Since the start of lockdown, business leaders have been forced to use agile decision-making to help their organisations survive. However, a failure to effectively respond to the crisis could see an increase in claims from aggrieved shareholders.
So, how can directors ensure that shareholders are on board with decision-making during the crisis and what should they do if they find themselves facing a dispute? Barry Jervis, partner and head of dispute resolution at law firm Shakespeare Martineau, offers his advice on how company heads can avoid litigation.
During the pandemic, company directors have been forced to take fast action to build resilience, keep up continuity and maintain a healthy financial position. From adapting business models in line with changing consumer habits to following government guidance and taking advantage of emergency funding, they have had to become used to rapidly introducing contingency measures and making tough decisions. However, with the significant financial impact of COVID-19 already evident from the news agenda, high-level decision-making is likely to come under far greater scrutiny in the coming months and company shareholders that believe not enough was done to protect the business’s bottom line might file claims against their directors.
At the start of lockdown, some business leaders may have gone into “panic mode” and made rash or ill-informed decisions, such as taking out emergency funding, despite such finance being at significantly higher rates than normal. In the long-term, this could have a significant negative impact on the business’ financial position. Similarly, a common misconception that government-backed business loans represent “free money” may have resulted in some directors taking a relaxed approach to company spending during the crisis, rather than tightening their belts. When taking such measures, it’s vital to bear in mind that all directors are ultimately accountable to the company’s shareholders and that any decisions they make could have long-term implications.
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Where shareholders feel that there is evidence of corporate mismanagement having taken place during the pandemic, they may choose to file an “unfair prejudice” claim (if the directors are shareholders) or a derivative claim against the business’s directors. Under the Companies Act 2006, shareholders can use a derivative action when they believe that any form of business taken by a director was not performed in the interests of their fellow shareholders. These claims protect from “fraud on the minority” when the individual a claim is being brought against is in control of the company.
Directors of companies experiencing financial pressure as a result of coronavirus may also have been tempted to keep on trading, in the hope of turning their fortunes around. However, this runs the risk of committing wrongful trading. Under the Insolvency Act 1986, once a director should have concluded that there is no reasonable prospect of their company avoiding an insolvent position, they have a duty to take steps to minimise potential loss to the company’s creditors. If shareholders have reason to believe that wrongful trading has taken place, they may choose to report the directors to relevant authorities. This could ultimately result in the directors being prosecuted.
In order to protect against shareholder claims following a crisis, it’s vital for directors not to lose sight of the fact that they are ultimately answerable to shareholders in all of their decision-making. As such, it is important to be able to back up their choices with logical reasoning and good financial grounding.
A good question to keep in mind is: “Would I be able to justify this in a court of law?” It is also good practice to ensure thorough record-keeping, clearly documenting why any business measures were taken. Keeping active and open lines of communication with the company’s shareholders will also help to avoid potential disputes by ensuring that shareholders are on board with business changes from the start.
A good question to keep in mind is: “Would I be able to justify this in a court of law?”
Seeking expert legal advice from specialists with experience in helping businesses to resolve commercial disputes at an early stage is also crucial, to secure the fairest possible outcome for all parties. As it may also be necessary to get the support of a forensic accountant, ensuring that financial evidence, such as figures for losses and predicted revenues, is available to assist in any dispute is key.
One of the major challenges facing the UK courts following the pandemic will be the question of whether instances of financial fallout are truly the result of COVID-19, or simply poor governance on behalf of company directors. By being keeping shareholders front of mind when making business decisions and ensuring choices are supported by logical judgements, leaders stand the best chance of avoiding any commercial disputes which could arise once the pandemic comes to an end.
