Few businesses are able to escape the significant disruption caused by the Coronavirus (COVID-19) pandemic and the strict measures imposed by governments to protect their citizens. The pandemic is putting pressure on businesses and presenting company directors with a unique set of challenges. While businesses are moving quickly to implement contingency plans and adapt to ever-changing landscapes, it is more important than ever for all directors (both those in executive roles and non-executive directors) to weigh the options available to them in light of the duties that they owe to the company and to the company’s stakeholders.
This article considers the duties to which directors of companies incorporated in England and Wales are subject, and outlines factors that they may need to consider in the context of the COVID-19 pandemic, in particular as they evaluate the government support schemes that may be available to them. This article also lists steps directors can take to navigate these challenges.
Directors should evaluate options and make decisions in light of their statutory duties, and must act within their powers under the company’s constitution. These duties include:
- The duty under section 172 of the Companies Act 2006 to act in the way that they consider, in good faith, will promote the success of the company (and in doing so, have regard to a number of factors, including the long-term impact of decision making and employee interests).
- The duty to exercise independent judgment (and not rely on the knowledge or judgment of other directors, experts or advisers).
- The duty to avoid or manage conflicts of interest which may affect their objectivity, which may be particularly relevant during the current crisis when considering questions of directors’ and executives’ pay.
- The duty to exercise reasonable care, skill and diligence (meaning the care, skill and diligence that would be exercised by a reasonably diligent person with the general knowledge, skill and experience that may be reasonably expected of a person carrying out the functions of a director in relation to the company and the general knowledge, skill and experience of the relevant director).
If the company becomes insolvent, the interests of the shareholders are relevant, but directors should have regard to other interests as well, such as those of the company’s creditors. As of 28 March 2020, the UK government announced a temporary suspension of wrongful trading rules (but not the fraudulent trading regime), to be applied retrospectively from 1 March 2020. This decision has largely been welcomed, as it reassures directors that they will not be held personally liable for their decision to continue trading during the pandemic. Directors should nonetheless be mindful that this decision does not relieve them of their wider duties under the Companies Act and the Insolvency Act 1986.
Governments have moved quickly to try to soften the pandemic’s impact on businesses with initiatives and support packages. Directors should work with their advisers to assess their eligibility for such schemes, not only in the jurisdictions where the company is incorporated and headquartered, but in each of the countries in which it has staff and operations. Directors also should keep a watching brief for additional initiatives that may be announced as the situation develops.
The UK government has announced a range of initiatives to support businesses affected by the COVID-19 outbreak. Some examples are set out below:
- Coronavirus Job Retention Scheme: Reimburses businesses for 80% of the wages (plus some other expenses such as minimum pension contributions and employer’s national insurance contributions) of eligible furloughed workers, up to a cap of £2,500 per month.
- COVID-19 Corporate Financing Facility: Bank of England short-term funding through buying of short-term commercial paper. Minimum loan size is £1 million. This initiative is focussed on larger businesses, as companies must have an investment grade rating to be able to apply. As a result, this funding may not be available to many private equity portfolio companies.
- Coronavirus Business Interruption Loan Scheme: Loan fund providing various financing options to small and mid-size enterprises over the short to medium term. Applicants must demonstrate that they are a sound business that would otherwise have been entitled to the loan, but they could not get it because of the COVID-19 crisis.
- Cash grants: Certain small businesses will be entitled to a £10,000 one-off cash grant, with smaller businesses in the retail, hospitality and leisure sectors potentially eligible for a £25,000 grant.
- Tax schemes: HMRC has introduced a variety of rates holidays and payment deferral schemes to assist businesses through the COVID-19 disruption. In particular, the government will work with lenders to provide mortgage payment holidays to residential homeowners and buy-to-let landlords over the next three months.
Directors must act responsibly in considering these government initiatives and their availability, eligibility and suitability in supporting the business in the short to medium term, along with the consequences to the operational and financial capacity of the business. They will need to weigh these options against alternative arrangements. A key aspect of this evaluation will be understanding when cash is likely to be received if the business does choose to take part in any of these programs.
Limiting cash outflows and ensuring the availability of cash reserves have been at the forefront of directors’ minds. When looking at funding options, it would be easy for businesses to simply jump at the chance to take the funds available under the government schemes. Some directors may be reticent to go down this route due to previous experiences with government grants and initiatives after the 2008 financial crisis. However, they should not dismiss the current schemes out of hand.
Having reviewed the options, some boards may feel that they gain greater future flexibility by first engaging with their existing finance provider to draw down existing facilities, extend facilities, restructure payments or flex covenant testing in the short term, while alternative solutions are explored, in order to achieve the most favourable result for the company overall. Banks are being encouraged to support borrowers that were performing well before the crisis. In this environment, companies should maintain regular dialogue with their lenders, as lenders are often more likely to lose faith with those who are not engaging with them.
For listed companies, the Pre-Emption Group’s relaxation of its guidance on non-pre-emptive offers, for example, may make it worth exploring whether existing shareholders would be willing to support the business by injecting equity through a cashbox placing. Ultimately, no single option that will fit all companies, and boards are duty bound to consider each of the options available to their company in the context of the relevant business and its present circumstances.
Directors must consider the options in light of their operational capacities and business focus. For example, the government furlough scheme is only available in respect of employees who are furloughed and doing no work at all. Therefore, designating workers as furloughed will not be appropriate where employees are still needed to do some work, even if there is less work to do. Alternative strategies such as reducing pay and/or working hours might be more appropriate instead of or alongside furlough.
In terms of commercial real estate, directors should be alert to the new government emergency measures that will affect business and residential tenancies. Under the Coronavirus Act, in the case of business tenancies, landlords are unable to forfeit a lease and commence possession proceedings if a tenant fails to pay rent (or other sums, including service charge and insurance rent) until 30 June 2020. Similarly, in the case of residential tenancies, landlords are required to give at least three months’ notice for any notice seeking possession or notice to quit until 30 September 2020. Directors of landlord or property holding companies should be aware of these measures and consider how tenants taking advantage of these schemes could affect cash flow.
Directors of tenant companies should be careful about using these provisions as a blanket excuse not to pay rent as proceedings for non-payment of rent can still be brought by landlords after June 2020 (in the case of business tenancies) or September 2020 (in the case of residential tenancies), subject to these dates not being extended. It may be more suitable for directors to engage in productive rent review or deferral talks with landlords to lessen the likelihood of rent disputes in the aftermath of the current pandemic.
Some landlords are concerned that some tenants may use this legislation as a “green light” from the government to withhold rental payments for three months even if they do not need to do so. However, landlords can take comfort from the fact that the Coronavirus Act only offers a temporary suspension of a landlord’s right to forfeit in any event (rent still remains payable, and the right to forfeit will be reinstated at the end of the relevant period), and interest is payable on any late payments.
Sensible commercial discussions between landlords and tenants can help to deal with such issues early, and in a mutually beneficial manner. Many landlords appear to be taking a longer term view of the situation. When contemplating forfeiture, landlords must weigh the commercial benefit of evicting a non-paying tenant against the reality of finding a willing tenant able to pay rent (with a potential rent-free period to be factored in) plus associated costs of re-letting the property and running forfeiture proceedings. In the current climate, landlords may therefore prefer to wait and see with a tenant that they know.
Other Relevant Considerations
In addition to the impact of COVID-19 on businesses cash flow, directors should bear in mind operational challenges that the disruption may cause, and ensure that the business has appropriate measures in place to address them. Issues that may be accentuated and factors to consider include the following:
- Reporting obligations. The Financial Reporting Council, Financial Conduct Authority and Prudential Regulation Authority released joint guidance for companies and auditors to address the challenges that remote working may raise in this context. While deadlines for publication of annual accounts have been relaxed for both listed and unlisted companies, the guidance also reminds companies to make appropriate meaningful disclosures in annual reports in order to facilitate the continued correct functioning of UK capital markets. Companies should include the principal risks associated with and the impact of COVID-19, while ensuring that risks are sufficiently tailored and precise to avoid generic disclosures. Listed companies are also reminded that they should have appropriate systems and procedures in place to ensure that they comply with their fundamental obligations, and must continue to maintain systems and control disclosures in respect of inside information to the public as soon as possible through the correct regulatory channels.
- Deferral of dividends. In the current environment, “cash is king.” To maintain flexibility, many businesses are deferring dividends so that this cash is retained in the business. Directors should think carefully before proposing dividends, particularly until there is greater clarity on how long the crisis will last and the government restrictions will remain in place.
- Cyber risk. The disruption caused by wide-scale remote working has opened the door for a rise in opportunistic social hacking. Directors should check that the company has the resources to maintain a working IT function and should remind employees to be vigilant for potential threats. Directors also should ensure that reporting lines will remain open even if key individuals are ill, and that matters will continue to be promptly escalated to the directors.
- Renegotiation of contracts. Directors may be considering whether they will be able to comply with the business’s obligations to third parties (such as delivering to customers and paying suppliers). The company will no doubt be receiving similar requests from counterparties in their supply chain. If renegotiating terms, directors should bear in mind that although the wrongful trading legislation has been suspended, the rules around transactions at an undervalue (within the meaning of the Insolvency Act 1986) and preferential treatment of creditors remain in place (and accordingly, such transactions could potentially be challenged if the company goes insolvent within two years).
Practical Steps for Directors
There are several practical steps directors can take to demonstrate compliance with their duties. Boards should consider the following actions:
- Call regular board meetings specifically aimed at addressing COVID-19-related issues. Robust decision making by a well-informed and prudent board of directors will put the company and its shareholders in a favourable position. Given the rapidly changing landscape, decisions that have been made and initiatives that have been implemented should be reviewed to ensure that they remain the correct course of action. Full and accurate board minutes should be taken to help demonstrate how key issues were debated and considered, and the basis on which decisions were ultimately made.
- Obtain full and up-to-date financial information. Directors must ensure they have up-to-date financial information. Staffing arrangements and staff illness could present challenges in relation to gathering this information, but directors will need up-to-date data and might want to obtain verification by auditors in some circumstances (including cash flow).
- Adaption rather than suspension. Directors should consider whether their company’s products and services could be adapted to provide assistance to public health bodies or to meet the changing needs of consumers. Examples of such adaption include the VentilatorChallengeUK Consortium, manufacturers repurposing lines to make protective equipment for medical professionals or hand sanitisers, and service providers whose normal customers are in the hospitality and leisure industry exploring whether they can provide similar services to the NHS.
- Obtain professional advice. Advisers can provide a different perspective and can share valuable insights in terms of options and approaches that are being adopted by other business and in other sectors. When considering directors’ liability, courts will take a sympathetic view of directors who have acted honestly, reasonably and sensibly, particularly if the board has obtained specialist financial and legal advice on valuations and strategies for minimising loss to creditors.
- Health and safety. Businesses will need to assess whether their health and safety practices need to be adjusted in order to comply with the Social Distancing in the Workplace principles published by Public Health England to allow operations to continue while protecting employees. From a practical perspective, employers may also need to ensure that they have additional staffing capacity in the event that some staff cannot work due to illness or illness within their household. This might be achieved by asking employees to agree to different shift or working patterns, or even asking part time employees to increase their hours.
The fundamental principles that directors should follow in making decisions have not changed, but the current circumstances present directors with increasingly challenging decisions. From a practical perspective, directors can take comfort that they will likely only be in breach if they have acted with a lack of integrity or done something that no reasonable director would have done. Directors cannot avoid the fact that decisions taken now could be scrutinised later with hindsight bias. However, they are considerably less likely to be challenged if they can demonstrate that, in making decisions, they had regard to their duties and considered each of the options on their merits in light of the company’s specific circumstances.