COVID-19: Legal considerations for UK Boards (updated to reflect the position as at April 1, 2020)

The COVID-19 pandemic poses immediate current and future challenges for English businesses.

What are the legal duties of directors on the boards of English companies in responding to this unique challenge, the support for boards and proposed changes to insolvency law?

Practical steps for  directors to take as a result of the Covid 19 pandemic when considering insolvency issues

1. Directors are facing huge challenges at the current time, with the situation getting worse by the day. The Government made an announcement on March 17, 2020 indicating that it would provide a £330 billion life line to address the urgent liquidity needs for all sizes of businesses in a number of ways, including making loans available, providing guarantees of liabilities, granting relief from payment of business rates and payment holidays on mortgage payments.

2. Following the announcement, a new financing facility was proposed by the Bank of England and details of the other measures have been mentioned in various subsequent announcements. 

In summary, the financial support will be provided in a number of different ways:

(a) The Covid Commercial Financing Facility (CCFF) is a commercial paper facility offered by the Bank of England to large companies that make a “material contribution to economic activity in the United Kingdom” and have an acceptable creditworthiness. (A link to our commentary on the CCFF facility)

(b) The Coronavirus Business Interruption Loan Scheme (CBILS) is a government-backed guaranteed loans programme for small companies. The programme will assist with loans of up to £5 million to SMEs with an annual turnover of less than £45 million for terms of up to 10 years. The first 12 months will be interest-free.

(c) Deferral of certain tax payments and sick pay relief and promotion of time to pay agreements with HMRC; Government grants for certain SMEs; relief from business rates for 12 months for all businesses; and agreement to pay 80 per cent of employee wages for  “furloughed employees” who would otherwise be made redundant.

3. Since the Government announcement on March 17, directors have been able to take comfort from the fact that the statements clearly signalled the Government’s intention to do whatever it can to minimise the economic fallout from the virus, which assists directors in making decisions to continue to trade at the current time. 

Government announcement on March 28, 2020 of the suspension of wrongful trading liability for three months and changes to Insolvency Law

4. Further comfort for directors was given in the speech by Business Secretary Alok Sharma on Saturday, March 28, 2020, in which he announced new insolvency measures to support businesses under pressure as a result of the coronavirus outbreak.  He said that the Government would be amending insolvency law to give companies breathing space and keep trading while they explore options for rescue and temporarily suspending wrongful trading provisions retrospectively from March 1, 2020 for three months.  

5. The Government announcement was as follows:

“The government will also temporarily suspend the wrongful trading provisions to give company directors greater confidence to use their best endeavours to continue to trade during this pandemic emergency, without the threat of personal liability should the company ultimately fall into insolvency.
Existing laws for fraudulent trading and the threat of director disqualification will continue to act as an effective deterrent against director misconduct.”

The draft legislation to enact the suspension of liability for wrongful trading for a three-month period with effect from March 1, 2020 and the new insolvency law reforms which are being introduced is being prepared and we understand that it will be available later in April 2020, and that the changes will come into force soon after given the urgency of the situation. As at April 1, 2020 the only additional information we have is a Commons briefing paper.

6. We will be able to comment further once the draft legislation is available. We understand that the legislation is likely to introduce two new restructuring procedures which were canvassed in a consultation paper in 2016. One procedure is the introduction of a “28-day business rescue moratorium” where directors would be able to continue to trade whilst seeking to restructure the business, with the assistance of an insolvency practitioner. The second procedure is a court-based restructuring tool allowing the company to propose a restructuring plan to its creditors. There is also likely to be a ban on the enforcement of termination clauses which enable suppliers to terminate a contact in the event that the customer/counterparty goes into an insolvency process. Currently the ban extends only to essential suppliers of gas, water, electricity, IT and telecommunication systems.

Legal duties of directors

7. The legal duties of directors under English law comprise common law duties, codified duties in the Companies Act 2006 and various statutory duties in different pieces of legislation for example the Health and Safety at Work Act, environmental and employment legislation.

8. The duties set out in the Companies Act 2006 provide, inter alia, that when companies are solvent the duties of directors are to promote the success of the company for the benefit of its shareholders. When a company is insolvent or likely to become insolvent the duties change and directors are required to act in the best interests of the company’s creditors, with the focus of the board being to maximise the value of the assets of the company in the interests of those creditors. These duties are likely to remain unchanged by the proposed insolvency law reforms and it is important to bear in mind that the suspension of wrongful trading will not suspend other claims which can render directors personally liable, such as fraudulent trading, misfeasance, breach of duties set out in the Companies Act 2006 as set out above or where a company enters into transactions which can be clawed-back by an administrator or liquidator. Recent case law  indicates that the duty to consider the interests of the creditors arises at the point “when the directors know or should know that the company is or is likely to become insolvent” and directors owe a creditors’ interests duty at that point, which again will not be relieved by any suspension of wrongful trading. This is fact-specific in every case.

9. As a result directors of companies which are experiencing financial uncertainty and distress and which may become insolvent, need to consider and act in the best interests of their creditors, and document their decisions and thought processes to be able to demonstrate that they have considered these interests in their decision-making. Many companies will fall into this category at the current time if they are unable to continue to provide goods or services due to the current restrictions and are  also to be experiencing difficulties in receiving payment for prior goods and services provided from debtors.

10. Prior to the suspension of the liability for wrongful trading, or after the end of the proposed three-month period of suspension, the directors would also have to consider whether there is a reasonable prospect of avoiding insolvent administration or liquidation, and if there is no reasonable prospect the directors have to take every step to minimise losses to creditors. This is a high test to pass. If they fail to do this, absent the suspension, they could be considered to be “wrongfully trading” as set out in Section 214 Insolvency Act 1986. A liquidator subsequently appointed could issue proceedings against the directors making a claim against them under Section 214 Insolvency Act 1986 and seek an order from the court requiring them to contribute to the losses of the company. The cases indicate that this is usually by reference to the amount that the deficiency to creditors increases after the date that the court finds the directors should have ceased trading and put the company into an insolvency process. As we reach the end of the suspension period in May 2020, boards will need to consider the reasonable prospect test again to ensure that the company is not wrongfully trading unless the suspension is extended

11. Another factor which could give the board comfort that to continue to trade is in the interests of the creditors, will be to consider the likely alternative outcome for creditors in the event of an insolvency procedure at the current time. Given the state of the economy there are unlikely to be buyers for businesses who are prepared to pay fair value for a going concern business in such uncertain times. Therefore the creditors of a company are unlikely to be a better position, in terms of realisations, if the company was in an insolvency process, as the business would be likely to close down and cease trading.   However, this does not mean companies should carry on trading at the expense of one creditor or class of creditors just because it may result in a better outcome for other creditors, for example, secured creditors.

12. The board should ensure that it considers what steps it can take in the best interests of the creditors very regularly and the discussions should be documented in the board minutes.

13. The board also needs to be mindful of the fact that the Government statement indicated that the provisions regarding fraudulent trading in Section 213 Insolvency Act 1986 and the Directors’ Disqualification Act 1996 will remain in force. Directors therefore need to bear in mind that they should not continue to incur credit, including any banking or Government funding, at a time when they know that the company will be unable to pay this back when due or otherwise see it discharged and the director’s conduct was found to be dishonest . Further, their conduct will be reviewed by a subsequent administrator or liquidator who will report to the Secretary of State on the conduct of each director in the three year period prior to the administration or liquidation commencing. If an adverse report is made the director could face disqualification proceedings, which can result in a director being disqualified for up to 15 years as well now as compensation order.  Directors acting reasonably and responsibly in the light of the unprecedented situation we now find ourselves in should not worry unduly but we have set out below some practical steps and considerations they should take

Practical steps for the board to take

14. Prudent planning of the way that the company can continue to operate through the COVID-19 crisis is essential as is the need to ensure that the board has considered the steps that need to be taken in the interests of  the creditors. The recent guidance papers from a number of Regulatory Bodies including the FCA emphasise the need for such planning, although with the situation evolving so quickly, guidance given even a few days ago may become quickly out-of-date. That said, as best as one can, a scenario plan (Plan) should be prepared to deal with the way that the business will operate in light of the pandemic with the likelihood of staff working remotely and how that work will be managed and how staff absence due to sickness will be covered. The Plan needs to include revised trading and cash flow projections to take account of the changing trading position of the company. If director numbers permit, a member of the board or a member of the senior management team should be appointed to take charge of the steps to be taken to manage issues arising from the spread of the COVID-19 virus and to appoint other members of staff to assist with the work streams required.

15. Stress test the Plan once prepared, probably at the current time on a daily basis, and revise it following the testing. Also ensure the board regularly reviews and discusses the Plan and ensure any sub-committees (see paragraph 20 below) reports back to the board on this regularly.

16. Review the resilience of the operation of the company and the areas in which it is vulnerable and set out plans to manage and deal with those areas.

17. Continue to consider and review the supply chain and contingency plans for any issues with the supply chain.

18. If the business is regulated, consider any guidance from the regulator and consider communicating with the regulator about the Plan.

19. From an insolvency perspective, directors may be judged if a company has gone into administration or liquidation, and they had not put in place good governance procedures. Sub-committees of the board should be set up to take forward particular initiatives to deal with the effect of the pandemic on the business. An increased focus on cash collection and cost cutting measures will be increasingly important over the weeks and months ahead. Given the fact members of the sub-committees may have the virus or be self-isolating, we would recommend such sub-committees cater as best they can for these eventualities.

20. Insofar as is possible, provide up-to-date financial information to the board, which should be regularly reviewed by the directors so that they can consider whether the company should continue to trade. We expect this may become increasingly difficult as staff catch the virus or are self-isolating but again directors should do the best they can in order to determine whether the company should continue to trade.

21. The board should review the cash flow and business projections and revise them in light of the revised projections produced in the Plan. Ensure that the board communicates regularly with its stakeholders, including shareholders, employees, lenders and suppliers, to inform and reassure them of the steps being taken to implement the Plan so as to ensure that the company can continue to trade, and if necessary, to manage messages where there are difficulties in providing a “business as usual” operation, particularly where there is a risk of supply chain disruption. We expect lenders, customers and suppliers will look to provide support during these unprecedented times and regular engagement is extremely important.

22. In our view, directors should hold daily management calls whilst the position remains fast moving. The board needs to react to the changing landscape, so very regular board meetings should be convened, so that the board is in a position to consider carefully whether the business should continue to operate and whether it has a reasonable prospect of avoiding insolvent administration/liquidation.

23. The directors should keep a written record of the reasons for any key decisions and, in particular, the decision to continue or cease trading.

24. The directors should ensure that the interests of creditors are considered carefully when considering any step or course of action.

25. The directors must keep the financial position of the company under very regular review and should not  allow the company to incur new liabilities unless it is clear how any such liabilities are going to be met when they fall due.

26. The board should obtain and act with the benefit of professional advice on legal and financial issues and should consider taking advice from restructuring specialist who could comment on the Plan, assist the board with the implementation of the plan and the revision of the Plan, and at the same time to advise on contingency planning.

27. The board should consider undertaking basic contingency planning, so that the board understands the position for creditors if the company goes into an insolvency process.  The board should consider the processes which may be available to the company, including administration, company voluntary arrangement and voluntary liquidation, and the likely outcomes for creditors from those processes, and the best timings for the company to go into such a process, so that it can consider and compare those outcomes when considering whether it is in the best interests of the creditors for the company to continue to trade outside of an insolvency process.

28. The directors must avoid allowing the company to enter into any transactions outside the ordinary course of business which may have the effect of preferring any particular creditor over others or which may have the effect of diminishing the net assets of the company available to its creditors. Questions might arise in the future as to what the “ordinary course of business” means currently. Directors should consider each transaction based upon taking reasonable objective and subjective views of the benefit of the transaction for the company, and in light of the current crisis.

Extension of time for the filing of annual accounts

29. The Government has also announced that companies can apply for a 3 month extension for the filing of their accounts by making an application on line which will be automatically approved if the reasons are COVID-19 related and the company has not already applied for an extension or sought to change its year end resulting in an extension for the time for filing accounts. This may mean that directors now have more time to agree terms with their existing lenders and/or take advantage of the new funding schemes available to them before finalising their accounts and agreeing as a board that the company is a going concern, and discussing with their auditors whether the auditor will be happy to sign off the accounts on a going concern basis.