COVID-19 has brought new challenges for directors. As the decision makers, with personal fiduciary responsibilities to the company, directors – both executive and non-executive - earn their money in times of crisis. The response to the pandemic has required directors to make major and difficult decisions quickly, often based on incomplete information and limited advice. Many of these decisions have required striking a balance between competing interests and priorities, and will have long-term consequences and ramifications for the business and its reputation. As we move into the next phase, looking forward, prudent directors are reviewing their duties to ensure their decisions not only comply with the "statutory code" of duties in the Companies Act 2006 (the Act), but to ensure that their decisions are the best they can be today, and are defensible tomorrow.
We set out below some of the key issues that directors should consider when meeting their duties against the backdrop of the COVID-19 pandemic; these are difficult times and will inevitably lead to criticisms (or potentially litigation) from shareholders. How can you as a director properly fulfil your duties as a director and protect yourself? We also provide some practical tips for directors to best fulfil their duties.
What are the seven principle duties?
To summarise, the seven principle duties with which a director must comply are set out in the Act as follows:
- Duty to act within powers (section 171)
- Duty to promote the success of the company (section 172)
- Duty to exercise independent judgement (section 173)
- Duty to exercise reasonable care, skill and diligence (section 174)
- Duty to avoid conflicts of interest with third parties (section 175)
- Duty not to accept benefits from third parties (section 176)
- Duty to declare interest in proposed transaction or arrangement with the company (section 177) and the declaration of interest in existing transaction of arrangement (section 182).
The statutory duties are based on (and are to be interpreted in accordance with) the case law which they codify as well as case law which develops post codification. Legal duties and obligations are the same for all directors - but the courts look at what was expected from individual directors in determining whether they have satisfied duties by reference to their role; for example, executives, non-executives, founders, professional directors or shareholder appointees. There are also un-codified duties, such as the duty to consider creditors' interests in times of potential insolvency; something that the current crisis is requiring many directors to consider for the first time (explained further below).
A point to note: there are additional requirements for listed company directors in terms of regulatory and governance code requirements.
Criticism at this time seems inevitable – how best do you manage it?
In periods of economic uncertainly and disruption, it is not uncommon for shareholders to direct criticism at directors. This may manifest itself in challenges in relation to the financial performance of the company, complaints about excessive director salaries, greater questioning of decisions made, disputing reduced dividend payments being made, and so on.
During these times, prudent directors should ensure clear and timely communications with shareholders to assure them that they are acting appropriately to protect their interests. Consider the company as a whole; if the company has furloughed or made staff redundant, should you also look to reduce director salaries?
Directors' duties are owed to the company itself, so the proper claimant for a breach of duty is the company. However, under Part 11 CA06 a shareholder may bring an action against a director (on behalf of the company) arising from an actual or proposed act of omission involving negligence, default, breach of duty or breach of trust. So long as directors have acted proactively, in good faith and to promote the success of the company, they should have a reasonable defence to any allegations made.
It is important to note that good faith requires honesty, integrity and fairness. Integrity in particular will be scrutinised in times of crisis; priorities have changed drastically over the last few weeks. As far as possible, ensure that all current (and future) decisions are considered in the light of the pandemic and its aftermath. Decisions that you may have made and risks you were prepared to take pre-COVID may be seen as inappropriate and in bad faith in the changing climate.
Many of us have started to question our previous values. Will shareholders expect the same decisions as before?
Possibly not. The decisions made by directors in response to the pandemic reflect the underlying values and purpose on which a company is run – which may have changed in light of the crisis. Because of this, the course a company takes at this time will have a greater than usual impact on its reputation. First, companies with stronger ESG – environment, social and governance – credentials have proved themselves to be more resilient (both in terms of performance and share price) through the crisis. Major banks and investment companies are tipping these businesses to outcompete their rivals and recover quickest and most strongly. The pandemic has shown our society and economies to be significantly more fragile than we had thought and the prospect of climate change is now more centrally in mind. Directors interested in building long-term value and sustainability need to ensure they robustly and properly address these ESG factors as they review the purpose of their company and its role in society. ESG can no longer just be seen as a matter of reputation, but is central to profitability and success.
Does the risk of insolvency change your duties as a director?
Given the precarious economic situation many companies are at risk of insolvency. Does this change your duties as a director?
In short, yes – your duties change significantly. Of particular note is that your primary duty changes so that you must act in the best interests of the company's creditors i.e. do not accept credit or incur new liabilities if there is no reasonable expectation of the relevant creditor being paid. If you believe – or ought to have suspected – that there was no reasonable prospect that the company would avoid entering insolvent administration or liquidation, you run the risk of being held personally liable for "wrongful trading". Companies should only continue to trade if there is a reasonable prospect of the company avoiding insolvent administration or liquidation.
Whilst the UK Government intends to introduce measures to suspend the existing restrictions on wrongful trading i.e. to remove the sanction of personal liability of its directors for allowing the company to continue to trade whilst insolvent. Although not yet implemented in legislation, the Government has stated that this suspension will be retrospective to 1 March 2020. However, it is unclear precisely how this suspension will be implemented, and in any case, this suspension will only last for a few months and does not alter a directors' ongoing duty to act in the best interests of the company's creditors. Further, it will not affect other elements of the insolvency regime such as the other director's duties outlined above, or the prohibitions on fraudulent trading, transactions defrauding creditors, or misfeasance under the Insolvency Act 1986.
Ask for information
Directors need to access (and assess) up to date financial and accounting information for the company, cash flow forecasts, management accounts – and anything else you believe may be of particular note. Even more important in the current situation is to constantly reassess any decisions that have been made in light of the fast-changing situation.
Where decisions are taken they should be clearly recorded in minutes. You need to think carefully about contributing properly in meetings, making sure you are challenging decisions being made, demonstrating your own strategic thought processes. And more important than ever, carefully reviewing and editing the meeting minutes so that they are an accurate reflection of what was discussed. You should push for meeting minutes to be circulated as soon as possible after the meeting so that the discussions remain fresh in their minds. You are advised at all times – but especially now – to keep any notes of meetings that you make.
Take professional advice
Whilst the company may not want to be spending money on what might be perceived to be expensive professional advisors at this time, if you are concerned about decisions being made without advice from the company lawyers, accountants or auditors, taking (and following) professional advice is your best defence to a negligence claim. Ensure you are happy with any instructions they are given and assumptions they are asked to work from.
Now is not the time for it. You need to do what is necessary to fulfil your directors' duties. Disagree with your allies or side with those you have not historically got on with if you believe it is the right position to take. Your clear focus must be on your duties and demonstrating that you are fulfilling them; you have a duty to exercise independent judgment. Times of economic uncertainly often lead to litigation – be prepared to explain (and in the extreme) defend your position.
Board meetings should continue in the same way as before, as far as practicable. Papers must be circulated in good time, agendas need to be drawn up and gone through. You must not allow administrative issues to prevent you from taking part in decision making processes. If you are 20 minutes late to a meeting due to technical issues – ensure that is noted in the minutes. If you are unable to hear something being said or review something being discussed, ensure that is noted in the minutes. These are unprecedented times and there are many challenging issues to working at home but these will not justify you failing to fulfil your obligations and duties as a director.
Practical guidance for COVID-19
Read the latest COVID-19 related updates on our hub.