By Lucy McCann, partner at Brodies LLP
Directors’ duties and navigating economic headwinds.
The current economic climate across the UK presents challenges and uncertainty for businesses. Renewed inflationary pressure following geopolitical tensions, together with increases to minimum wage and NI contributions, make for a challenging operating environment.
The British Chambers of Commerce reports that consumer-facing businesses are feeling these pressures most acutely. However, sectors across the board all report similar concerns, from tech start-ups and housebuilders to food and drink producers. With changes in leadership at No 10, British businesses are hoping to see reinvigorated efforts to prioritise growth and make the UK more attractive to investment.
What we do know is that the economic landscape will not change overnight. If you are a director of a company that is feeling these pressures, understanding and fulfilling your directors’ duties becomes even more crucial.
A company director’s principal role is to act in good faith to promote the success of the company for the benefit of the shareholders as a whole, typically referred to as the “section 172 duty”. Directors also have broader obligations to consider the likely consequences of any decision they make, the interests of employees, and business relationships with suppliers, to name a few.
However, where solvency becomes a concern, a director is obliged to consider the interests of creditors above that of the company – known as the “creditor duty”. Knowing when that shift occurs, and when the creditor duty is engaged, can be hugely important to a director, both in terms of their personal liability and their reputation.
So what should directors do to ensure that both they and their businesses are well-equipped to navigate economic headwinds?
Proactive and well-documented decisionmaking sits at the centre. Get a clear view of finances and monitor these on a more regular basis. Review short- and medium-term cash flow forecasts, stress test assumptions and identify key creditors to assess the extent of liabilities that are owed.
If financial challenges arise or a pressure point leads to the creditor duty engaging, directors will need to ensure they can demonstrate – if it is reviewed – that they considered the impact of each decision on creditors. Generally speaking, directors of companies in financial distress should take care to avoid taking actions that could worsen the position of creditors. For example, if cashflow is constrained, directors should carefully consider which creditors (if any) should be paid and in what order.
Refinancing deadlines are another pressure point. Directors should maintain an understanding of upcoming obligations, such as loan maturities and covenant tests. Engaging with lenders and stakeholders early to explore available options will be essential.
It is crucial that contemporaneous records of discussions and decisions are carefully maintained. Minutes should be kept of all board discussions – and the rationale behind decisions taken – to ensure directors have the relevant evidence if any decision(s) are later scrutinised.
If you are noticing signs of financial distress, seeking advice early is key navigating these complex legal duties and reducing the risk of personal liability. Remember – economic challenges are an expected and regular part of the business cycle. Directors who understand their duties and take proactive steps to comply will be well placed to help their business withstand pressure and emerge stronger.
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