With over 2 million confirmed cases of the COVID-19 worldwide, companies around the world are faced with severe loss of revenues and disrupted supply chains due to industry shutdowns and restrictions on movement and commerce. In particular, small and medium-sized enterprises (SMEs)—which are the backbone of the world's economy and represent 99% of all businesses in the EU (OECD, 2019)—suffer enormous economic loss, and the continued existence of their business as ongoing concern is questionable. Thus, corporations and their boards of directors are asked to design comprehensive strategies to address the challenges associated with the epidemic crisis and its aftermath.
In a recent paper, I discuss the directors' duty of care in times of financial distress from a global perspective and focus on directors’ roles in different types of SMEs. I argue that while the economic crunch of the years 2007–2009 was a direct result of large governance deficiencies (Bruner, 2011), which generated various reforms that reinforced the monitoring role of directors, the current crisis will highlight the significance of the directors’ managerial roles. Accordingly, we can expect jurists and policymakers to design numerous regulatory reforms that will reinforce their advisory role in a fashion that will assist them in tackling the severe consequences of our current times. Moreover, supervisory authorities may decrease the regulatory burden imposed on directors to allow them to invest considerable managerial resources for supporting the survival of companies (as Enriques demonstrates concerning corporate law, and Chiu et al point out regarding financial regulation).
Furthermore, I argue that the civil law on directors' duty of care provides boards with a broader scope of discretion to confront the challenges associated with COVID-19 than the Anglo-American law. Delaware corporate law, for instance, posits that since directors, rather than shareholders, manage the affairs of the corporation, they should be protected by the business judgment rule. However, a recent empirical study demonstrated that challenges to business judgment in English and Welsh cases have been increasingly successful from the mid-nineteenth century until the present, with a marked increase in legal liability since 2007. This indicates that the proposition that English courts will generally not review directors' business decisions is incorrect (Keay et al, 2020). In contrast, under the law applicable in countries such as Germany, France, Italy, and the Netherlands, the standard of care cannot be determined absolutely: it must address the specific situation for which the question of the due diligence of organ dealing arises. Accordingly, this standard is at the same time objective and relative, ie, a company comparable in size, business, and the economic situation shall serve as a model (as illustrated by, the Cancun ruling of the Dutch Supreme Court).
Moreover, civil law adopted the so-called stakeholder model as the leading concept underlying directors' duties (Sjafjell et al, 2015). As a consequence, directors should, at all times, take due care of the company's interest defined in rather broad terms (Gerner-Beuerle et al., 2013). In contrast, the jurisprudence of the American Delaware courts opposes such conception and insist that those duties are directed for protecting shareholders exclusively (Bebchuk and Tallarita, 2020). Border interests can be considered only when the corporation is insolvent (North American Catholic Educational Programming Foundation v. Gheewalla, 930 A.2d 92, 101 (Del. 2007). Similarly, under Section 172 of the 2006 UK Companies Act: A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. The members of the company are essentially its shareholders. Section 172 further specifies that in promoting the success of the company the directors should have regard to the interests of other stakeholders. However, directors’ duty to promote the success of the company is towards its shareholders, while the duty to consider the interest of other stakeholders is derivative. Therefore, considering the interests of stakeholders is possible only when it is necessary to promote shareholders wealth (Mayer, 2018, p 110-112; Ferrarini, 2020). At the same time, UK law posits that only in the vicinity of insolvency are directors required to act solely in the best interest of the creditors (ss 214 and 246ZB of the Insolvency Act 1986; West Mercia Safetywear Ltd v Dodd  BCLC 250). The rationale advanced is that creditor-oriented duty-shifting rules may deter directors from disposing of assets in 'high-risk, high-reward' projects in insolvency and its vicinity even though shareholders may support these strategies (van Zwieten, 2018). Therefore, the Anglo-American restricts the particular constituency that directors should serve and promote by focusing only on two extreme and concrete scenarios, ie, when the business is solvent (shareholders' interests should be given absolute preference) and insolvent (preference should be mainly provided to creditors' demands). Yet, this formal distinction is inconsistent with the complexity and the fluid nature of conducting business, particularly during an economic crisis because it identifies the welfare of the company with the promotion of distinct constituency's claims (which may be driven by a vast and conflicted range of interests) without considering the best interest of the company as a separate and independent legal personality (Keay, 2008).
This formal distinction is also reflected in academic discussions on whether the rule of West Mercia should be relaxed in times of global epidemic crisis. For example, van Zwieten (2020) opposes such proposal because creditors will ‘be less inclined to cooperate if the signal sent by lawmakers is that the ordinary rule…does not apply.’ However, lawmakers should not devote their efforts to relaxing such duty as such. Instead, they should articulate a comprehensive approach to the duty of care following a firm-specific interpretation. The firm-specific view rejects the sharp distinction between the preference given to shareholders' interests when the company is solvent and the preference given to creditors' interests when the company is insolvent because it does not provide directors with the necessary scope of discretion needed to lessen financial distress by adopting policies that go beyond the interests of any particular constituency. In fear of imposing liability, the Anglo-American regimes may, in some circumstances, incentivize directors to initiate insolvency proceedings even when an out-of-court restructuring attempt would be preferable and increase overall welfare.
These difficulties are relevant to a much lesser extent in the civil law systems because they provide nuanced arrangements to directors’ duty of care following the special features of the company and markets. For example, the German, AktG §93(1) considers behavior to be contrary to the duty of care if it violates the knowledge and experience recognized in the industry. Thus, the degree of care to be taken cannot be determined absolutely, but must address the specific situation for which the question of the due diligence of organ dealing arises. Accordingly, the standard of due care is at the same time objective and relative, i.e., a company comparable in size, business and economic situation shall serve as a model. Another interesting example is the Swedish Supreme Court ruling concerning the limits of board responsibility for not presenting the necessary financial reports in times of financial distress (NJA 2012 s. 858). In this case, the Court considered whether individuals who joined the board of directors in the period of the company’s statutory duty should also incur liability. The Court ruled that the liability assessment should focus on whether the director acts in a way that is in accordance with the company’s current situation, and director business judgment should be reviewed more freely if a company is struggling with severe economic difficulties. In such cases, courts should refrain from questioning the business decisions of directors as long as they have made a comprehensive assessment and were informed about the company's condition. As was clarified by the Court (note 22):
The negligence test should not focus on questions of admissibility but on whether the board member concerned has acted responsibly in the specific situation in which the company was. In the frame of court's ex post-assessments, a relatively generous and understanding view of what should have been done and not done will be carried out. As long as the board member has met reasonable requirements when it comes to staying informed and making a serious evaluation of the situation, there is rarely a reason to question the conclusions the board member has reached.
Consequently, the civil law’s standards of conduct enable directors to implement a custodial approach, which focuses on protecting the company's assets (rather than those of its different stakeholders) with the view of readopting entrepreneurial strategy when possible (Licht, 2020), without consistently worrying that wrongful trading liability will be imposed on them. I implement these arguments in relation to two types of SMEs, namely family businesses and venture capital-backed firms, and demonstrate why firm-specific views based on the stakeholders-governance approach provide boards of directors with significant mechanisms to confront the consequences of the global epidemic situation.
Leon Yehuda Anidjar is a doctoral candidate at the Rotterdam School of Management, Erasmus University