As COVID-19 continues to cause widespread economic disruption, the UK government has announced lending measures to support struggling businesses. This alert summarises:

• the measures available;
• key legal considerations for directors hoping to take advantage of new debt; and
• practical steps directors can take to protect themselves from personal liability.

This alert is relevant to directors of disrupted, stressed, and distressed companies who are considering additional borrowing.

What has the government announced?

As part of a wider package of business support, the government plans to introduce:

• the Coronavirus Business Interruption Loan Scheme: whereby certain lenders will provide SMEs with facilities of up to £5million, 80% guaranteed by the British Business Bank, and with the first six months’ interest paid by the government; and
• the COVID-19 Corporate Financing Facility: a new short-term lending scheme provided by the Bank of England (and indemnified by the Treasury) to support the liquidity of investment-grade firms which make a material contribution to economic activities in the United Kingdom, through the purchase of new commercial paper.

The government will publish further information concerning both of these lending schemes before they come into force week commencing 23 March 2020.

Directors' Personal Liability

Directors may be interested in committing their struggling companies to further borrowings under these programs to make up for a sudden lack of liquidity. However, this decision cannot be a purely commercial one – to avoid personal liability, directors should also weigh up certain legal considerations, including the risk of breaching their duties and engaging in wrongful trading.

Breach of directors’ duties

Directors should be aware that:

• their duties will be under scrutiny in a situation of potential insolvency;
• their duties persist throughout insolvency, even when they have lost control of the company (see our earlier client alert here); and
• when they know or ought to know that insolvency is likely, their duties are owed to the company’s creditors, and not its members (see our earlier client alert here).

To incur further debt, directors should consider whether new borrowing will genuinely lead to the best result for the company’s stakeholders (and if insolvency is likely, in particular for its creditors). If a director does not have an honest belief that the further lending will be sufficient to avoid insolvency or generally be for the benefit of the company’s stakeholders, they will be in breach of their duties when their company takes on the debt. This applies equally to a director who abstains from the decision-making process, or who voices concerns but allows the funding to proceed.

Wrongful trading

Directors may also be held liable in insolvency proceedings for wrongful trading, which is where a director:

• knows or ought to know that there is no reasonable prospect of their company avoiding insolvency; but
• fails to take every step to minimise the potential loss to creditors.

As such, where a company is distressed, a hasty decision by a director to take on further debt without duly considering their company’s solvency position and the protection of their creditors will exacerbate the risk of being found guilty of wrongful trading. Particular care is required in the current situation where liquidity positions can change rapidly and dramatically.

We note that the government is currently considering a proposal to suspend operation of these laws. However, there is no definite policy yet, and so while we are of the view that the courts would be minded to give a broader latitude to a director’s discretion in deciding to utilise the government’s funding programmes, all the usual factors that inform a director’s decision to borrow should still be considered.

Practical Steps for Directors

There are a number of practical steps directors can take in order to demonstrate compliance with the above. As a starting point, we recommend:

• calling regular board meetings, which are carefully documented to show that the directors are considering these issues at every stage;
• maintaining regularly-updated and robust financial results and projections, taking into account the new debt;
• engaging professional advisers to obtain specific guidance – when considering directors’ liability, the courts have paid close attention to whether they obtained specialist, professional financial and legal advice to evidence the reasonableness and honesty of their decisions;
• reviewing existing contracts and covenants to ensure that the new debt can be validly taken on; and
• keeping creditors informed in an open dialogue.

Conclusion

COVID-19 poses an unprecedented threat to businesses, and many companies are already facing disruption and liquidity shortages. While governmental and other lending programs may be enticing, directors should exercise caution so as to avoid personal liability.

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