James Whitaker, Partner, international law firm Mayer Brown
Directors of all companies, large and small, public and private, owe duties to their companies; those duties should be front and centre in mind whenever decisions and actions are taken. Understanding the duties, and discharging them satisfactorily, is crucial, not only for the success of the company, but also in order to avoid potential exposures to litigation and regulatory penalties. The importance of doing so is all the more acute in times of economic stress, when the business may be encountering difficulties; decisions and actions taken by the business – often at speed and in response to rapidly-evolving circumstances – are being, and will be, pored over, and often challenged, to a significantly enhanced degree.
As we enter into the next phase of COVID-induced restrictions and consequent hardships for many businesses across multiple sectors, and company directors increasingly face the risk of criticism for the adequacy of their performance, we take a look at the position directors find themselves in as the pandemic continues to impact businesses.
The duties owed
Directors owe a range of duties to their companies which are designed, in essence, to ensure that individuals, whether acting in an executive or non-executive capacity, and whether formally appointed as a director or merely acting in a manner akin to that of a director, promote the interests of the company they serve above all else. Arguably the most significant – and certainly the widest in scope – is the duty to act in such a way that the director considers, in good faith, will promote the success of the company for the benefit of the members as a whole, found in section 172 of the Companies Act 2006.
In order to discharge the section 172, and other, statutory general duties, directors must have regard to a broad range of factors, which will go beyond simply maximising shareholder value; the central theme is promoting and embedding the right culture. Key considerations that need to be borne in mind by all persons acting in the capacity of a director will include, by way of example:
- The standards of business conduct that prevail within the company, including its treatment of employees, customers and business partners;
- The impact of the business on the community in which it operates; and
- The solvency of the company and its ability properly to continue to trade.
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.
For some years now, company directors have been operating against a backdrop of increasing litigation and regulatory exposure, amidst the trend of recent years towards greater individual accountability for corporate decisions and actions, as well as a growing focus on ethical boardroom conduct. It is already apparent that these trends are being turbo-charged by the pandemic, both as a result of direct COVID-related actions, and also more generally of the challenging economic environment.
Because directors owe duties to the company itself, any breach of such duties will give rise to a cause of action that vests in the injured party, namely, the company itself. Shareholders may, in certain circumstances, be able to pursue the company’s directors, if and when values of companies’ stock fall significantly; we may see increased shareholder activity targeting directors and officers in the months and years ahead. In addition to private claims for compensation in respect of breaches of duty, the courts have wide-ranging powers to disqualify individuals from acting as directors, or from otherwise becoming directly or indirectly involved in company management.
The ability to pursue claims against directors – including post-insolvency claims – is growing as a result of the increased availability of specialist litigation funding, and increased awareness of the likelihood that D&O insurance may pay out at the end of successful claims. Stakeholders are increasingly able to pursue claims that may previously have been unviable as they look to mitigate losses incurred as a result of the current strained economic environment.
The onset of COVID-19, the rapid developments since that time, and the accompanying economic strains, have given rise to a host of potential new risks and exposures for directors. 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 dealing with the pandemic. In particular, we are already starting to see – even if not directly related to COVID – an increase in putative claims arising from:
- Financial and other reporting, both pre- and post-COVID, including as to how well the business was prepared for, and/or reacted to, the pandemic;
- The payment, or non-payment, of dividends, in circumstances where cash conservation is vital;
- Creditor-related actions, as well as difficulties arising from the giving of personal guarantees to support company borrowing;
- Data protection and cyber security, particularly as opportunistic criminals take advantage of shortcomings in businesses’ security arrangements in the context of remote working;
- Human resource-related issues, including how any redundancies were dealt with;
- Relatedly, Health and safety issues, and modern slavery issues throughout the supply- and value-chains;
- Competition infringements and/or abuses, again incentivised by a challenging economic environment, and a perception of regulatory leniency;
- Bribery, corruption and fraud, often incentivised by the economic hardships businesses confront; and, crucially
- Solvency- (or insolvency-) related claims.
The way forward
The challenge facing many businesses as a result of the pandemic are severe and, sometimes, existential. Those responsible for leading the business will, rightly, be focused on ensuring, to the extent possible, the survival of the companies they run. It becomes more important than ever, though, that duties and obligations are observed meticulously in these difficult times, and the potential exposures, not only of the business, but of the individual directors themselves, are kept in mind. Directors would be well-advised to observe the following precautionary measures:
- Ensure all directors and senior officers are well-versed in their obligations; and that they have sufficient information, and training;
- Ensure sufficient, transparent, and ongoing engagement with all stakeholders, including employees, suppliers, creditors and funders, to ensure their interests are considered;
- Ensure that risk management, compliance, security and contingency procedures and protocols (including litigation strategies) are in place, and are reviewed regularly.
- Have regard to the interests of, and potential impact on, all stakeholders in the business when making both short- and long-term decisions,
- Thoroughly document decision-making processes and the reasons underlying key decisions (as well as any disagreements that arise); keep in mind that all decisions and actions may subsequently be scrutinised with the benefit of hindsight; and
- Ensure that appropriate professional advice is obtained where necessary, in order that decisions and actions are taken in a properly informed manner.
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 at Mayer Brown.