In doing so, directors must comply with the duties they owe, which can be difficult during periods of significant uncertainty, particularly if the company or its trading partners are facing financial difficulties.
Directors are required to exercise reasonable care, diligence and skill when performing their duties and must act in good faith and in the best interests of the company. In certain circumstances, creditors' interests must also be taken into account. Keeping level heads and applying these first principles of corporate governance will assist directors in their decision-making processes.
What should a board be considering now?
The following practical questions should be considered when trying to determine how best to navigate a business through these very uncertain times:
- How will the company seek to minimise the risk of infection for its workers from other workers, visitors, customers or contaminated surfaces?
- What might result in stress and anxiety in the workforce and how will the company manage the risks of psychosocial hazards? Our article “COVID-19: updated practical tips for employers in an evolving situation" provides guidance on health and safety considerations, employee leave and other people considerations.
- Acknowledging the uncertainty, what do I reasonably think the company's revenue will now be?
- Will it be down on last year? If so, by how much?
- If it will reduce by more than 30%, might support from the government bridge some of the difference?
- How much of our revenue is contracted as opposed to variable, and how financially stable are our customers?
- What sources of funding does the company have available?
- Is there cash in the bank or a pre-approved overdraft?
- If there are covenants to existing funding, is there a risk of breaching those covenants, allowing lenders to withhold funds?
- What do the expenses now look like?
- Going forward, what expenses will reduce as a natural function of a reduction in revenue and what spending can be deferred or trimmed?
- What are the more difficult levers to reducing expenses, such as reducing headcount?
- Does it continue to be in the best interests of the company to pay these?
- How confident am I that the company satisfies the required solvency tests?
- In light of these considerations, are we forecasting that the company will have funds available to be able to meet its obligations as they fall due?
- Is there a gap between the funds that you reasonably expect to have available and the company's expected outgoings? And what would the position be if the forecasts were out by a margin (given the uncertainty)?
- If there is a potential gap, what sources of new funding might be available?
- Could shareholders contribute more capital?
- Is debt available? Are there assets that could be sold?
- What does the contingency plan look like?
What are the other key considerations?
In addition, it is worth considering:
- Additional reporting: Directors should consider seeking additional reporting on the company's financial position and forecasts, and reports from management about the financial, operational, and (if relevant) reputational risks posed by the virus and the company's response to it. More frequent or detailed reporting may be required than ordinary board cycles.
- Understanding the response plan: It is critical that directors understand the company's preparedness and contingency planning and its crisis management plan and processes. Our article “COVID-19: Tips for effective crisis management and incident response" examines five key ingredients of an effective plan.
- Indirect effects: Directors should also consider indirect effects on the company, such as the effect of an important supplier or other trading party becoming insolvent or otherwise being unable to perform their usual obligations, which can in turn affect the company's ability to deliver for its customers, its cash flows and balance sheet.
- Existing obligations: Directors may need to consider whether COVID-19 means that the company should consider exiting their obligations under force majeure clauses, and whether the company's trading partners (including facilities management and services providers) may likewise seek to terminate contractual arrangements as part of their own crisis management strategies. Our articles “COVID-19: Will the effects of the Coronavirus allow you to avoid your contractual obligations" and “COVID-19: How leases respond to a pandemic situation" highlight relevant issues when considering exiting obligations.
- New obligations: Directors must not agree to the company incurring an obligation without having reasonable grounds to believe that the company can perform the obligation when it needs to. This can be particularly difficult to apply when it is so difficult to forecast revenue. It requires directors to test forecasts and sensitivities, including asking the sorts of questions referred to above, and conclude that the company will have sufficient resources to meet the obligation being incurred. Importantly, compliance with this duty is tested at the time that an obligation is entered into, based on the information known to the directors at that time.
- Reckless or insolvent trading: When a company is of doubtful solvency or if solvency could be prejudiced by a particular transaction, directors must take into account creditors' interests (and not just the company's interests), as creditors may be the ones who bear the consequences. Directors of a company with doubtful solvency will often have a complex set of motivations to “keep the company afloat", including loyalty to employees and other stakeholders, as well as personal emotional attachment. However, they must not take risks that will unreasonably prejudice creditors.
- External advice: Directors may rely on information or advice from management, professional advisers and experts. Crucially though, a director must believe on reasonable grounds that the advisor has the necessary expertise. Directors must still also make proper inquiries and act in good faith. As seen in the Mainzeal proceeding, directors should seek appropriate independent advice at an early stage. Where necessary, a director should also consider whether they need their own independent advice.
- Record decision-making processes: Documenting how the board reaches conclusions and the reasons for following the chosen path can be critical evidence if required in the future.
If you have any questions about the matters raised in this article, please get in touch with the contacts listed, or your usual Bell Gully adviser.
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Disclaimer: This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.