The Coronavirus (COVID-19) has quickly become a key and prevalent issue for all trading businesses and their directors, in many cases adding further pressure to existing uncertainty caused in recent years by Brexit.
Company directors are likely to be pulled in a number of different directions in the coming weeks and months – managing cashflow, customers, suppliers, and staff – but they must also remain mindful of their duties as company directors with reference to these as a framework for their decision-making in such unprecedented circumstances.
On 28 March 2020, the Government confirmed that the wrongful trading regime for distressed and insolvent companies was to be temporarily relaxed (retrospectively from 1 March). Whilst this will offer some comfort to directors faced with difficult decisions in times of trading uncertainty, directors must continue to have regard to their statutory duties under the Companies Act and certain other trading offences which continue to remain in place.
Under normal circumstances, directors of a company owe their duties to the members of that company as a whole. When making decisions, directors must exercise independent judgement and have regard to the likely consequences for various stakeholders, including employees, suppliers, customers, and communities. They should also consider the impact on the environment, the reputation of the company, company success in the longer term, and the interests of shareholders as a whole (including minority shareholders).
These are, however, more testing times, and where there is a reasonable prospect of insolvency those duties realign, and the interests of the company’s creditors take priority. Breach of duties to creditors can attract personal liability or disqualification for directors. These duties remain in place despite the temporary relaxation of the wrongful trading regime and so the ability to say, with reasonable certainty, whether a company is, in fact, insolvent (or close to becoming insolvent) is crucial, particularly as commercial decisions in the interests of creditors may be dramatically different to decisions benefitting members.
Is the company insolvent?
Establishing insolvency is not always a straightforward process, and both legal and financial advice should be sought as early as possible. There are two tests: the cashflow test considers whether a company is unable to pay its debts as they fall due, whilst the balance sheet test looks at whether a company’s liabilities outweigh its assets. The cashflow test is not concerned simply with debts which are presently due, but also with debts falling due from time to time in the reasonably near future. Beyond the ‘reasonably near future’, any attempt to apply the cashflow test will become speculative, and, at that point, a comparison of present assets with present and future liabilities becomes the only sensible test for insolvency. A company that meets either or both the cashflow and balance sheet test criteria will be deemed insolvent, and risks being placed into administration or wound up.
The application of the balance sheet test requires an evaluation of whether a company has sufficient assets to have a reasonable expectation of meeting all of its liabilities, including prospective and contingent liabilities. This assessment has to be made in light of the available evidence and circumstances of the particular case.
Wrongful trading and voidable transactions
The wrongful trading regime becomes relevant where a company has no reasonable prospect of avoiding insolvent administration or liquidation. Although the regime has been temporarily relaxed, the offence of fraudulent trading (incurring liabilities that the directors know will not be settled before the company enters an insolvency process) remains in place, and knowledge of the company’s solvency will have a direct bearing on any director’s potential liability for that offence.
Certain other transactions may also be caught under the insolvency legislation, including a company entering into transactions preferring one or more of its creditors over others; transactions for no, or insufficient, value; and transactions defrauding creditors. All of these will continue to apply during the wrongful trading suspension window, and require careful analysis on an ongoing basis. Directors’ duties must be assessed on a company-by-company, rather than group, basis.
Practical tips for Company Directors
Whilst uncertainty remains over the scale and duration of the Coronavirus outbreak, directors can – and should – be taking steps now not only to plan ahead for brighter times but also to insulate themselves from inadvertent breaches of duty. Well-prepared and well-advised boards occupy a far better position in the event of a company’s insolvency. We have set out below some key practical considerations for directors at this time:
- Review key contracts for termination rights and/or force majeure clauses if performance of the contracts is now becoming impractical or burdensome.
- Review the terms of any banking documents to establish whether, or when, financial covenants may be breached, or if other default provisions have or will be triggered; consider whether to open dialogue with creditors.
- Consider where and how each aspect of the business supply chain operates, and how disruption to one component may impact others, including any alternative fulfillment channels; maintain dialogue with suppliers.
- Consider the availability of Government-backed aid (including the Coronavirus Business Interruption Loan Scheme for SMEs, the new “Future Fund” announced for start-ups, and the Coronavirus Job Retention Scheme).
- Where appropriate seek legal advice, particularly where a business is at risk of collapse as a result of the ongoing situation. If there is a risk of personal liability attaching to a director, or a divergence of views amongst the board, then an individual director may also need to be advised independently from the company’s advisers.
- Hold regular board meetings (by video conference or call) and carefully minute conclusions reached in them, setting out detailed justifications for trading and other decisions. As noted above, directors must have regard to a number of factors in reaching their decision; however, a decision which proves in hindsight to be wrong does not necessarily mean it was made wrongfully if it can be shown that the decision was made at the time with reasonable justification and after careful consideration of relevant factors.
For further information or advice, please contact James Lyons, Partner in the Corporate team.