Directors should beware the “creditor duty” but not forget the shareholders

The Supreme Court recently considered the existence of the “creditor duty” and when this duty arises in the case of BTI v Sequana. The creditor duty is the duty for company directors to consider the interests of the company’s creditors when the company becomes insolvent or is at real risk of insolvency.

In May 2009, the directors of a company called AWA distributed a dividend of €135 million to its only shareholder (Sequana). At the time of the dividend, AWA was solvent on both a balance-sheet and cash-flow basis. However, it did have long-term contingent liabilities of an uncertain amount and an insurance portfolio with an uncertain value.

AWA went into administration in October 2018 and BTI (an assignee of AWA’s claims) sought to recover the dividend from AWA’s directors and claimed the directors had breached the creditor duty as they had not considered or acted in the best interests of creditors when distributing the dividend to Sequana.

The Supreme Court dismissed BTI’s appeal and held that AWA’s directors were not at the relevant time under a duty to consider, or act in accordance with, the interests of creditors in the circumstances. It was decided that at the time of the dividends being distributed, AWA was not actually or imminently insolvent, nor was insolvency probable.

The creditor duty – where are we now?

Where the company is insolvent, or bordering on insolvency, but is not faced with an inevitable insolvent administration or liquidation, the directors should consider the interests of creditors and balance this against the interests of shareholders where they may conflict. The greater the risk of insolvency and financial difficulties, the more the directors should prioritise the interests of creditors (as a general body).

The progress towards insolvency may not be linear. It is not as simple as a switch from a duty owed to shareholders to directors. The shareholder’s interests remain important. As such, Lady Arden noted in the judgment that directors should stay informed of the company’s financial position at all times.

Section 172(1) of the Companies Act 2006 requires directors to act in a way they consider to be in good faith and to promote the success of the company for the benefit of its members as a whole. The creditor rule is a common law duty and does not replace this statutory duty but instead modifies it (in the circumstances mentioned above) to require directors to take into account the creditors’ interests as well as the shareholders’ interests.

It was also noted that directors owe their duty to the company, rather than directly to shareholders or to creditors.

How can directors be proactive when the company is experiencing financial difficulties?

• Have regular board meetings and keep fully informed of the company’s financial position and its affairs. It is helpful to keep board minutes to evidence this.
• Ensure the company’s accounts are accurate and are kept up to date.
• When a creditor duty arises, the directors should consider creditors’ interests and balance these against shareholders’ interests where they conflict. The greater the company’s financial difficulties, the more the directors should prioritise creditors’ interests.
• Where an insolvent liquidation or administration is inevitable, creditors’ interests become paramount.
• When the directors become aware of potential financial difficulties, seek independent advice from a solicitor or licensed insolvency practitioner. This may include obtaining advice regarding the company’s options and whether a recovery or insolvency strategy is most appropriate.
• Ensure their actions as directors comply with the duties imposed on them as they may be scrutinised at a later date should the company enter into a formal insolvency process.

It is important that directors deal with the company’s financial issues as early as possible to avoid the necessity of formal insolvency procedures. As directors, it is essential to keep an eye on the solvency of the company by reviewing recent financial information and obtaining professional advice where necessary.

However, if a director chooses to ignore the company’s financial position, this not only worsens the position of the company but can lead to personal liability.

Should a director be concerned about their personal liability or require advice in relation to their company’s financial position, please contact Aman Sehgal and Sam Hall-Burnett.