Directors’ Duties in Times of Change

This article was originally posted in R3’s Recovery Newsletter.

Lisa Linklater QC

Introduction

As we pass the second anniversary of the first lockdown measures that followed the Covid-19 pandemic, it can become easy to forget the array of challenges directors faced in navigating companies during the last two years.  Many businesses urgently sought and obtained financial support to survive the Covid-19 pandemic and were protected from creditor action by different measures in the Corporate Insolvency and Governance Act 2020 (“CIGA”).  As liquidators and administrators now review directors’ responses to the pandemic, how does the cocktail of fast-paced legal and economic change impact upon directors’ duties and their enforcement?

Codified Directors’ Duties

It is now 15 years since directors’ duties were codified by the Companies Act 2006 (“CA 2006”). The various no conflict rules (e.g. s175 CA 2006 – duty to avoid conflicts of interest) are unlikely to have been affected by the impact of the pandemic and are intuitive to apply.

However, the changes and uncertainty arising from the pandemic are very likely to impact on the standards expected of directors when exercising their duties under s174 CA 2006 to exercise reasonable skill, care and diligence. It is to be recalled that the test under s174 CA 2006 is objective, by reference to the “reasonably diligent” person with a combination of the actual characteristics and role of the director and the standard expected of a person in the director’s role.  The standard is therefore highly fact sensitive and office-holders will need to carefully consider the relevant factual matrix.

The starting point under s172 CA 2006, the duty to promote the success of the company, is that the test is subjective (“a director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole”).  This is subject to there being evidence of actual consideration by a director (see Charterbridge Corp Ltd v Lloyds Bank Ltd [1970] Ch 62 and Re HLC Environmental Projects Ltd (in liq) [2013] EWHC 2876 (Ch)).  While breach of this duty is therefore more difficult for the office-holder to establish than breach of s174 CA 2006, the multi-faceted pressures of the pandemic may have exposed more directors to breach of this duty.

“Duty to Creditors”

The judgment of the Supreme Court in BTI 2014 LLC v Sequana SA regarding the so-called duty of directors to creditors (which is a duty owed to the company) is awaited and will be very important for office holders. Section 172(3) of the CA 2006 preserves this duty, which may be traced to the Court of Appeal decision in Liquidator of West Mercia Safetywear Ltd v Dodd (1988) 4 BCC 30.

The trigger point for this duty was provisionally settled by the Court of Appeal in BTI 2014 LLC v Sequana SA [2019] EWCA Civ 112.  The Court of Appeal held that the duty was triggered when the director knew or should have known that the company is or is likely to become insolvent; “likely” meaning “probable”.  This issue will be settled by the Supreme Court when it delivers its judgment.  The practical application of this duty will raise many novel points flowing from the unusual economic climate of the past two years.  In addition, it is hoped that the Supreme Court will deal with the content of the duty.

Interplay with “Suspension” of Liability for Wrongful Trading

While described as a “suspension of liability”, section 12 CIGA modified the remedy of wrongful trading by providing that the court is “to assume that the person is not responsible for any worsening of the financial position of the company or its creditors that occurs during the relevant period.”  This suspension was in force from 1 March 2020 to 30 September 2020 and 26 November 2020 to 30 June 2021, leaving a temporal gap between 1 October 2020 and 25 November 2020.  By contrast with the restrictions in respect of the presentation of winding up petitions, no specific link between Covid-19 and the worsening of the financial position was required.  Unlike ss239 and 240 IA 1986, which expressly provide that there are certain presumptions “unless the contrary is shown”, the suspension was not expressed as a rebuttable presumption but a mandatory assumption.  The impact of this assumption on directors’ duties during the periods it was in force remains to be seen.

Conclusion

The past two years have been a period of rapid change for companies and their directors.  There are likely to be novel factual and legal issues arising for liquidators and administrators as they review what directors have done or omitted to do during that period.