Directors’ decision making in the current climate

All business decisions you make at this time, no matter how critical, still need to be made taking into account your duties as a company director.

The focus of this note is on those duties and their application in the current climate both generally and also specifically in relation to proposed dividend payments (for companies of all sizes) and secondly in relation to insolvency and the effect of the suspension of wrongful trading announced at the government’s press conference on 28 March 2020.

Directors’ duties

When making any decisions, directors should always refer to fiduciary duties which they owe to their company. These duties are set out in the Companies Act 2006 as follows:

· To act within their powers.

· To promote the success of the company.

· To exercise independent judgment.

· To avoid conflicts of interest.

· Not to accept benefits from third parties.

· To declare an interest in a proposed transaction or arrangement.

There is an obligation to comply with each of these seven duties and if you have any questions in respect of any of these duties then please contact us straightaway. In the current climate many decisions need to be made and swiftly, placing pressures on company directors to address pressing issues. It is important not to panic and to consider each decision first in isolation so you understand the situation fully and then consider those decisions collectively before making a final decision. It is important to sense check these decisions by speaking to the rest of your board (if you have one) or your accountant, lawyer and/or other professional adviser.

Although all the duties come with equal obligation, the duty to promote the success of the company is often one which receives much attention (section 172 CA 2006). Given its application, it is one which directors today should pay attention to when making decisions regarding the future of their business.

Section 172 replaced the fiduciary duty to act in good faith in the best interests of the company, and the statutory duty to consider the interests of employees under the original section 309 of the Companies Act 1985 (CA 1985).

Section 172 provides that a director must act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole (section 172(1)). In so doing, the director must have regard (among other matters) to:

· The likely consequences of any decision in the long term.

· The interests of the company’s employees.

· The need to foster the company’s business relationships with suppliers, customers and others.

· The impact of the company’s operations on the community and the environment.

· The desirability of the company maintaining a reputation for high standards of business conduct.

· The need to act fairly as between the members of the company.

Key points to consider when determining how best to promote the success of your company:

· The duty applies to all decisions made by a director, not merely formal decisions made by the whole board.

· The obligation to have regard to the listed factors is secondary to the overarching duty to promote the success of the company for the benefit of its members as a whole. However, the obligation to have regard to at least the listed factors, in carrying out the overarching duty, is mandatory.

· The list of factors is not exhaustive: directors should have regard to other matters relevant to the duty to promote the success of their company.

· In having regard to the listed factors, the duty to exercise reasonable care, skill and diligence will apply. In some cases, to satisfy the duty, it may be necessary to seek expert advice.

· The government has historically stated that “success” in this context will usually mean “long-term increase in value” for commercial companies, and that what will promote the success of the company, and what constitutes such success, will be for the director’s good faith judgment – this would ensure that business decisions on, for example, strategy and tactics, are for the directors, and are not subject to decision by the courts, provided the directors were acting in good faith.

· This subjective test will only apply where there is evidence of actual consideration of the best interests of the company. Where there is no such evidence, the proper test is objective, namely whether an intelligent and honest man in the position of a director of the company concerned could, in the circumstances, have reasonably believed that the transaction was for the benefit of the company.

· When evidencing the subjective test, one view is that directors would be in a much better position where, if litigation later arises, they can provide records, such as minutes of discussions, to prove that they paid due regard to the factors listed in section 172(1). Another view appears to be that it will be sufficient for the minutes to state that the directors have taken the factors into account in carrying out their duty and where any factor is particularly relevant, whether or not in the specified list, the minutes should reflect points made during discussions (subject to company policies on record-keeping), but otherwise the discussion of each factor need not be minuted; and for significant or potentially controversial decisions, briefing papers prepared by management should address each listed factor, unless clearly irrelevant, along with other relevant matters. It is important to ensure clarity when proposing information and making decisions and where possible this should be evidenced and carried out consistently.

· The duty in section 172 is subject to any enactment or rule of law requiring directors in certain circumstances to consider or act in the interests of the creditors of the company. Accordingly, the duty to shareholders is displaced when the company is insolvent, and may be modified by an obligation to have regard to the interests of creditors as the company nears insolvency. It is very important to seek professional advice where the company is struggling financially or at risk of insolvency.

· Section 233 CA 2006 permits a company to purchase insurance for its directors, and those of an associated company, against any liability attaching to them in connection with any negligence, default, breach of duty or breach of trust by them in relation to the company of which they are a director. It would be sensible to speak to insurers about putting in place directors and officers insurance for added protection and we know many companies already have this in place.

Dividends in the time of Corona

You may have read in the financial press last week that a number of UK listed companies cut or cancelled billions of pounds worth of dividends to protect their balance sheets and to ensure that if they need to seek future financial assistance, they can demonstrate prudence in the short term. In addition, where shareholders are required to approve the dividend payment at an AGM at which they have to be physically present, this has meant a delay to the AGM and therefore any dividend payment regardless of stock exchanges relaxing such rules.

This is not just an issue for listed company directors, private company directors will also be considering, along with a host of other considerations, their obligations to pay a dividend to their shareholders. In some cases, these obligations will be contractual and obligations to pay a dividend may be found in shareholders agreements. For example, a duty to pay a dividend after profits have been generated in excess of a specific sum. Many shareholders agreements will however leave the question of dividend policy to the discretion of the board.

The starting point, in order for a company to be able to lawfully pay a dividend, is that it must have sufficient distributable profits that are justified by reference to relevant accounts. The directors must also have regard to the company’s articles of association, legislation, as well as their fiduciary duties. These include the duty to promote the success of the company, to act within their powers and to exercise reasonable care and diligence.

With such rapid changes taking place, it is likely that many businesses’ most recent accounts will not reflect their present financial picture. Directors should consider all relevant circumstances and assess whether the company’s interests are best served by retaining distributable profits.

In the event a dividend payment has already been declared, directors may now want to consider whether and if so how they can delay or cancel payment of that dividend. Most articles of association permit the payment of interim dividends.

If the dividend declared is an interim dividend it can in usual circumstances be cancelled before it is paid.

If the dividend is a final dividend it is usually subject to board approval and as such the board should withhold or withdraw their prior recommendation as appropriate.

The provisions discussed above are included in most standard form articles of association. If you are unsure you should always check the provisions before exercising your decision making powers. Do let us know if we can help.

Insolvency update: wrongful trading

Directors duties to shareholders are replaced by duties to creditors when a company is in financial difficulty. Once a director or directors of a company conclude (or should have concluded) that there is no reasonable prospect of the company avoiding an insolvent liquidation or administration, they have a duty to take every step which a reasonably diligent person would take to minimise potential loss to the company’s creditors (as opposed to the company’s shareholders or themselves).

If, after the company has gone into insolvent administration or liquidation, it appears to the court that a director has failed to comply with this duty, under the offence of wrongful trading, the court can order the director personally to make such contribution to the company’s assets as it thinks proper. Given the current economic uncertainty caused by COVID 19, this has understandably caused great concern among company owners forced swiftly into situations of great financial turmoil and uncertainty.

The government has stepped in and announced the temporary suspension of the wrongful trading rules to remove the threat of directors incurring personal liability during the COVID 19 pandemic. The change has not yet been legislated, however, in his announcement on Saturday the Business Secretary stated that the change will apply retrospectively from 1 March 2020.

It is expected that this suspension will form part of a range of measures to be introduced to improve the insolvency system for struggling companies during this difficult time, to help them emerge intact, wherever possible, on the other side. The overriding objective will be to help companies to keep trading, by providing them with extra time and space to weather the current storm. Details are awaited.

This is an important recognition of the immense pressure directors are facing. It does not mean to say that directors can disregard their duties. All other checks and balances to ensure directors continue to fulfil their legal duties and obligations will remain in place.

We will be back in touch with further updates.

If you would like to discuss any of the decisions you are making in these challenging times, or have any other questions, you can contact us via 020 3709 9673 or enquiries@fortunelaw.com

See the links below to our other COVID-19 related articles which may be a usefull read in these stressfull times,

What you need to know about furloughing

Remote working? Practical advice for small businesses

Coronavirus; practical guidance for small businesses