade while facing potential insolvency. This Q&A elaborates on the Q&A we published at the beginning of this month as well as more detailed guidance that we have published relating to directors duties whilst trading in the zone of insolvency and other governance considerations

What support is available to companies to navigate the Coronavirus?

The government has announced that it will seek to support business through the COVID-19 crisis and has set out an unprecedented raft of measures to this end. These measures include making lending available to businesses of all sizes, reductions and deferrals on a range of taxes, and income support, as well as certain sector specific measures; overviews of these measures can be found here. The government and its relevant private sector partners are still working on the precise details around a number of these measures but the expectation is that during the course of next week substantial government support will come into play to assist various parts of the private sector.

Beyond looking to the government support, it is crucial that companies facing financial distress seek to engage pro-actively as soon as possible with all their key stakeholders. The expectation is that the banking sector will try to support business either directly through lending made available under government backed measures or through accepting appropriate standstill arrangements in relation to payments due under existing lending arrangements. Customers and suppliers are likely to be facing their own financial distress and it will be important to have open and transparent negotiations to ensure that businesses work together to support each other rather than seek to recover monies owed through enforcement or petitioning for insolvency where creditor recoveries are likely to be minimal.

What are directors’ key duties for a company facing financial distress or even potential insolvency?

Directors need to weigh up whether or not there is a reasonable prospect for their company to avoid insolvent liquidation. To the extent that directors conclude that there is no prospect of avoiding insolvency then they must either put their company into an appropriate insolvency process or continue to trade but ensure that they take every step to ensure that losses to creditors are minimised. This is the so-called wrongful trading test and it exposes directors to personal liability for the losses incurred by creditors in the interim period between when they knew, or ought to have known, that their company faced no reasonable prospect of avoiding insolvent liquidation and the point at which the company entered an insolvency process whether that be liquidation or administration.

This is a difficult decision as directors face potential liability from the value destruction resulting from a premature insolvency filing as well as a delayed insolvency filing. There is no escaping this decision either as directors do not absolve themselves of liability by merely resigning from their board. It is important to note, however, that liability only arises once a company has entered into insolvent liquidation. As such, an insolvent company may continue to trade provided that there is a reasonable prospect of avoiding insolvent liquidation - a light at the end of the tunnel.  Further detail on the full scope of directors’ duties and liabilities is available here.

How can directors' get comfortable continuing to trade in the current economic environment?

The unprecedented level of support being made available to business by the government should provide directors with significant comfort that their business has a reasonable prospect of avoiding insolvent liquidation. In our view the fast changing nature of COVID-19 and the government measures being put into place to help businesses in light of it are mitigating factors and ones which directors may legitimately take time to consider in determining the correct strategy and course of action for a company experiencing financial difficulties which have predominantly been caused by the current outbreak.

Nevertheless, it is imperative that directors carefully consider the detail around how their business will benefit from this support. Making informed decisions on the basis of all appropriate financial, trading and operational information is crucial. The relevant information will need to be considered in light of the uncertainty around both the time period over which COVID-19 will continue to cause an impact to your business and the amount of government support available to the business. 

Directors will need to consider a revised business plan addressing trading prospects which provides for a worst case and best case scenario. This plan should provide for a more conservative strategy which protects creditors’ interests. Key information that directors should look to consider depending on the nature of their business includes:

  • Short term cash-flow forecast: Cash is king and directors should ensure that they have an appropriate short term 13 week cash flow forecast; 
  • Operational plan: this should address business critical functions, ability to deliver services or produce product in light of employee sickness and any supply chain constraints;
  • Debtors: an overview of debtors with a realistic assessment of appropriate timeframes to maximise the realisation of cash;
  • Cost cutting review: a careful review of expenditure to cut all non-essential costs;
  • Contingency valuation: this should provide directors with information on the likely realisable value for creditors in an insolvency process and may support a decision to continue to trade to maximise value for creditors; and
  • Government concessions: being the steps the government has put into place to help business trade through COVID-19 and whether any further support is likely.

Considering this information on a timely basis will help directors not only navigate their company through these difficult times but ensure that directors can demonstrate that they considered the relevant issues and took every step to minimise losses to creditors should their decision to continue trading be challenged following an insolvency process.  

What other measures should be taken to ensure good governance?

It is crucial that the board is well advised both internally and externally with appropriate legal and financial advisory support. It may be appropriate for the board to set up a sub-committee to consider the impact of the crisis on the business on a daily basis, ensure that initiatives are implemented and reported to the board. However, the full board should review the position on a timely basis, this may mean weekly or even daily board meetings are appropriate depending on the extent to which new information is likely to impact decision making. Board meetings should be well documented with detailed board minutes addressing the directors’ deliberations in reaching their decisions.

Are companies able to incur further liabilities if they are insolvent?

Directors of distressed companies need to carefully consider incurring further credit in light of all the information that is available and their ability to repay the credit. Incurring credit in and of itself will not necessarily alter the net deficiency of the company for which a director is liable under a wrongful trading claim. Nevertheless, depending on how the credit is deployed it may expose the directors to preference claims in the event of insolvent liquidation and remove their ability to defend their actions against a wrongful trading claim on the basis that they took all steps to minimise losses to creditors. 

What insolvency process is appropriate if the directors conclude that insolvent liquidation is unavoidable?

If negotiations with key stakeholders are unsuccessful then before considering options around an insolvent liquidation or administration directors should consider whether they have sufficient support from stakeholders in order to use a collective process such as a scheme of arrangement or a company voluntary arrangement to bind in a minority of dissenting creditors to a restructuring plan which is supported by the majority of its creditors. Schemes of arrangement are an effective tool to implement a restructuring plan for secured creditors where the plan has the support of at least a majority in number of creditors that represent 75% in value of those who vote on it. A CVA is an effective tool to implement a restructuring plan for unsecured creditors where the plan has the support of 75% in value of the unsecured creditors (provided that no more than 50% (by value) of any creditors who vote against the plan are creditors who are unconnected with the company).

Navigating the zone of insolvency is a challenging task for directors in what has rapidly become an unprecedented financial crisis. It is important for directors to engage professional legal and financial advisers as soon as possible once they become aware of solvency issues. Professional advisers are able to provide invaluable support in steering the company through its difficulties and ensuring that the directors are adequately protected should an insolvency process be required.  Our team stands ready to help so please contact us if you require assistance. 

Article authors:

Alex Rogan Julie Killip Rebecca Ferguson