Boardroom response: COVID-19 and what should directors be doing now?

Directors' statutory duties

Company directors will need to carefully consider how to address coronavirus risks within their own businesses. In addition to specific regulatory obligations (for example, financial services regulation or under health and safety law) directors will need to carefully consider:

• the duty under under section 172 Companies Act 2006 to act in the way that they consider, in good faith, will promote the success of the company (and in doing so, have regard to a number of factors, including the long-term impact of decision making and the interests of employees)
• their duty to exercise reasonable care, skill and diligence.

Discharging the section 172 duty is almost certain to align with generally prudent decision making during the current coronavirus outbreak – for example, electing to restrict foreign travel by employees. While this will have a short-term adverse impact, it is likely to promote the longer-term success of the company through:

• safeguarding the workforce;
• reducing the likelihood of having to close business premises in less affected areas; and
• avoiding adverse publicity.

Realistically assessing the likelihood of a claim for breach of statutory duty

Could directors face a potential claim for a breach of these statutory duties, in particular section 172, if their response to the virus outbreak caused the company loss – or, in the worst case, it contributed to a company failure?

While the possibility can never be discounted, in our view the number of fact patterns in which a claim would be successful would be very limited – the section 172 duty in particular is a "good faith" duty; provided the actions taken by directors are honestly made with the aim of securing the short- and long-term survival of the company (even if decisions taken at the time turn out to be poor ones) the duty is not infringed; courts will not look to unpick the commercial judgment of directors, particularly those made in a rapidly changing environment.

The changing nature of the duties at the onset of insolvency

The coronavirus is hitting company cash flows hard, and as the UK looks to step up the "delay" phase of its coronavirus response, companies in exposed sectors are likely to face significant – and increasing – cash flow pressure. This may mean that previously financially stable companies are rapidly faced with the prospect of insolvency.

If the continued solvency of a company looks doubtful, the focus of the duties of directors switches from promoting the success of the company to acting in the best interests of the creditors of the company as a whole, as equity value is eliminated. It is at this point that the potential for personal exposure becomes much more acute for company directors.

Managing the risk of potential personal liability in an insolvency situation

If a company's continued solvency is at all in question, directors need to take appropriate professional advice at the earliest opportunity. This is to guard against the risk of potential personal liability under specific insolvency legislation, with the most likely cause being a breach of wrongful trading laws.

Wrongful trading

Where a company goes into a formal insolvent liquidation or administration, the insolvency practitioner can require a contribution from relevant directors, if at some point before the commencement of the winding up of the company or the insolvent administration, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation or insolvent administration, but continued to trade.

A wrongful trading claim against a director is compensatory rather than penal in nature, and is intended to provide creditors with recourse for the loss suffered from the point in time at which the director developed (or should have developed) the relevant awareness.

That said, just because a company is potentially insolvent does not mean the directors should automatically take the decision to cease trading. There are relevant defences which recognise that there may be circumstances when the company should continue trading to improve the position for the creditors, even if insolvent liquidation or insolvent administration is unavoidable.

However, any decision to continue to trade should be made only with the benefit of professional advice.

Managing a deterioration in financial condition

Companies experiencing a deterioration in financial condition as a result of the outbreak will need to consider the impact on existing debt arrangements, including the ability to meet scheduled repayments and covenant tests (usually assessed quarterly) and potentially enter into a dialogue with lenders to restructure payments or flex covenant testing in the short term while solutions are explored.

Companies may also look to extend existing debt facilities and/or seek additional equity finance to bridge cash flow constraints.

Listed company disclosure obligations

For publicly traded companies, boards will need to be mindful of their responsibilities to disclose unpublished price sensitive (or "inside") information under the EU Market Abuse Regulation, and, for AIM companies, broadly parallel obligations under the AIM Rules for Companies.

Relevant inside information may include adverse changes in a company's trading performance (or expectations of performance) arising from the specific impacts on an issuer of the coronavirus outbreak (such as disruption of supply chains or suppression of customer demand), even where the root cause of the issue is publicly known. For example, a number of listed airlines have updated the market on the impact of the outbreak on passenger numbers.

Deterioration in financial condition and/or stress on debt repayment is also potentially disclosable by listed companies as inside information.

Listed company AGMs

Boards of listed companies should start thinking about how the coronavirus outbreak may affect AGMs in the forthcoming reporting season.

Financial reporting

It is not only listed companies that need to consider their disclosure obligations. The Financial Reporting Council (FRC), the body responsible for the oversight of corporate reporting in the UK, has recently written to companies reminding them of the need to make appropriate meaningful disclosures in annual reports relating to the disclosure of principal risks and uncertainties affecting a company’s business model.

These considerations apply to all companies required to prepare a strategic report (both listed and unlisted) under the UK financial reporting framework. In addition, the FRC has reminded boards that they will need to consider whether the impact of coronavirus will necessitate specific balance sheets adjustments (including impairments), or post-balance sheet event disclosures, depending on when the relevant year-end falls.

Additionally, listed companies subject to the UK Corporate Governance Code should be mindful of relevant Code provisions, in particular the need for issuers to describe in their annual report how opportunities and risks to the future success of the business have been considered and addressed.