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Coronavirus - Private equity and the pandemic: Directors Duties – Global

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  • Restructuring and insolvency

21-07-2020

Many of the business issues that have received focus during the Covid-19 pandemic are not new ones for financial sponsors or their portfolio companies. The topics of short-term funding, sponsor-led funding and tax housekeeping considered in recent articles in this series are all matters that well-run organisations keep under constant review. Similarly, directors’ duties are readily in the forefront of the minds of conscientious directors.

So, what’s different and why care now? Well, as Gouldner once said, “context is everything” and few will have failed to notice that we are in the grip of an aggressive pandemic, the implications of which are being felt far beyond hospital wards. Directors’ duties, like so many other issues, take on heightened focus during times of crisis. In the current context, there are two key drivers for this:

1)    Firstly, increased pressure on general operational management as a result of widespread economic stresses has led to tensions across the board of many businesses. From supply chain and cash flow issues to workforce and health and safety considerations, directors are finding themselves stretched and stressed not only with the range of matters requiring their attention, but also the urgency and speed at which their input is required;

2)    Secondly, directors’ duties are not a static concept, but a complex myriad of ever-shifting responsibilities owed to different stakeholders, the emphasis or priority of which moves with circumstances and may require a tightrope-like exercise to balance. Add to this the statutory changes that are made to directors’ duties from time to time, including during the pandemic, and directors find themselves navigating what can feel like a minefield.

These issues will be of concern to all directors, but investor directors in particular may face increased tension arising from the division of their perceived loyalties to the companies of which they are a director and the financial sponsors who have appointed them.

This fourth article in our bitesize series looks at the nuances of directors’ duties during the pandemic and the statutory changes resulting from the crisis that will impact upon the way that directors carry out their duties.

General Duties in Solvent Situations

The framework for the most relevant directors’ duties in this context is set out in section 172 of the Companies Act 2006, which provides that a director of a company is obliged to act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to: (a) the likely consequences of any decision in the long term, (b) the interests of the company's employees, (c) the need to foster the company's business relationships with suppliers, customers and others, (d) the impact of the company's operations on the community and the environment, (e) the desirability of the company maintaining a reputation for high standards of business conduct, and (f) the need to act fairly as between members of the company.

Whilst it is difficult to balance these different interests at the best of times, the unchartered territory brought about by Covid-19 has resulted in an increasingly delicate balancing act and heightened pressure on boards. Directors reading this will no doubt be shouting at the screen that it is unrealistic in the current climate to place too much emphasis on the long-term impact of decisions, or that the welfare of employees must carry greater weight in the midst of a global healthcare crisis than other considerations. These are fair assessments and the legislation governing directors’ duties is sufficiently broad to permit directors to take account of those matters most relevant to their businesses and place different levels of emphasis on those considerations having regard to the current circumstances, provided that they act in good faith and have as their underlying motivation, the success of the company for the benefit of its members as a whole.

Investor directors appointed by financial sponsors to portfolio companies in particular will find the tension between their competing considerations grow. For example, companies of which they are a director may face cash flow issues and require funding. In these circumstances does the investor director advocate for an equity injection from its sponsor shareholder to benefit the company, or consider that its appointing sponsor may face multiple cash calls and may wish to invest in a different entity where there is insufficient funding to go around? The legislation allows both of these considerations to be placed on the decision-making scales provided, again, that the investor director also takes account of other relevant considerations, acts in good faith and in a way in which he considers is most likely to promote the success of the company for the benefit of its members as a whole.

Directors may be forgiven for heading straight to their local for a post-lockdown G&T whilst bemoaning the demands on their role, but they would do well to remember that discharging their duties as directors is an art not a science. The bottom line for directors of solvent companies, be they operational or investor directors, is that their duties are owed to the shareholders of that company as a whole (as opposed to individually). Other factors can be thrown into the decision-making mix, and these factors and the emphasis given to them will shift depending on context. Some practical tips to help overwrought directors sleep easier are: (a) ensure clear records are made of board decisions and decision-making processes; (b) take professional advice where needed; (c) ensure that decisions are based on the most current information, including cash flow trends, and (d) plan for a range of different scenarios and update these as the crisis evolves.

Insolvency and Shifting Statutes

The restrictions brought about to address the spread of Covid-19 and the uncertainties these have created have had a devastating effect on many businesses. For some, the pandemic has proved fatal, and for others, cashflow and solvency issues are becoming a day-to-day reality and give rise to further, more complex considerations for their directors in the discharge of their duties.

In usual circumstances, where a company is facing financial difficulties the focus of directors’ duties shifts from promoting the success of the company as described above, to acting in the best interests of creditors as a whole, because any possible equity value in the company is eliminated where it faces insolvency. Indeed, the duty described above is explicitly stated to be subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company. In particular, insolvency laws impose personal liability on directors for wrongful trading if they knew, or ought to have realised, that there was no reasonable prospect of a company avoiding an insolvent liquidation/administration and then failed to take every step to minimise potential losses to creditors. 

The issues created by the Covid-19 pandemic and resulting uncertainty for businesses has created a perfect storm for directors. In the current circumstances, it is extremely difficult to assess whether a company is insolvent either on a cash flow or balance sheet basis and the resulting uncertainty would understandably compel caution in directors mindful of the fine balance around their duties. At a time when directors could be expected to show strength in positive leadership, conviction and focus on steadying the ship in choppy waters, the economic turmoil created by Covid-19 coupled with the lurking phantom of possible personal liability for wrongful trading arguably results in an unduly cautious approach when confidence is needed to trade through the storm.

Mindful of the conflicting demands on directors, the government has introduced a temporary suspension of wrongful trading provisions for company directors, effective retrospectively from 1 March 2020 until 30 September 2020 (with the possibility of extension by the Secretary of State). The intention is to give directors the confidence to continue to trade throughout this period of uncertainty without the fear of incurring personal liability for wrongful trading.  This suspension, implemented by the Corporate Insolvency and Governance Act 2020, provides some respite for frazzled boards, but does not provide a get out of jail free card for directors. It is imperative that directors remain compliant with their general duties as described in the Companies Act 2006 (including section 172, outlined above) and mindful that liability for other aspects of the law relating to directors’ duties in the context of insolvency, including fraudulent trading, transacting while insolvent and granting preferences remains.

Fundamentally, the framework of directors’ duties has not changed, but the context in which they are discharged has. These are unprecedented times and there is no historical yardstick to provide guidance. Directors should be mindful of how the situation and legal framework progresses and continue to discharge their duties in the utmost of good faith with a view to emerging from this crisis with stable, stronger companies and a few battle scars.

If you have questions about directors’ duties or this article, please contact the Eversheds Sutherland lawyer with whom you usually work, or any member of our UK Private Equity team.

Next week, as part of our on-going series, I will look at contractual considerations during Covid-19.