With fewer than 50 days to go until the end of the transition period, directors should be preparing for the regulatory challenges that Brexit poses for Britain’s companies. This article will look at the steps necessary for directors to comply with their general duties under the Companies Act 2006. Directors of companies outside the small companies regime or which have more than 250 UK employees will also have more formalised disclosure or reporting obligations.
Brexit impact is complex but generally known
The consequences of Britain’s decision to leave the EU trade bloc have been clear across the various options since before the EU referendum in 2016. Even leaving the single market and customs union with a free trade agreement was always going to involve significant disruption. Indeed, free trade deals barely cover services, which may be necessary to support trade in complex goods.
Yet many studies in 2020 have shown that 80% of UK companies are not fully prepared for the impact of Brexit on their businesses. This is a problem not only for those companies but also anyone who deals with them. This alone makes Brexit a very serious issue for directors of UK companies, even if they do not trade in goods or services directly with customers based in the European Economic Area.
This lack of preparation could be problematic where it is due to general inaction or lack of knowledge (other than specific details that even the UK government has not addressed). Some directors may be in denial about the general impact of Brexit itself, let alone whether it will impact their business. Others may have mistaken the UK government’s political rhetoric, negotiating demands and lack of preparation for a sign that the EU will depart from trade rules that it has denied it would and which are realistically only a feature of EU membership.
What are your duties?
UK company directors have seven general statutory duties under the Companies Act, three of which are particularly relevant to Brexit:
- To promote the success of the company.
- To exercise independent judgment.
- To exercise reasonable care, skill and diligence.
You have to comply with each duty, even where more than one applies.
Some duties continue after termination or resignation, but not the three above.
There is no distinction between the duties of different types of directors.
The duties are owed to the company, not to shareholders or creditors, but in certain circumstances shareholders may be able to bring a derivative claim against the directors on the company’s behalf.
Duty to promote the success of the company
As a director, you must make any decision in a way you consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. That means having regard to the following, among any other relevant matters:
- likely consequences in the long term;
- interests of employees;
- the need to foster business relationships with suppliers, customers, etc.;
- the impact on the community and the environment;
- the desirability of maintaining a reputation for high standards of business conduct;
- the need to act fairly as between the members of the company; and
- what would be most likely to achieve any of the company’s formal purposes.
The term “success” will usually mean “long-term increase in value” and what will promote the success, and what constitutes such success, will be for the director’s good-faith judgement.
The obligation to have regard to at least the listed factors is mandatory. It may be necessary to seek expert advice, and this can be relied upon, but the decision has to be yours.
This duty is set aside when the company is insolvent (and the company may bring this point forward to where the company nears insolvency). The precise point is the subject of an appeal to the Supreme Court but may be encapsulated broadly by “when the directors know or should know that the company is or is likely to become insolvent”.
Generally, the question is whether you honestly believed that you acted in a way most likely to promote the company’s success. But that subjective test will only apply where there is evidence of actual consideration of the best interests of the company. Where there is no such evidence, the test will be whether an intelligent and honest person in the position of a director of the company concerned could, in the circumstances, have reasonably believed that the transaction was for the benefit of the company. That test might also affect the subjective assessment.
Duty to exercise independent judgment
You must also exercise independent judgment. That means not agreeing with an appointing shareholder, for example, to vote at board meetings in a particular way.
Again, you can rely on advice but must exercise you own judgment in deciding whether to follow it.
The company can agree to restrict the exercise of your discretion as a director or a restriction could be authorised by the company’s articles.
Duty to exercise reasonable care, skill and diligence
You must exercise the care, skill and diligence which would be exercised by a reasonably diligent person who has both:
- the general knowledge, skill and experience that may reasonably be expected of a person carrying out your functions in relation to the company; and
- your general knowledge, skill and experience.
That means you must at least display the knowledge, skill and experience generally expected, and meet a higher standard where you have specialist knowledge (e.g. other professional qualifications), depending on your functions, specific responsibilities and the circumstances of the company.
You will also be required to exercise your duties diligently, keeping yourself informed about the company’s affairs; and to join with your co-directors in supervising and controlling those affairs. You can rely on colleagues’ experience and expertise and delegate tasks or decision-making authority but cannot avoid responsibility.
So, what steps should you take to satisfy your duties in relation to Brexit?
You will need to be able to demonstrate that you satisfied your directors’ duties in the context of Brexit.
This will mean having board meetings where Brexit is discussed (with regular briefings/updates on negotiations and UK/EEA government preparations, expert advice and presentations), with minutes of those meetings stating that the necessary factors were taken into account and recording decisions and actions taken, such as:
- appointing a board sub-committee or management committee, taking input from directors with specialist knowledge in particular;
- assessing the listed ‘success’ factors and deciding what ‘success’ means, factoring in the costs and benefits of mitigating threats and pursuing any opportunities;
- analysing the operational impact on the production, sale, transport and distribution of your goods or services;
- supply chain analysis to identify suppliers at risk who may need to be replaced or assisted, and the impact of any proposed changes in the terms of sale (e.g. different Incoterms® Rules);
- checking contracts with customers and suppliers for consequences of any likely breaches;
- assessing the immigration or visa status of employees in or needing to visit the UK/EEA;
- ensuring the company has the right licences to trade;
- assessing the potential impact on working capital/solvency, particularly due to additional time required to reclaim VAT paid to European customs authorities;
- creating and updating risk registers;
- scenario planning sessions/documentation; and
- action to address threats and opportunities identified, such as:
- communications/surveys/FAQs for customers, suppliers, investors and other stakeholders;
- the incentives offered for setting up a new subsidiary in an EU27 member state;
- the impact of visa and immigration requirements (bearing in mind the Common Travel Area between the UK and Ireland);
- whether contracts need a new governing law and other pertinent changes;
- establishing a new basis for transferring personal data from EU customers/suppliers to the UK;
- assessing whether you need to appoint an EU representative under the General Data Protection Regulation; and
- considering the tax impact of moving business activity to an EU27 country (for instance, whether there might be a capital gain, tax on profits moving offshore, or an impact on withholding tax exemptions).
Generally, it will be sufficient for board minutes to state that the directors have taken the necessary factors into account in carrying out their duty. The minutes need only specifically record consideration of the duties where the particular circumstances make it particularly necessary or relevant. If any factor is particularly relevant, whether or not in the specified list, the minutes should reflect points made during discussions (subject to company policies on record-keeping), but otherwise the discussion itself need not be minuted. For significant or potentially controversial decisions, briefing papers prepared by management should address each listed factor, unless clearly irrelevant, along with other relevant matters. Where advice is obtained, the minutes should reflect that a decision was taken as to whether or not to rely on that advice.
Legal consequences of not taking steps to satisfy your duties
Rights of action against directors
Only the company can enforce directors’ duties, but shareholders may be able to bring a derivative action on the company’s behalf in relation to actual or proposed acts or omissions involving negligence, default, breach of duty or breach of trust by a director, even if the cause of action arose before the person became a member. The director does not need to have benefited personally from the breach.
Derivative claims are hard to make. A court must refuse permission for a derivative claim where it is satisfied that either a person acting in accordance with the general duty to promote the success of the company would not seek to continue the claim or the act or omission involved has been authorised or ratified by the company. There are many other factors the court must also take into account. Costs will usually be awarded against unsuccessful claimants and even if the claim is successful, relief will be awarded to the company, not the actual claimant.
Remedies for breach
The remedy for a breach of the duty of care, skill and diligence could be damages, while additional remedies for breaches of other duties include, injunction, setting aside of a transaction, restitution, account of profits, and restoration of company property held by the director. A breach of duty may also be grounds for the termination of an executive director’s service contract, or disqualification as a director.
A company can ratify or approve conduct by a director otherwise amounting to negligence, default, breach of duty or breach of trust in relation to the company, but the decision must be taken by members without reliance on the votes in favour by the director or any connected person.
A company cannot exempt a director from any liability for negligence, default, breach of duty or breach of trust in relation to the company, but may indemnify the director against defence costs, or costs incurred in an application to the court for relief, provided that the director repays the costs if he or she is unsuccessful.
A court may also relieve the director of liability if it considers that the director acted honestly and reasonably; and ought fairly to be excused, considering all the circumstances of the case.
A company may also purchase insurance for its directors, and those of an associated company, against any liability attaching to them in connection with any negligence, default, breach of duty or breach of trust by them in relation to the company of which they are a director.