Directors' Duties: Surviving times of change and uncertainty

Without a doubt, these are extremely difficult times to be running a business. Can you remember that short period when the turmoil caused by Covid seemed to be ending and there was the prospect of ‘economic calm'? Sadly, it didn't last long, as at the same time the many support mechanisms provided during the height of the pandemic were being scaled back or removed, supply chain and energy cost-inflation went into overdrive, partly fuelled by the war in Ukraine. Interest rate rises, the cost-of-living / wage inflation spiral and industrial action on a scale not seen since the 1980's all of which seems to be causing regular revision to most economists' predictions of the size and length of this inflation bubble and the increased risk of a recession, is giving a constant backdrop of challenge and uncertainty.

Whilst business groups call for additional support for UK plc, most evidently against crippling energy cost increases, this may or may not be quickly forthcoming. This all feeds into business confidence levels, which have noticeably fallen (ICAEW's recent business monitor survey put confidence at minus 5 for Q3 2022, the first negative reading since the pandemic and significantly down on its peak of 47 a year ago).

But what if these difficulties become too much? Directors need to understand their duties and responsibilities and no more so than in times of potential distress.

What duties do directors have?

As a rule, a director's duty is owed to the company and its shareholders. The Companies Act 2006 has codified the main ‘general' duties of any director, namely to:

• Always act within their powers.
• Act in the best interests and promote the success of the company.
• Exercise independent judgement.
• Use reasonable care, skill and diligence.
• Avoid conflicts of interest.
• Not to accept benefits from third parties.
• Declare any interest in a proposed transaction.

But these duties change when directors become aware (or should be aware) that a company is facing financial difficulty. Then a director's duty is primarily to act in the best interests of the company's creditors. The Court of Appeal recently confirmed that this shift in duties occurs not only on insolvency but a period prior to insolvency if the directors knew, or ought to have known that formal insolvency was a probability. It is crucial therefore that directors are aware of this shift and they think carefully about how they manage a company's business and its assets at the time.

When insolvency is on the horizon, directors must act in a way which does not worsen the creditors' situation. So how might this be applied:

• Directors cannot dispose of any of the company's assets or make any payments to shareholders if provisions for the interests of the creditors have not been made.
• Directors should not continue to trade when they know (or should have known) that there was no reasonable prospect of avoiding insolvency - this raises the risk of “wrongful trading” where their actions have led to creditors being worse-off.
• Creditors must be treated equally, so as to avoid the risk of one or more being given a preference. This is particularly important with connected party creditor liabilities, such as overdraw director's loan accounts, other group companies and extending to third-party creditors where director personal guarantees have been given, where under the Insolvency Act the desire to prefer is presumed
• Assets should not be disposed of for less than their market value or outside of the normal course of business without the requisite approvals (e.g. shareholders, secured creditors).
• Directors should ensure they do not breach directors' duties, known as misfeasance, for instance by improperly paying dividends or making unauthorised loans.

Failure to adhere to the above brings the risk of transactions being set aside by a subsequently appointed insolvency practitioner and potential personal liability, disqualification, fines or even imprisonment. Their importance should therefore not be under-estimated.

Some practical steps for survival

These strains are causing real problems for businesses in all sectors and the companies that will flourish are the ones that keep a keen eye on their day-to-day performance. In this environment of constant change, it is vital that you are able to react quickly to rising costs, whether that be changing supplier or increasing the sales price of your products or services. However even if this is possible there will generally be a period where rising costs are likely to cut profit margins. Your customers will also be feeling the financial strain so they may delay paying down invoices due. More than ever, in the coming months cash will be king. Here are five key ways to aid the survival of your business:

1. Understand your cash position: Turnover and profits are important, but knowing what your cash position is helps drive decision making and can be the difference between whether you survive a crisis or not. Prepare a cash flow forecast to establish the cash requirements over the next few weeks and months, and help you deal with any delays in the supply chain. Given the additional borrowing and creditor arrears built up during the pandemic, this should be on the basis of “free” cash rather than an EBITDA approximation.
2. Stay on top of your debtors: Credit control is massively important, and any overdue amounts should be chased immediately. Consider what leverage you may have, such as putting the customer on ‘stop' if they are late paying. In times where you may be supplying a product that is scarce, you may even be able to negotiate improved terms such as an upfront deposit, or a small discount for shorter credit may be a worthwhile consideration.
3. Examine all your costs: Cost control is vital. Go through all your costs line by line to see if each cost is required to achieve your turnover.
4. Manage your creditors strategically: Always try to negotiate the best payment terms with your creditors. If your cashflow projection shows a shortage then communication with your suppliers is vital.
5. Get rid of outdated or excess equipment: Cast a critical eye over your equipment. Is it necessary to maintaining turnover? With so many hold-ups in the supply chain for capital equipment you may be able to sell items at a premium or it may be worth considering leasing rather than buying assets.

There will be opportunities and chances for some to flourish. This may be via battening down the hatches, or taking a different but calculated strategic route against the grain, subject to understanding and appraising the position and prospects and of course resources.

In summary: The delays to the supply chain and general uncertainty will likely have an impact on most business' cash position. Monitoring your cash position and looking forward will help you to ascertain whether you need additional support, either in managing your cash or in reviewing your working capital requirements.

R3, the insolvency and restructuring trade body, has produced a guide for directors around their Companies Act duties and the Insolvency Act risks, which can be found at:

R3 | Technical Library | England & Wales | Guidance | Directors

Moreover the obligations on directors when a company is facing insolvency are significant and challenging. Being aware of them is a vital first step, after which taking advice from a lawyer or restructuring professional to determine their applicability or otherwise in fact-specific situations can help to manage the risks and avoid the pitfalls.

To discuss this or hear more about RSM's Restructuring for Growth guide please contact chris.lewis@rsmuk.com or visit our webpage, Restructuring for growth - review, reset, rebuild | RSM UK