During the COVID-19 crisis, many companies are facing unexpected financial distress, and taking steps to stabilise their business and bolster their finances.
Many directors will not have experienced these issues before, and should be aware of how their duties are impacted when the company is in financial distress.
This guide has been prepared on the basis of Hong Kong law principles. Many of the principles will also be applicable to other common law jurisdictions.
How are companies responding to the current crisis?
Speaking with our clients in Hong Kong and internationally we are seeing the following corporate responses
- Stabilising the business:
- Cuts in discretionary spend and capex
- Reviewing overheads and seeking flexibility in trading arrangements
- Managing revenue collection
- Taking stock of directors’ duties
- Considering access to government support (if available)
- Retention of profits and distributions:
- Considering changes in dividend policy
- Assessing debt service obligations
- Assessing the company’s going concern status
- Considering the relevance of local and overseas insolvency law
- Existing facilities
- Assessing what facilities are available
- Seeking to maximise liquidity reserves by drawing down existing facilities
- Drawdown will require careful consideration
Directors’ duties in times of financial distress
- Directors must act in good faith and in the best interests of the company. When a company is solvent, this generally requires directors to act in the best interests of shareholders.
- In times of financial distress, directors remain subject to their usual duties as directors, but they need to adapt to the new environment of distress.
- Actions are required as soon as directors realise there is a prospect of insolvency.
- When a company is under financial distress, creditors (including trade creditors and employees) become important stakeholders, whose interests the directors must take into account. The directors’ duty remains to act in the best interests of the company, but the duty expands to include creditors.
- Directors may be exposed to personal criminal and civil liability for fraudulent trading; that is, if they engage in carrying on any business of a company with intent to defraud creditors or for any fraudulent purpose. An example would be if directors trade on credit while knowing that the company is unable to pay its debts.
- If a company goes into liquidation, a director can be disqualified by the court from being involved in the management of a company, if it is found that his conduct makes him unfit to be concerned in the management of a company.
- Directors should seek timely professional advice in ensuring fulfillment of their duties.
What can boards of directors do in the short term to protect the company, shareholders and creditors?
- Ensure the whole board is involved in decision making
- Consider holding board meetings more often than before
- Undertake contingency and business continuity planning
- Update financial models, business plans and budgets
- Review debt terms against reducing demand and cash flows
- Maintain open dialogue with lenders and consider covenant resets
- Consider availability and eligibility of government fiscal support
- Make sure board minutes and materials record thoughtful consideration given to key decisions
The contents of this publication are for reference purposes only and may not be current as at the date of accessing this publication. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2021