Keeping Shareholders on Side During Lockdown 3.0

By Barry Jervis, partner and head of dispute resolution at law firm, Shakespeare Martineau

With no end yet in sight for the third national lockdown, agile decision-making is vital if company directors are to adapt their business models and keep their organisations above water. However, despite the unprecedented challenges facing business leaders, they are under more scrutiny than ever before and could be at risk of claims, such as corporate mismanagement, from aggrieved shareholders.

So, when making tough decisions to safeguard their business’ future, how can directors keep shareholders on side and consider the long-term implications of any measures they’re considering putting in place?

Throughout the pandemic, reactive decision-making has played an important role in helping company directors to build resilience and keep up their performance. Often, this has involved the need to take tough decisions, from how to adapt their operations in line with emerging industry trends, to ensuring compliance with government guidelines and taking advantage of fiscal support measures. However, despite this tough trading environment, directors are facing a new level of scrutiny from company shareholders, which could see them facing costly legal claims in the months ahead.

The stress involved in reduced trading or the enforced closure of businesses during the lockdown may have impacted the judgement of some directors, causing them to make ill-informed decisions. For example, they may have been tempted to take out emergency funding, despite it currently being at inflated rates. The misconception that government-backed business loans represent “free” money may also have led to directors failing to reign in their spending habits. In the long-run, however, it’s vital for business leaders to bear in mind that they’re ultimately answerable to shareholders and remember that their actions could have long-term implications.

Barry Jervis

If shareholders believe that there is evidence of corporate mismanagement within a business, they have the option of filing an “unfair prejudice” claim or a derivative claim against its directors. Under the Companies Act 2006, shareholders can use a derivative claim when they feel that any actions taken by a director were not performed in the interests of fellow shareholders. These claims protect against “fraud on the minority”, which applies when the individual a claim is being brought against is in control of the company.

With many company directors under considerable financial strain at the moment, there may be a temptation for them to continue trading, in order to keep cash flowing. However, this can lead to directors committing wrongful trading. Once a director is aware of the possibility of their company becoming insolvent, they have a duty to take steps to minimise potential loss to the company’s creditors. Any suspicion of wrongful trading by the company’s shareholders could lead them to report directors to the relevant authorities, which could lead to the directors being prosecuted.

The key to protecting against shareholder claims during a crisis is for directors to remember that they must bear shareholder interests in mind at all stages of their decision-making. This should involve ensuring that all choices can be supported with logical reasoning and have a strong business case behind them. Directors should also ask themselves the question, “Would I be able to justify this in a court of law?”

Accurate record-keeping and clearly documenting why business measures were taken will help directors to back up their decision-making, in the event that a claim is brought against them. They should also communicate effectively and constantly with shareholders to ensure they’re in agreement with any potential business changes from the outset.

Securing specialist legal advice from experts with experience in helping businesses to resolve commercial disputes at an early stage can play an important role in getting a fair outcome for all relevant parties. There may also be the need for support from a forensic accountant, so it’s vital to ensure that financial evidence, including figures for losses and predicted revenues, is to hand.

One of the major legal dilemmas facing UK courts in relation to the pandemic is whether cases of financial struggle are a direct result of COVID-19, or the result of poor governance on behalf of company directors. By making sure that shareholders are at the heart of every business decision made and ensuring they are backed up by logical judgements, leaders can take action to kickstart their financial recovery while avoiding the likelihood of commercial disputes occurring.