The uncertainty caused by the COVID-19 pandemic is unprecedented. Business owners and company directors will face many challenges, including issues relating to the solvency of their businesses during and in the aftermath of this crisis.
Directors of distressed businesses at risk of insolvency should pay heed to several important legal considerations.
Directors’ Duties
Directors should be incredibly careful to observe the provisions relating to directors’ duties set out in Chapter 2, Part 5 of the Companies Act 2014. These stipulate the duty to act in good faith and in the best interests of the company. Notably, directors should be mindful that the general duty to act in the best interests of the company transforms into a general duty to act in the best interests of the company’s creditors where the company is technically insolvent or nearing insolvency (it becoming unable to pay its debts as they fall due). In such a scenario, directors must balance their duty to creditors while at the same time solving the company’s financial difficulties.
Reckless Trading
The risk for directors for trading while insolvent is being held liable for the debts of the company. This can arise where the directors of a company are culpable of reckless trading or fraudulent trading.
A director may be held liable for reckless trading where they knowingly continue to trade in a reckless manner specifically if:
- their actions or those of the company would cause a loss to the creditors of the company, or any of them; or
- they contracted a company debt and did not honestly believe on reasonable grounds that the company would be able to pay the debt.
In deciding whether to impose liability in favour of a particular creditor, a court is obliged to have regard to whether the creditor was aware of the company’s financial state of affairs at the time the debt was incurred.
Reducing Risk and Pitfalls
The ODCE recently issued a statement providing that directors are permitted to take certain risks to ensure the survival of their business. In such circumstances, it is important that directors demonstrate that they have acted honestly and responsibly. There are several practical things directors can do to demonstrate compliance with their duties:
In order document this, the board should ensure that, at a minimum, the following occurs in order demonstrate that they have conducted themselves accordingly:
- closely investigate the financial position and the future prospects of the company
- consider financial statements presented to the board and stress test the financial information, which is being relied upon and ensure that the company’s records and books are up to date and accurate
- support the view that the company can continue to trade through its financial difficulties and adduce documentary evidence and independent advice
- consider restructuring options and get independent advice on any proposed material transaction from an insolvency practitioner; and
- hold regular board meetings involving all of the directors and record detailed minutes as a full paper trail will be very important in demonstrating that directors have taken appropriate advice on a regular basis and exercised sound judgment.
It is important to avoid simply rubber stamping decisions made elsewhere. Common pitfalls include:
- employees fulfilling the role or director as part of their employment and simply doing their employer’s bidding; and
- directors of subsidiary companies authorising transactions for the ‘greater good’ of the group. Their duty is to the company in which they are a director and not to the corporate group as a whole.
In each situation and at all other times, directors should remain mindful that they are directors of the company with the same obligations as any other director under law. They need to ‘own’ the actions that they take as they will ‘own’ responsibility under law for those actions.