30th Mar 2020

Directors – wrongful trading and ongoing obligations

It is of course risky saying very much about a lot in the present circumstances, as things move so quickly; but the duties of directors in the circumstances of the current COVID-19 emergency have received some oblique mention in relation to changes in wrongful trading rules, and in relation to financial support for the self-employed. It’s worthwhile to look briefly at what the implications are.

First though, a disclaimer:  please don’t take this as advice, because it’s a quick set of reactions to policy made on the hoof, so these are thoughts, not advice!

What are the duties of a director?

By way of quick summary – a director has certain duties, in law; it’s not a free ride and a fancy title.  There are some general duties, and some very specific ones. The general ones are called fiduciary duties i.e. a duty to act in good faith toward the company, and a duty to exercise care in skill in performing the role of director.   These obligations are owed to the company itself, primarily, and in certain circumstances, to the company’s creditors.  These override the director’s own interests.

The Companies Act 2006 codified this, identifying seven core duties which directors owe to the company (to raise standards and ensure companies are well run):

  1. To act within their powers
  2. To promote the success of the company
  3. To exercise independent judgment
  4. To exercise reasonable care, skill and diligence (not a fiduciary duty)
  5. To avoid conflict of interest
  6. Not to accept benefits from third parties
  7. To declare an interest on proposed transactions or arrangements:

For now we’re not delving into these (another time – training is available!), but focusing on the two issues we mentioned.

Promoting the success of the business  

In relation to the second item – the duty to promote the success of the business – the duty is owed principally to the company itself - but in specific circumstances, to the company’s employees, shareholders and creditors. Broadly, then, not usually to another company, a supplier, a creditor or to anyone else.

However, if the company is potentially insolvent, the focus of that duty changes, and the directors have certain specific additional duties to their creditors, who are then most likely to lose out by the company becoming insolvent. Because of this danger, there is a personal liability on the directors for wrongful trading – that is, continuing to trade when the company, the directors having taken advice (which they must) continues to trade.  The personal liability is of course intended to ensure that directors aren’t protected from wrongdoing (this liability also applies to fraud). 

On 28th March 2020 the Business Secretary made a specific but short-term concession – removing personal liability for wrongful trading. The intention is to encourage companies to trade through the current problems, rather than fold into insolvency because of fear of personal disqualification and financial penalties.   It’s a small concession, one intended to have some effect in rescuing the economy – but it’s difficult to judge if it will make a significant difference.

Furlough and statutory obligations  

The other element to highlight here is this – the provisions which are being made by the government to protect the self-employed, in ways similar to the government-backed furloughing provisions for employees - apply to self-employed individuals. 

Many freelancers and self-employed operate through limited companies, for a number of reasons. It’s often more tax efficient; many companies who engage these individuals insist on contracting with a limited company; and it protects the individual from personal liability, because of a company’s limited liability (hence, of course, “limited”).

Even if the company’s taxable profits are below £50,000, it still won’t benefit from the protection announced last week.  Often the freelancer will receive a basic salary, generally less than £10,000, and the rest of the remuneration would be by way of dividends, reflecting risk and variable profits.  What the individual can do, in principle, is to furlough him/herself. However, unlike the self-employed provisions, the furloughed individual cannot work whilst furloughed.  However, so long as the freelancer is also a director (as will generally be the case) he/she will still, it seems, be able to perform the statutory obligations outlined earlier.  It remains to be seen though if this will be an effective get-around to enable business to continue.   When we first looked at, it looked like a potentially valuable allowance; but in reality, it may be slight or illusory.

We will be interested to hear what people are seeing and hearing on these issues.  It feels as if some of the remedies are falling short of the intended mark;  that’s why legislation is generally subject to consultation. There’s going to be a lot to clear up after this time; as well as a lot of scams to unpick.  

Paul Berwin is Senior Partner at Berwins and has over 30 years' experience in supporting businesses.  

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