Right on cue, law firms up and down the country are issuing briefing notes to their clients and contacts about directors’ duties, and the risks that directors run if they breach those duties. The content of these suggests a lack of understanding of the commercial world in which directors operate and what their current priorities are.
We offer an alternative view…
The Government needs companies to survive the virus
Owner managed businesses are at the heart of the UK economy and are vital in creating employment and generating tax revenues to fund public services.
There are around 1.8 million company owner managers of trading businesses in the UK. The average taxable income of a company owner manager is around £44,000 and around 2% earn over £150,000 a year.
It is inevitable that some companies will suffer financial failure and in normal times between 15-20,000 companies will go into administration or liquidation each year. This failure rate has minimal impact on the UK economy. However, the Coronavirus poses an existential threat to businesses and to the UK economy in a way not seen since the Second World War. The Government has introduced a number of financial measures and says it will spend whatever it takes to see the UK through the crisis.
The message is quite simple. The Government does not want to see companies going into liquidation or administration over the next few months.
I’m a director – do I need to worry?
At the moment directors are consumed with making operational decisions in a rapidly changing landscape. There are uncertainties about how quickly funding from the various Government initiatives will arrive and whether their business will run out of cash in the meantime. For the majority, they know that if the company ceases to trade then they will personally suffer serious economic hardship or, at worst, financial ruin. Crucially, incomes will cease, and personal guarantees will be called upon.
The briefing notes currently circulating from most law firms are all variations on the same playbook and focussed on the risk that directors could be personally liable for making the wrong decisions. The main recommendations are for directors to regularly review financial information, keep records of decisions taken, and take professional advice.
Do directors need to worry about this? No they don’t - because the vast majority are honest people who are being encouraged by their Government to keep their business going.
Directors duties – myths and realities
The best way to think about these duties is to think of the typical company balance sheet, which is divided into assets and liabilities.
The statutory duties owed to the company under sections 171 – 177 Companies Act 2006, and the powers of a liquidator to challenge transactions carried out by the directors, are all aimed at protecting the company’s assets for the benefit of its creditors. A director will only be in breach if they have acted with a lack of integrity or done something that no reasonable director would have done. Funnily enough, when you are advising directors of a live company, they are usually disinterested in discussing such matters because either they are affronted by the suggestion that they would act in an inappropriate manner or, if they are planning to sail close to the wind, then they will not usually discuss what they have in mind. The rules relating to money laundering also make it difficult and risky for a professional adviser to give advice on ideas that a director might have.
Wrongful trading is about unnecessarily increasing a company’s liabilities when the business is bound to fail. The law acts as a deterrent because directors mistakenly think they can be personally liable for any debt incurred if the company continues to trade when it can’t pay its debts on time. Wrongful trading claims are actually quite rare because they are difficult and expensive for a liquidator to take. Nevertheless, the Government has announced a relaxation on the rules relating to wrongful trading initially for a period of 3 months from 1 March 2020 but with that period possibly being extended.
Do directors really need to take professional advice now?
The answer for most, at the moment is, no - they don’t. In the current crisis it will be difficult for directors to find the time or money to take and pay for advice, whilst the rules on social distancing create barriers for effective advice to be taken.
When contemplating whether to take advice, the director should consider whether that is to help the company devise and implement a strategy to survive or to guard against the personal risks to the director of continuing to trade. This will be important in deciding who to take advice from. Advice is only beneficial if it is informed advice, meaning the adviser will need a lot of information about the current state of the business in order to give good advice.
There are undoubtably many professional advisers who can provide helpful support and guidance through this difficult period, but also many others whose involvement can create more problems than solutions, especially lawyers who are fixated on directors’ duties and lack essential commercial experience. Solicitors do have one advantage over accountants and Insolvency Practitioners in that their advice can be legally privileged and not disclosable if the company does go into liquidation, so long as the director seeks the advice personally… but most solicitors will not have the breadth of commercial experience and financial knowledge that enables accountants and Insolvency Practitioners to give more practical advice to the company.
The current Government focus is for businesses to survive the next 3 months. Many of the Government’s financial incentives result in liabilities being deferred rather than waived (the main exception being the Job Retention Scheme) and the likelihood is that, come late summer and early autumn, companies will need advice to work out whether their debt burden is too great for the business to continue. Then advice could become very important.
Top three tips
1. Board meetings by social media
Modern methods of communication make it much easier for directors to consider and make decisions together, and at the same time create an audit trail of their decision making. The briefing notes that law firms are issuing witter on about the need to have regular board meetings, but in practice it is now possible to have an open ended board meeting running through a directors’ group by email, on WhatsApp or Microsoft Teams. As long as all directors are included and decisions are consensual, the record of the decision-making of the directors will be created in real time and capable of being produced in the future should the directors’ conduct be questioned.
2. Take a salary not interim dividends
Directors of owner managed business will often be remunerated through a low salary and dividends as this is marginally more tax efficient. In practice directors will withdraw regular cash sums from the company which they will look on as remuneration for the work they are doing, without going through the formalities required for declaring interim dividends. They do not appreciate that if the company goes into administration or liquidation then they will be asked to pay the monies back.
In the current environment it is going to be difficult for most companies to show they are making profits to justify interim dividends. Directors on low salaries should actively consider taking a proper salary (rather than interim dividends) for the next six months to eliminate the risk of having to pay the money back if the company eventually fails.
3. Beware HMRC
For companies the Government’s financial measures to keep businesses afloat include deferral of the current quarter’s VAT payment, and an expectation that HMRC will be more open to entering time to pay agreements over a 3 – 12 month period. The Government has also postponed ‘loan charge’ measures and enhanced powers for HMRC to go after directors personally for unpaid tax.
This doesn’t mean HMRC has gone soft and we can expect HMRC’s normal approach to resume in a few months. There are three particular things to bear in mind:
- HMRC expects directors to pay the right amount of tax on the benefits they receive from the company and applies pressure on liquidators to investigate payments made to directors. This is why it is important for directors to consider switching to a proper salary basis of remuneration for the immediate future.
- HMRC does not like directors making payments to all other creditors rather than to HMRC. If you need to defer paying taxes then it is important to do this within a formal time to pay arrangement.
- HMRC take it very badly if a company breaches a time to pay agreement.