Expansion of Directors’ duties to Creditors
Howat Avraam Solicitors
Solicitors specialising in Corporate, Commercial, Employment and Disputes.
It is well known that, when a company becomes insolvent, its directors owe a duty to the company’s creditors (i.e. compared to their usual duty to shareholders) to minimise the creditors’ losses. ?It is less certain, however, as to when a company tips over into insolvency and therefore when a director’s fiduciary duties expand to include creditor interests – with many arguing that a duty to creditors doesn’t arise prior to a company’s actual insolvency.
The recent case of BTI 2014 LLC v Sequana SA [2022] UKSC 25 gave specific thought as to whether, when a company is insolvent or even bordering on insolvency, the company’s directors must have regard to the interests of its creditors in addition to, or instead of, its shareholders; and, if such a duty exists, precisely when it is engaged and its scope and content.
In summary, the case involved a challenge to the directors’ decision some 10 years previous to pay a €135 million dividend to the company’s parent company and only shareholder, Sequana SA. ?At a time the dividend was paid, the company (Arjo Wiggins Appleton Limited (AWA)) was balance sheet and cashflow solvent but had long term pollution-related contingent liabilities of an uncertain amount and its assets included an insurance portfolio of an uncertain value.?Accordingly, whilst there was a real risk that AWA might become insolvent in the future, insolvency was not imminent or even probable when the dividend was paid so no director liability arose.
When does a Director’s duty to Creditors arise?
The Supreme Court unanimously affirmed the existence of the so-called “creditor duty” and provided clarity to the effect that the duty arises when directors know, or ought to know, that:
In deciding the above, the Court rejected the argument that the creditor duty arises simply because of a “real risk” of insolvency in the future, which many claim to be the catalyst for a widening of a director’s fiduciary duties.?This future risk was deemed to be too remote.
What is the extent of a Director’s duty to Creditors?
Once a duty to creditors has arisen, the Supreme Court then gave thought to the extent of a director’s creditor duty and how this should be balanced against a director’s existing duty to the company’s shareholders.?
Potentially unhelpfully, the Judges’ preference was for a “sliding scale” approach. ?Where, for example, a company is insolvent or bordering on insolvency but not faced with an inevitable liquidation or administration, the duty is to consider creditors’ interests, to give them appropriate weight, and to balance them against shareholders’ interests where they may conflict. ?Contrast this situation with one where an insolvent liquidation or administration is inevitable and therefore creditors’ interests are paramount.
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As a technical point, note that the term “creditor duty” is perhaps slightly misleading, as directors have no direct duty to the company’s creditors themselves. ?Instead, the term refers to the widening of a director’s fiduciary duties to the company in that directors must take creditors’ interests into account and give them appropriate weight.?
Take-home for Directors
Matthew Howat, Dispute Resolution Partner, comments:
“Directors need to very closely monitor and react to a company’s financial position and alter their actions accordingly.?Failure to do so could give rise to a liquidator claim against the director for Wrongful Trading under s.216 of the Insolvency Act 1986?(i.e. requiring the director(s) to contribute towards the funds available to creditors in an insolvent winding up where the director(s) ought to have recognised that the company had no reasonable prospect of avoiding insolvent liquidation and then failed to take all reasonable steps to minimise the loss to creditors).?
?The case unfortunately provides little further clarity as to the definition of “insolvency”.?Instead, the essence of the test was that the directors ought, in their conduct of the company’s business (including a decision to pay dividends), to be anticipating the insolvency of the company.?The rationale here is that, at such time, the creditors have a greater claim to the assets of the company than the company’s shareholders so their interests must be considered.
Helpfully, at least so far as directors are concerned, the Judges also unanimously held that the creditor duty is not triggered merely when a company faces a real risk of insolvency at some point in the future. This was found to be too remote and perhaps helps to remove some of the grey around exactly when a director’s fiduciary duty shifts from the company’s shareholders to its creditors”.
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Howat Avraam Solicitors provide Commercial, Employment and Contract Dispute advice to companies and business owners. As business owners ourselves, we have a pragmatic in-house approach to resolving issues before they arise by working alongside our clients, often on monthly retainers. We are commercial, practical and entrepreneurial in our approach to legal services.??
To discuss any commercial or legal matter on a no obligation basis, please contact Matthew Howat, Company and Disputes Partner, on his direct dial on 020 4566 7154 or email Matthew at [email protected]. Alternatively, visit our website at www.howatavraamsolicitors.co.uk.?