Going concern or concerned about going: why director’s communications have never been more important

By Charlie Ansdell, Managing Partner

Who’d be a company director at a time like this? 70% of British companies have furloughed staff according to the British Chamber of Commerce; research from SME bank Tide in early April showed that 37% of small businesses would run out of cash in just six weeks. To cap it off, the current furlough schemes (which directors can apply for) don’t include dividends, an important component of director remuneration.

Chancellor Rishi Sunak has admitted that not all businesses can be saved; directors may face the real prospect of their business failing and going into administration. 

In turn, this presents directors with the prospect of a legal minefield.  Company articles of association, market abuse rules and other legislation place specific duties of care and responsibilities on directors.  Breaching these could lead to legal action being taken personally against directors.

Accordingly, directors need to be more diligent than ever about how they communicate with different stakeholders.

A minefield of regulation and responsibility

Directors working for listed businesses will be well aware of stock market disclosure requirements and of the Financial Conduct Authority’s (FCA) Market Abuse Regulation which impose strict rules on how and what companies communicate to the market. For example, London Stock Exchange premium listing principles include a provision that “a listed company must communicate information to holders and potential holders of its listed equity shares in such a way as to avoid the creation of a false market in those listed equity shares.”

In addition, in annual report and accounts, directors are required to issue a statement on the appropriateness of adopting a going concern basis of accounting and the director’s assessment of the prospects for the company.  

In other words, directors have a responsibility to ensure they don’t misrepresent the trading prospects of their company and accurately supply information.  This can be particularly challenging in current conditions, where almost daily changes in government policy, coronavirus statistics and market response can materially impact trading and share prices.

The FCA has announced that listed companies can have an extra two months to complete audited financial statements and has asked market participants not to draw ‘undue adverse inferences’ if companies use this additional time; whether they will or not is another matter.

Directors of listed businesses must ensure that, before communicating to the market, they are making an accurate representation of circumstances/ prospects and should always seek advice from their independent advisors.

Where duties are owed

While stock market rules are highly codified, directors face specific duties under the Companies Act 2006 to

• Act within their powers under the company’s articles of association
• Promote the success of the company for the benefit of its shareholders
• Exercise independent judgement
• Exercise reasonable care, skill and diligence
• Avoid or manage conflicts of interest (not accept benefits from third parties and declare interests in proposed/ existing transactions).

However, if a company ceases to become a going concern (i.e. it becomes insolvent or technically insolvent) then a director’s duties become to the creditors (not to shareholders or themselves). 

The test of whether companies are insolvent or not is a technical accounting one.  However, if a company is deemed insolvent then there is a question of whether it should keep trading or not.  If a company continues to trade where it has no realistic prospect of avoiding insolvency, its directors could be accused of wrongful or fraudulent trading (though it is important to note that the government has announced plans to introduce legislation to temporarily suspend wrongful trading rules). 

Transactions may also be scrutinised; any attempt to settle with a creditor preferentially or to sell off assets could later be challenged.

In this environment directors need to be extremely prudent in how they communicate; if they indicate to stakeholders that a company is a going concern when it faces insolvency, they may face legal action or regulatory sanction.

A reputational cost

Although directors may be reassured that Directors and Officers (“D&O”) liability insurer may cover a potential legal liability, any issue could ruin their reputation. The media, social media and other stakeholders will not treat kindly any director who is perceived to have misled them or not been transparent in their communications.

It is worth considering that in the post-pandemic world, there is likely to be a quest for “blame” – to discern heroes and villains from the crisis. While the NHS are likely to be portrayed as heroes, company directors may not be so fortunate.  In surveys on trust, doctors and nurses routinely score top.  Directors fare less well. 

Already, wealthy owners who have furloughed staff have faced criticism from mainstream media; companies and universities have been pressured to return government loans. 

In such a febrile, volatile and rapidly evolving situation, careful communication for directors has never been more important.