COVID-19 and Directors' Duties

It has long been the case that directors of limited companies are considered to act in the capacity of a fiduciary to that company (i.e. that they act on its behalf, and the company places trust and confidence in them to do so).

These duties arise partly from legislation (prescribed by Sections 171 – 177 Companies Act (2006)) and partly from an established body of case law.

The central requirement is that a director must act at all times in furtherance of their company’s best interests, rather than their own or that of other persons or entities. They must do so by acting in good faith.  The “company’s best interests” means the company as a whole, and includes (but is not limited to) its employees and shareholders. In certain circumstances though, which will be of particular relevance at the present time during these challenging economic conditions, directors must also consider the interests of the company’s creditors.

Should directors act in a way which is contrary to their duties they run the risk of facing personal liability for their actions, particularly if the company enters insolvency.  The Insolvency Act (1986) contains a myriad of ways in which delinquent directors can be required to give redress to the company, should they act in breach of their duties, including:

• Fraud in anticipation of winding up (section 206);
• Transactions in fraud of creditors (section 207);
• Misconduct in the course of winding up (section 208);
• Misfeasance (section 212 or Paragraph 75 of Schedule B1, depending on the insolvency arrangement);
• Fraudulent Trading (sections 213 and 246ZA);
• Wrongful Trading (sections 214 and 246ZB);
• Transactions at Undervalue (section 238); and
• Preferences (section 239).

Now, more than ever, directors need to be extra-vigilant and exercise even greater scrutiny of their proposed acts on the company’s behalf.  With the introduction of numerous Government schemes to shore up businesses and UKPLC (some in the form of grants, some in the forms of loans, some in the form of proposed relaxations of statutory requirements), it is of the utmost importance that directors seek professional advice if in any doubt of their obligations.

For example, it is presently understood that the Government intends to announce changes to the Insolvency legislation to suspend the wrongful trading provisions in the Insolvency Act, which would otherwise create potential personal liability for a director if the company goes into insolvent liquidation and, at some time before that, the director knew or ought to have known that there was no reasonable prospect of the company avoiding insolvent liquidation and did not take every step to minimise the potential losses to the company’s creditors.

As presently understood, this (and other) proposed changes to the Insolvency Act are due to be laid before Parliament at the earliest possible opportunity, which could be as soon as 21 April 2020 when it reconvenes (albeit virtually).

The provisions are proposed to take retrospective effect from 1 March 2020.  However, and a word to the wise, these proposed changes are intended to allow otherwise viable companies to “mothball” themselves, to weather the storm caused by the ongoing COVID-19 pandemic, and allow directors to trade their way out afterwards without fear of their conduct during the pandemic being criticised.  What it is not intended to do is provide carte blanche protection for directors of unviable businesses hoping to shirk liability. 

There will inevitably be cases that proceed through the Courts once the COVID-19 pandemic is over, and possibly before that, when these very questions are scrutinised, including:

1. what is or is not deemed to be a “reasonable prospect of the company avoiding insolvent liquidation” in the COVID-19 era?
2. what steps (if any) would a director be expected to have taken to avail the company of Government support?
3. what criteria will be used to assess the subjectively and objectively viewed knowledge of the director, in what are completely unprecedented circumstances.

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These notes have been prepared for the purpose of an article only. They should not be regarded as a substitute for taking legal advice.