Directors’ Duties to Consider Supply Chains

Directors have significant ongoing duties towards the company they lead, including taking the changing factual landscape into account. This should include learning lessons from the recent disruption of global supply chains.

The COVID-19 pandemic has highlighted the interconnectedness of global supply chains, and how easily they can be disrupted. Even as the rollout of COVID-19 vaccines has allowed the global economy to begin rebuilding, significant disruptions to global supply chains remain in its wake—including a lack of key components and raw materials. These disruptions have been worsened by a shortage of essential workers, including HGV (heavy goods vehicle) drivers in the United Kingdom, United States, and parts of Europe. It is widely expected that supply chain issues will continue to weigh heavily on businesses for some time. To navigate these supply chain issues, companies have been required to consider not just their immediate suppliers but also their “invisible” lower-tier suppliers. Company directors need to focus on supply chain issues for practical as well as legal risk reasons.

Directors’ Duties

Under English law, the core duties of directors are set out in the Companies Act 2006 (CA06). In summary, these are: (1) to act within their powers; (2) to promote the success of the company; (3) to exercise independent judgment; (4) to exercise reasonable care, skill and diligence; (5) to avoid conflicts of interest; (6) not to accept benefits from third parties; and (7) to declare any interest in a proposed transaction or arrangement with the company. Directors are also bound by other uncodified obligations—for example, to keep themselves informed about the company's affairs and to join with their co-directors in supervising and controlling those affairs.

These duties are owed to the company, although in certain instances shareholders may be able to bring a derivative claim, and potentially creditors (i.e., in the event of an insolvency). Shareholders can of course also vote to remove directors in whom they have lost faith.

For these purposes, we are principally interested in directors’ duties to promote the success of the company (s.172 CA06), and to exercise reasonable care, skill, and diligence (s.174 CA06).

• s.172 requires all directors to have regard (amongst other matters) to the likely consequences of any decisions in the long term and the need to foster the company's business relationships with suppliers, customers, and others. This is a subjective test as to whether the director honestly believed that their act or omission was in the interests of the company. The issue is as to the director’s state of mind, and the standard of review by the courts is whether the decision was one that no reasonable director could have considered to be in the company’s best interest. However, where it is clear that the act or omission in question resulted in substantial detriment to the company, the director will have a harder task persuading the court that they honestly believed it to be in the company’s interest.
• s.174 requires all directors to carry out their role with the care, skill and diligence that would be exercised by a reasonably diligent person with: (1) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions of the director in relation to the company; and (2) the general knowledge, skill, and experience that the director has. It has been acknowledged through case law that, when managing a company, directors will necessarily have to take risks and, accordingly, a director is not automatically negligent should the company suffer a loss as a result of the director’s activities. The director is not required to always be right, but rather to display reasonable care.

Considerations for Supply Chains

Global supply chains can lower costs for businesses by reducing labor and operating costs, and “just‑in‑time” manufacturing can cut the amount of inventory that the business must finance and pay to store. However, this can make businesses reliant upon a single manufacturer or geography to source particular components and leave them with limited contingency plans in the event of supply disruptions.

Directors should take the opportunity to work with their company’s management team to consider their supply chains in light of the risks highlighted by COVID-19—including building a clear picture of the full structure of their supply chains and the key companies, stakeholders, and contacts at each stage. This can enable companies to identify potential vulnerabilities and build in contingencies, as well as help protect against other supply chain risks such as breaches of the United Kingdom’s Modern Slavery Act. It is acknowledged that the costs of such detailed information gathering can be high. However, such costs are likely offset by creating additional resilience in their supply chains. This may include building better relationships with suppliers further down the chain, where possible reducing reliance on single suppliers, and constructing contingency plans.

While it is unlikely that a director would face a successful legal action as a result of a good faith decision to prioritize efficiency over resilience in a company’s supply chain, it is important for directors to be able to show that they have complied with their duties to diligently promote the success of the company.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

London
Peter Sharp
Robert Bolgar-Smith