The Mishcon Academy Digital Sessions
Conversations on the legal topics affecting businesses and individuals today
Katy Colton
In this episode, what is Covid-19 teaching us about the focus of directors’ duties in an age of crisis? Should businesses be putting profit considerations above all else? And how have businesses adapted their usual practices to contribute to the Covid-19 effort? Hello, and welcome to this Mishcon Academy Digital Sessions podcast. I’m Katy Colton, a Managing Associate at Mishcon de Reya specialising in commercial and political disputes and I am joined by my colleague, Victoria Pigott, a Partner in our Private Commercial Litigation Team and studiously following social distancing rules – as all lawyers love rules – we are recording this podcast from our own homes, over the internet. Victoria, hello.
Victoria Pigott
Hi there, greetings from sunny Essex.
Katy Colton
Turning to the first question. A key concept of corporate governance and directors’ duties is that directors should promote the company’s success for the benefit of its shareholders that has historically meant putting profits above all else. But Victoria, do you think that this has changed or adapted in the Covid-19 crisis?
Victoria Pigott
In short, yes. Until recently the uncontested marker of success or corporate success was linked to shareholder returns and in turn executive pay was often linked to that as well. The recent movement – and this is pre-Covid – was in relation to corporate social responsibility and ESG which is the Environment Social Governance, looking at the concerns around that. So, directors have to look at the impact of the company on the community and the environment. So, for example not using a sweatshop in Pakistan or trying to reduce the company’s carbon footprint in ways that they can. But the fact is, pre-Covid, this very much was still with a focus on profit; “Oh, we can make a good profit and we can do something that might be seen as ethically admirable.” I think with the Covid crisis and the fact that nobody seems to have seen it coming, it’s really brought it to the fore that directors are having to make reactive decisions on the information they have at that time, which changes very quickly and they’re having to make choices about their businesses which actually aren’t necessarily about profit. The most obvious one is having to close businesses because the employees should not be going in, they should not be mixing with each other. So, what you find is that the directors are having to choose between running their business, the health of their employees and very few have not chosen the latter. A few presidents have not chosen the latter but certainly most directors have chosen the health of their employees over the profits of their business.
Katy Colton
I think it’s really interesting what you were saying and actually I think it was most stark pre-lockdown when it was in the hands of businesses to decide whether they continue business as usual or whether they shut for the benefit of their employees and the health of their employees. Obviously, when lockdown was put in place it was taken out of their hands but before that happened there was quite a lot of uproar and there are some businesses that have been criticised, such as Waterstones that stayed open and its employees said it’s not safe to do so. So, I think even before lockdown these issues were really coming to the fore. Which brings me to a more positive question of what examples have you seen of businesses adapting their usual practices to contribute to the Covid-19 effort?
Victoria Pigott
There have been some really creative ways that businesses have adapted and very, very quickly. I think there are two key ways that businesses have really been adapting. The first is giving away produce or donating profits or directing their employees to different services and the other is repurposing. So, in terms of giving away the most high-profile examples of things like Pret – the coffee chain – despite the fact that they have had to close the majority of their 530 shops, they have been giving free coffee away from the ones that have remained open. And the ones that have remained open are the ones nearest to hospitals and they are takeaway only. So, it’s free coffee to keyworkers and half-price on everything else and similarly, Leon – who are the healthy fast-food chain – they’ve been giving free meals to NHS workers and supermarkets have been giving special opening hours to key workers. It’s relatively simple calculation for a director; what are the costs going to be of us giving coffee away? And therefore they can look at the predicted impact on their balance sheet and make a decision. The other way in which business have adapted is obviously the repurposing and that’s a more complex discussion for directors. You could say there are greater risks so if you take the LVMH group of companies, they have repurposed their perfume factories into making antibacterial hand wash. They’ve used Burberry and the seamstresses who work there to make PPE. Again, the Formula One engineers, they’ve been working with medics to design completely new in fact, ventilators, working out how they could work and then how they could mass-produce them. So, the directors of companies that are repurposing, they have to look at the cost, not just as a loss. So, they’re buying raw materials, they’re having to keep paying their staff, they’re keeping their production lines going and actually it’s less clear what the impact will be on those businesses but the directors just have to rely on making good decisions on the basis of the information that they have at the time and hope that it works out correctly.
Katy Colton
And you mentioned before, balance sheets and obviously, if you look just through the prism of balance sheets, contributing to the Covid-19 effort by perhaps repurposing your business will not necessarily aid short-term profits and so do you think that short-term profit losses can ever be compatible with a director’s duty of promoting the success of the company?
Victoria Pigott
Yes, yes, very much so especially when you look beyond dividends. So, a director’s duty is to promote the success of the company and to act in good faith. So, good faith is made up of honesty, integrity and fairness. A good example of this would be the Excel Centre in London. It’s owned by the Abu Dhabi National Exhibition Company. Now, they could be charging the NHS £3 million a month to rent it in order to be able to set up the Nightingale Hospital there, but actually they made a decision not to charge the NHS and are in fact paying fixed costs. They put out a statement saying they have joined the national effort to combat Coronavirus. I think that is a really good example of directors demonstrating real integrity at a time of national crisis. I don’t think anyone would argue that these short-term losses were incompatible to their duties as directors.
Katy Colton
And thinking of the reverse, have you actually seen examples of businesses damaging stakeholder relations by focusing more on short-term profits rather than the mid to long-term?
Victoria Pigott
Yes. I mean a very well-publicised example is obviously the football clubs and I am singling out Tottenham for no reason, I have no allegiance or dislike for them. Tottenham decided to furlough their non-playing staff so they would be taking a 20% pay cut and not going to work. But their players would remain on full salaries. So, just to give you an example, Harry Kane earned £10.4 million last year. Now, whilst on average only 9% of a premier league’s income comes from ticket sales the views of their fans are obviously important and have to be taken into account and it was the Tottenham Hotspur Supporters Trust who approached the Board and voiced their discontent at the decision of furloughing the non-playing staff whilst their players remained on 100% of their enormous pay packets and following this approach, the club actually reversed their decision. So, at the time, when the directors made the decision to furlough their staff – which they were perfectly entitled to do under the Government scheme – it really damaged stakeholder relations but actually on this occasion, the Board recognised the damage that was being done and were able to reverse the decision.
Katy Colton
And I think that emphasises how dynamic directors need to be in this current crisis. They’ve not had to deal with these issues before and actually making a decision based on historic prism of profits may not actually be the best decision for the success of the company and I think that’s a really interesting example. Do you think that this extension or adaptation of director’s duty to consider societal issues is a new phenomenon?
Victoria Pigott
No, it’s definitely not a new phenomenon. You just have to look back to for example, the ‘60s where investors would exclude certain stocks from their portfolios on the basis of they might be involved in tobacco production or anything to do with South Africa’s apartheid regime. People have always made choices based on their beliefs and so socially responsible investing is not new but ESG is relatively new. The phrase was first coined in 2005 and socially-responsible investing and ESG are actually different. So, ESG is based on an assumption that ESG factors have financial relevance. It was the former UN Secretary, Kofi Annan who really started the movement in 2005 and he wrote to 50 chief execs of major financial institutions because he wanted to integrate ESG into the capital markets. He was saying it’s good business sense, it’s more sustainable and it’s better for society. So, obviously it’s been going on for 15 years and there are some people who say, “Well, maybe this is a fad’ but I don’t think that’s right either because if you look at the way in which technology has enabled everything to be more transparent, the data is available and you have to look at people’s access to tech, which empowers them to express their own values in investing. And it doesn’t necessarily mean that they have to compromise on returns and a really obvious example here is climate change and how scientific certainty has forced directors towards good stewardship because the impact that businesses can have on the environment is now incredible clear. There’s also the concept in the UK of a B Corp framework which is essentially benchmarking and it measures company performances against their peers and you are measured in core areas which are governance, workers, community, environment and customers. In order to be seen as a B Corp company, to qualify as a B Corp company, you have to go through this assessment every three years and actually, when you apply, you also have to change your Articles of Association which is specifically to ensure that directors take equal account of all stakeholder interests so, for example the interests of shareholders – who are usually just interested in their profits – do not automatically trump those of any stakeholder. So, socially-responsible investing is not a new thing. ESG, the phrase was first coined in 2005 and I think the movement towards considering your environment and society when making decisions as a director is only growing at pace and Covid-19 has really, as I said before, has really brought this to the fore and directors have to consider it in every decision that they’re making.
Katy Colton
I think it’s really interesting to consider the stakeholders that this affects because you’ve mentioned investors and I think that’s very interesting that some investors may put considerations of what a company was doing during Covid-19 before returns. But also, I think business needs to think about their future employees and actually, there has been quite a lot of studies in relation to so-called millennials or younger employees that have shown that they put ESG considerations before perhaps money and salary. So, when we return to a better economic outlook and you want to attract the best talent, it may be that future employees will look and ask, “What were you doing during Covid-19 to help?” and it may preclude you perhaps from getting the best talent if you perhaps haven’t thought about your contribution to society.
Victoria Pigott
I think that’s definitely right and if you look at for example, the tobacco companies, if you have a role in the tobacco company and you had the equivalent role at another company that wasn’t involved in the production of tobacco, usually you’re being paid between 20-25% more to work at a tobacco company because actually they don’t have the same level of applicants that other companies do. So, that’s another thing for directors to realise that if they’re not seen as socially responsible there are going to be costs to them in different ways that they may not have predicted before now.
Katy Colton
And do you think that this new world of directors’ duties is specific to certain industries or do you think that the reach of Covid-19 means that directors of all businesses should be conscious of increased scrutiny on what they have been putting back into society over this time?
Victoria Pigott
Yes. I mean, I was thinking about this. I think almost everyone is feeling the impact of Covid, both personally and professionally. I was trying to think of an industry that hasn’t felt the impact and the only one I could come up with was perhaps the US gun manufacturing industry who had their second busiest month ever in March of this year, the first ever being in January 2013 when Obama had just been re-elected and there had been the Sandy Hook massacre. So, they’ve obviously had a bumper year and this has done them lots of favours but I’d probably go so far as to say that shareholders in American gun manufacturing companies have slightly different values to some of the rest of us. Generally, I think that all industries will have had a huge impact and that they all need to think about their ESG initiatives more. It comes down to the fact that this Pandemic, which none of us predicted or thought we’d ever have to live through, have all had to consider human frailty and mortality and what’s important in life and I hope that if anything good can come out of it, that it is people have different values that put society above individual profit.
Katy Colton
Some would say that in the current time that some businesses are really suffering and actually having a new value system is a luxury that businesses who are really struggling can’t afford. For directors of businesses that may perhaps be facing impending insolvency, are their duties different or do they still need to think about ESG considerations?
Victoria Pigott
Well, I mean they can certainly have ESG considerations in mind but if your business is struggling – and you’re right, there’s a huge amount of businesses that are struggling in the current situation, your duties change once you are heading towards insolvency in that your duty is no longer to shareholders but it’s actually to your creditors. The Government’s tried to assist in this. They brought in legislation to reduce personal liability of directors for wrongful trading or trading whilst insolvent but that ends on the 30 June. So, directors need to bear in mind their duties to creditors. A good example would be in relation to the coffee shop industry. If you are a big name like Prets, you will have the cashflow to enable you to buy the coffee that you are then giving away to the keyworkers. But if you are an independent business, you may not have that cashflow. So, as a director of a much smaller coffee chain or just one shop, you wouldn’t be allowed to increase what you owe to your suppliers, essentially your creditors, if you were then just going to give away that coffee. So, there’s certainly restrictions on what people can and can’t do and we need to recognise that being in a much larger company with probably likely much greater cashflow, enables you to do those kind of social initiatives that people of smaller companies would definitely want to do but don’t have the luxury. So, if your business is likely to go insolvent, you have to be really careful and really mindful of your duties even if the motive behind what you would like to do is obviously the right one.
Katy Colton
And you touched on personal liability for directors in an insolvency situation, but are there other areas that directors should be mindful of in relation to their personal liability?
Victoria Pigott
Yes. One of the Government’s announcements last week was in relation to people going back to work and making workplaces safe – Covid Secure, I think is the phrase and directors need to look very carefully at risk assessments if for example, they are getting employees to go back to work. There need to be clear risk assessments. They need to ensure that the social distancing guidelines can be observed. They need to ensure that they can keep the risk of infection as low as possible. Directors are personally liable for issues in relation to health and safety. So, they need to look very carefully at the health and safety guidance in relation to Covid-19 before they can even think about sending their employees back to work.
Katy Colton
I think this highlights the difficult situation that directors find themselves in, because this area hasn’t been tested and it’s difficult to know when a Regulator will say, “No, you’ve not acted as a responsible employer should in relation to securing the health and safety of employees and not spreading Covid-19.” This has never been done before, it’s just a very testing time for directors which leads me on to my next question. I know we’re both litigators and what areas in the Covid-19 response do you think are likely to be breeding grounds for future litigation and what can directors in particular do to protect their positions?
Victoria Pigott
The trends we are seeing are obviously that insurance litigators, insurance lawyers generally are incredibly busy as people put their claims for business interruption insurance, some people have pandemic insurance and so there’s lots of disputes regarding insurance policies. There’s also unfortunately a spike in insolvencies as companies realise that actually the difficulties that they’ve faced since the 20 March and lockdown has meant that they can no longer continue. In addition to that, I think there’s a lot of work for reputation lawyers. You’ve seen it all over the press, every day, the press have gone to town on those who have not behaved properly in this time of crisis. So, they’ve had a lot to say about those on the Rich List who are furloughing staff or commenting on the way that the ultra-high nets have spent lockdown on one of their three yachts whilst their companies have been mothballed and their employees furloughed, taking pay reductions or made redundant. I also think there’s something slightly distasteful about people profiting from the crisis. So, the reputation lawyers are busy having to help out those who completely properly made money out of this crisis just because of the industries that they’re in, so, cloud computers, video conferencing, electronic payments, video gaming. There’s going to be a lot of disputes and litigation about the rise in those industries, perhaps a regulation of them. There have already been a lot of disputes about the safety of using Zoom. I know that the cabinet at one point had been having meetings by Zoom but actually it was thought not to have the privacy restrictions that you would need, or the confidentiality that there ought to be working within. I think directly in relation to directors, as the dust settles as we come out of this crisis, we’re going to see shareholder director disputes arising because companies are going to be judged on how they performed during the crisis compared to their competitors. So, if your direct competitor did extremely well during the crisis and you didn’t, your shareholders are understandably going to say, “Why didn’t we do well during the crisis? What decisions were made that could have enabled us to do better?” I think directors need, at this time specifically, to be very mindful of their duties. They need to exercise reasonable care, skill and diligence. Those are the markers. They’re judged on what is reasonably expected of them. They’re not expected to be an expert in you know, the economics of pandemics. They’re not expected to have a crystal ball. But they need to be aware of their duties, they need to make sensible and reasoned decisions on the information that they’ve got at the time. They need to keep up to speed with the information as it changes. They need to challenge their fellow directors and they need to ensure that they, as a Board, are considering all the options and based on that, they need to make sensible decisions and that should, if matters do proceed to disputes, making sensible decisions on the information available to them should stand them in good stead.
Katy Colton
Well, thank you Victoria, I think that’s a great note to end on. I’d like to say a big thank you to you, Victoria, for joining me for this Mishcon Academy Digital Sessions podcast.
Victoria Pigott
Thank you.
Katy Colton
I’m Katy Colton and in the next episode, my colleagues Adam Rose and Jon Baines, will be chatting about data protection, privacy and how GDPR has played out in the two years since it came into force.
The Digital Sessions are a new series of online events, videos and podcasts all available at mishcon.com. If you have questions you’d like answered or suggestions of what you’d like us to cover, do let us know at coronavirus@mishcon.com. Until next time, take care.