Directors’ duties in the time of coronavirus

April 27, 2020

By David Mohyuddin QC

Companies are facing unprecedented challenges as the Government’s COVID-19 restrictions continue. Directors are faced with enormously difficult if not impossible decisions about those companies’ futures. And at the same time as they face the prospect of personal liability for the decisions they take.

Sections 171-175 of the Companies Act 2006 set out company directors’ general duties. They are not a complete code, requiring to be interpreted in keeping with the common law rules and equitable principles on which they are based. In broad summary:

(a)          section 171 requires directors to exercise their powers only for the purposes for which they were conferred;

(b)          section 172(1) requires directors to act in the way that they consider, in good faith, would be most likely to promote the company for the benefit of its members as a whole; this is sometimes referred to as the duty to act in the company’s best interests. That apparently subjective obligation can be tested objectively in certain circumstances;

(c)           section 172(3) introduces the so-called Creditors’ Interests Duty;

(d)          section 173 requires directors to exercise independent judgment;

(e)          section 174 requires directors to exercise reasonable care, skill and diligence. The extent of that requirement is to be gauged by reference to what is reasonably to be expected from a person carrying out the functions of a particular director and by that particular director’s own knowledge, skill and experience;

(f)           section 175 requires a director to avoid a conflict of interest but does not apply in relation to a transaction or arrangement with the company.

The Creditors’ Interests Duty has been the subject of a various judicial pronouncements. Where the company is insolvent or likely to become insolvent (i.e. before it enters into a formal insolvency regime), the directors’ duty to act in the best interests of the company is regarded as a duty to act in the interests of its creditors as a whole, and those interests are regarded as having become paramount. See, for example, West Mercia Safetywear Ltd v Dodd [1988] BCLC 250 at 252h-253b, (1988) 4 BCC 30 at 33, CA; Re HLC Environmental Projects Ltd [2013] EWHC 2876 (Ch) at 87-96 and BTI 2014 LLC v Sequana SA [2019] EWCA Civ 112 at paragraph 222. As for insolvency, see BNY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL plc [2013] UKSC 28 and Re Cheyne Finance plc (No 2) [2007] EWHC 2402 (Ch).

That obligation was extended to formal insolvency situations by ICCJ Barber’s very recent decision in Re System Building Services Group Ltd [2020] EWHC 54 (Ch). Whilst it might be argued that her decision is based on extreme facts, it does appear to be authority for the principle that directors’ duties – particularly the Creditors’ Interests Duty – continue even after the appointment of an insolvency office-holder.

And the declaration and payment of a dividend might involve a breach of the Creditors’ Interest Duty. See the Court of Appeal’s decision in BTI v Sequana and Zacaroli J’s decision in Re Burnden Holdings UK Ltd [2019] EWHC 1566 (Ch).

It is understatement to say that many businesses are struggling. Where a director has to act in the company’s best interests, what considerations might arise?

Has the company availed itself of governmental financial support? It is quite conceivable that a company might have furloughed its staff and been supported through the Coronavirus Job Retention Scheme. It might have deferred its payment of VAT or entered into a time to pay arrangement with HMRC. It might have sought a statutory sick pay rebate in respect of absence due to COVID-19. It might (if in the retail, hospitality or leisure sectors) have benefited from the automatic application of discounted business rates. Again, if in those sectors, it might have applied for an obtained a grant for each of its properties. If eligible, it might have applied for a Coronavirus Business Interruption Loan – though much is being said and written about the actual availability of such loans. Accepting such assistance might well demonstrate an absence of (cashflow) solvency. The same might be said for emergency borrowing from other funders.

And in addition, directors might have decided to defer the payment of the self-assessment sums due on 31 July 2020.

If the company is or is likely to become insolvent (or if the directors ought to know that it is) then the Creditors’ Interest Duty arises – and with it the risk of a claim, whether brought under section 212 of the Insolvency Act 1986 or otherwise.

Should the company cease to trade and enter a formal insolvency regime? But what about the realisation of its assets – who is going to buy them? And what lines of funding would be available to finance their acquisition? If the director wishes to acquire them and is the only potential buyer but cannot raise enough finance to pay their market value, could that director commit a breach of duty by buying the assets from the administrator (say) at a discounted value? Would it be a defence to a breach of duty claim like that brought in Re System Building to say that the director’s offer was the only one and something was better than nothing? What about if the director was unwilling to pay market value? Would that be a firmer basis upon which to allege a breach of duty?

Would it be contrary to the longer term interests of the company to go into a formal regime when there remained the possibility of its return to profitable trading? What about employees who could be furloughed under the current scheme – could taking into account their interests be a credible reason for not entering into a formal regime? Relevant here are the recent decisions of Snowden J in Re Carluccio’s Ltd [2020] EWHC 886 (Ch) and of Trower J Re Debenhams Retail Ltd [2020] EWHC 921 (Ch) – an appeal in which is understood to have been in the Court of Appeal’s list on 22 April 2020.

What about the funds received from HMRC? Are they part of the company’s general funds or earmarked for a specific purpose? A loan might well be general funds but is there an argument that money saved by not paying business rates are subject to some sort of trust – has there really been a “grant” made to the company? Maybe unlikely, but to be borne in mind – especially if it is the only money available to the company.

What about directors who are also employees? Can they be furloughed and still take a dividend? That would seem to be risky.

What if the company cannot take up an opportunity? Can the directors take it up themselves, maybe through another company? See Davies v Ford [2020] EWHC 686 (Ch).

And continuing to trade? What will the government do to ameliorate the risk of a claim for wrongful trading? Will there still be the potential for after-the-event allegations of preferences and transactions at undervalue?

These considerations and more will arise for directors – making their already difficult decisions harder. They should take proper advice and make careful records of how and why they reached the decisions they did. Section 1157 of the Companies Act 2006 allows the court to grant relief to directors who acted reasonably and honestly in all the circumstances – and keeping records will provide useful evidence in that regard. The court can be asked to exercise that power within a claim started against directors or on an application made by the directors themselves. By section 1157(2), directors may apply to the court for relief if they have reason to apprehend that a claim will or might be made against them in respect of negligence, default, breach of duty or breach of trust. Whether the current circumstances justify directors making such an application is not clear but it is certainly an avenue that they might – in an appropriate case – wish to explore.

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