By James Whitaker, Sheena Frazer and Mayer Brown
Throughout the COVID-19 pandemic, directors of companies across all industry sectors, ranging from small family enterprises to large multinationals, have been working flat out to keep businesses afloat. But as life begins to return to a semblance of normality, what risks will those directors face themselves during the challenging months ahead?
As with most things, awareness is key, and the best protection for those managing businesses is to be aware of their legal obligations and risks.
The obligations of directors
All directors, including executive and non-executive, de jure and de facto, nominee, and in certain circumstances, shadow, directors, owe duties to their companies, meaning that the director must put the interests of the company ahead of his or her own. Whether or not an individual is a “director” will depend on the specific circumstances of his or her role.
Possible complications can arise where individuals hold multiple-directorships (particularly of companies within the same group). Where the companies’ interests are ordinarily aligned, the roles can, and often do, become blurred; while the interests of the group should of course be considered, the duties owed to each company must be observed.
The main duties owed by company directors, long-present at common law, are codified in the Companies Act 2006.
Perhaps the most significant duty is the duty to promote the success of the company, which requires the director to act in the way in which he or she believes, in good faith, to be in the interests of the company. In discharging the duty, directors are required to bear in mind the interests of various stakeholders, including shareholders, creditors, employees, and the community in which the company operates. Managing a business with the single aim of maximising shareholder value is, increasingly, insufficient.
The general duties described above will continue to apply to directors of companies which experience financial distress or become insolvent, The onset of insolvency introduces a further layer of duties and risks for directors. Temporary modifications relating to wrongful training introduced as a result of Covid-19 is a welcome development, but it will not absolve directors from their various duties.
When a company becomes, or is likely to become, insolvent, directors will owe additional – paramount – duties to act in the best interests of the company’s creditors as a whole.
Who can bring claims against directors?
The duties owed by directors are owed to the company, and any cause of action arising from a breach of those duties vests in the company itself. Shareholders of the company may also, in certain circumstances, be able to pursue the company’s directors. If and when values of companies’ stock fall significantly, a shareholder derivative actions may become more prevalent as a means by which aggrieved investors seek redress. Further, shareholders of public companies are able to bring claims directly against directors in respect of statements and actions which have, allegedly, caused loss to the shareholders.
When a company is in a formal insolvency procedure, an appointed insolvency officeholder can also bring claims against directors relating to transactions entered into prior to the Insolvency Act 1986.
In addition to private claims for compensation in respect of breaches of duty, the courts have wide-ranging powers – both in the criminal and the civil contexts – to disqualify individuals from acting as directors, or from otherwise becoming directly or indirectly involved in company management, for a period of up to 15 years.
Risk factors arising out of COVID-19
The onset of COVID-19, and the accompanying economic strains, arrived against a backdrop of already-increasing litigation, and the trend of recent years towards greater individual accountability for corporate decisions and actions, with increasing calls for ethical boardroom conduct. The legal bases of individual liability for directors are wider than ever before, and include such areas as financial reporting, bribery, corruption and fraud, data protection, cyber security, competition infringements, health and safety, environmental factors, and modern slavery. Both anecdotal and survey evidence indicates a marked increase in recent experience of claims and/or regulatory investigations specifically involving individual directors, including criminal claims against directors. Further, the ability to pursue post-insolvency claims against directors is growing as a result of the increased availability of specialist insolvency litigation funding, coupled with the incentive of D&O insurance which may provide a pot of gold at the end of successful claims.
The result of these dynamics is that the all stakeholders, are increasingly able to pursue claims that may previously have been unviable. As stakeholders look to mitigate losses incurred as a result of the strained economic environment, we find ourselves in, those responsible for managing businesses will be scrutinised to a greater extent than usual.
The business challenges, and economic strains, arising from the pandemic are many; unfortunately, one of the likely impacts is extremely close scrutiny of decisions, and actions, particularly in the context of (i) dealing with the pandemic; (ii) ensuring continued solvency; (ii) maintaining shareholder value whilst protecting other stakeholders’ interests; (iii) data and cyber breaches; (iv) fraud risks; and (iv) competition / anti-trust issues, to name a few.
How might risks be mitigated?
Whilst the challenges faced by businesses – and their directors – will often be unique to the particular circumstances prevailing, there are a number of practical steps which may assist in mitigating risk factors more generally.
Directors should ensure that their business have engaged, and continue to engage, with all stakeholders, including suppliers and funders, to ensure their interests are considered. Risk management, compliance, security and contingency procedures and protocols (including litigation strategies) should be prepared and reviewed regularly.
Again, the importance of having regard to all stakeholders in the business when making both short- and long-term decisions, and considering the potential impacts of those decisions, as well as thoroughly documenting decision-making processes and the reasons underlying key decisions (as well as any disagreements that arise), cannot be overestimated. Should decisions and actions be scrutinised with the benefit of hindsight, these factors will be crucial.
Finally, directors should make sure they take appropriate professional advice where possible. Obviously, many companies expect to encounter cashflow difficulties in the coming months, and it may be difficult to justify additional expenditure. However, given the range and technical complexity of the risks faced by modern businesses, it is more crucial than ever for directors to ensure that they seek appropriate financial and legal advice, so as to protect the position of the company and to demonstrate that decisions have been taken in a properly informed manner.
These are difficult times to be a company director. However daunting the coming months may appear, there are steps which directors can take to mitigate the risks they will face. Fortunately, those steps – taking and acting upon appropriate advice, taking properly documented decisions and so on – are exactly the steps which directors of well-governed companies are used to taking on a daily basis.
This article does not provide legal advice. If you have any questions on this article, or would like to discuss the issues discussed, please contact James Whitaker or Sheena Frazer.