COVID-19 – Directors’ legal duties and minimising the risk of personal liability

Ailsa Anderson, an associate solicitor at law firm Irwin Mitchell, looks at the new Corporate Insolvency and Governance Bill and highlights how the legal duties of directors have changed during the coronavirus pandemic.

The coronavirus pandemic, lockdown and social distancing measures have placed a huge strain on businesses across a number of sectors, with many companies now at (or beyond) breaking point.

Directors have a number of legal duties including, but not limited to, those within the Companies Act 2006 and a key concern of many individuals, particularly those facing financial difficulties, is the threat of personal liability.

In solvent situations, directors’ duties are owed to the company for the benefit of its members, however, a company is on the verge of insolvency or actually insolvent, directors have a duty to consider or act in the interest of the company for the benefit of the company’s creditors as a whole. In practice, this means that directors must preserve the value of the company to maximise the potential return to creditors once they decide it is on the verge of insolvency. Failure to do so represents wrongful trading and action may be taken against directors personally. The last thing a company director or officer would want is court penalties to show up as a criminal history record on their national police check.

COVID-19

The Government announced a number of proposed measures intended to help businesses survive COVID-19. It suggested that it would temporarily suspend the wrongful trading provisions under the Insolvency Act 1986, retrospectively from 1 March 2020. This was intended to allow viable companies to trade through the pandemic (in certain cases restructuring, as necessary).

Corporate Insolvency and Governance Bill

On 20 May 2020, the Corporate Insolvency and Governance Bill (“Bill”) was introduced. According to the explanatory notes it has three main purposes:

  • To introduce new restructuring tools to the insolvency and restructuring regime to give companies breathing space;
  • To support directors to continue trading through the pandemic and to protect companies from aggressive creditor action;
  • To temporarily relax certain rules about company filings and annual general meetings.

The Bill seeks to achieve this by:

  • Introducing a new moratorium to give financially distressed companies an extendable 20-day period of breathing space from their creditors while they seek a rescue, and a new restructuring plan that will bind creditors;
  • Permanently prohibiting termination clauses that kick in on insolvency, preventing suppliers from ceasing or varying their supply or asking for additional payments while a company is going through a rescue process;
  • Enabling the insolvency regime to flex to meet the demands of the emergency;
  • Temporarily reducing the scope of directors’ personal liability for wrongful trading;
  • Temporarily prohibiting creditors from filing statutory demands and winding up petitions for COVID-19 related debts – voiding statutory demands made between 1 March 2020 and 30 June 2020* and restricting winding up petitions from 27 April 2020 to 30 June 2020*; and
  • Temporarily easing burdens on businesses by enabling them to hold closed Annual General Meetings (retrospectively from 26 March 2020), conduct business and communicate with members electronically, and by extending filing deadlines.

Wrongful Trading

As drafted, section 10 of the Bill addresses wrongful trading but does not, in fact, suspend it. Rather it provides that when assessing any contribution a director should personally make to a company’s assets, the court is to assume that the person is not responsible for any worsening of the financial position of the company or its creditors that occurs from 1 March 2020 to 30 June 2020*. Interestingly, there is no requirement in the Bill to show that COVID-19 played a part in the company’s financial difficulties.

Assuming that the Bill is enacted into law as drafted, it will support companies to continue trading through the immediate crisis and help to protect companies from aggressive creditor action. However, some of its key provisions may well be largely retrospective.

In the current climate, directors cannot be complacent about their legal duties. Rules regarding voidable transactions, such as preferences and transactions at an undervalue remain in place, and personal liability of directors for breaches of their duties in relation to acts of misfeasance and fraudulent trading remain unchanged.

Misfeasance

A director may be personally liable for misfeasance if they:

  • Misapply, retain or become accountable for any money or other property of the company; or
  • Breach any fiduciary or other duty in relation to the company, causing loss to the company.

Some examples of potential misfeasance include:

  • Declaring unlawful dividends;
  • Allowing transactions at an undervalue; or
  • Allowing the company to prefer certain creditors.

If faced with a misfeasance claim, directors may be required to restore the company property in question, pay compensation and / or make such contribution to the company’s assets as the court thinks fit.

Fraudulent Trading

In terms of fraudulent trading, directors may be held personally liable if they are knowingly, or recklessly, party to the company carrying on business with the intent to:

  • Defraud the company’s creditors;
  • Defraud the creditors of any other person; or
  • For any fraudulent purpose.

An example would be accepting customer deposits whilst knowing that the contract would not or could not be fulfilled.

Failure to comply with directors’ duties risks the imposition of sanctions, disqualification and, in the case of fraudulent trading which is also a criminal offence, a term of imprisonment of up to ten years.

Many of the issues currently being faced by directors and companies are unprecedented and laws are evolving quickly to seek to address them. Where any uncertainty arises, you should consider obtaining expert legal advice in order to minimise risks to yourself and your business.

*Either 30 June 2020 or one month after the provision comes into force, whichever is later.