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Directors duties to creditors clarified by the Supreme Court

View profile for Julie Hunter
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AR case judgment handed down by Supreme Court

On 5 October 2022 the 18 month wait for the Supreme Court to deliver its judgment in ‘BTI 2014 LLC v Sequana SA and others [2022] UKSA 25’ came to an end, with the court delivering a lengthy judgment in which it examined the nature and extent of a director’s duty to protect the interests of the creditors of a company and more importantly, at what point that duty arises.

It may seem a dry and technical point, but for directors of companies navigating uncertain economic times, it is important to know and understand when their duty to creditors overrides the duty to act in the best interests of the company, it’s shareholders and employees.

What is the duty to have regard to the interests of creditors?

Section 172 of the Companies Act 2006 imposes on directors a duty to promote the success of the company. That means acting in a way which the director considers, in good faith, would be most likely to promote the success of the company, for the benefit of the shareholders, having regard to the interests of, amongst others, the company’s employees.

This duty is subject only to a duty in certain circumstances to act in favour of the company’s creditors.

The Supreme Court confirmed that there is also a common law duty of directors to take into account and give appropriate weight to the interest of the company's creditors if the company is insolvent or bordering on insolvency.

So, for example, paying out dividends to shareholders instead of paying creditors is a breach of duty rendering the director personally liable for the loss arising, if the company is or becomes insolvent. This is what happened in ‘Sequana’. But, in that case the payment to shareholders was made nine years before the company became insolvent, and at a time when the company had no immediate creditors. However, it did have a contingent liability which may or may not have arisen in the future and if it did arise, the directors knew that the company would not have the funds to pay it and would be insolvent. This is exactly what occurred: the liability arose, and the company couldn’t pay it (because the shareholders had received the profits nine years earlier).

The issue before the court was whether the directors were personally liable to the creditor whose contingent liability had become payable by the company? Should the directors have taken this future creditor’s interests into account at the time they declared the dividend?

The court said that the directors in this case were not personally liable because the duty to creditors had not arisen at the time the dividend was declared.

When does the duty arise?

The court said that a director’s duty to take into account the interests of creditors will always arise if the directors knew or ought to have known that the company is insolvent or bordering on insolvency, or where it is probable that the company will enter insolvent administration or liquidation. But the duty does not arise where there is merely a real risk of future insolvency.

What did the Supreme Court decide?

In ‘Sequana’ the nine year gap between paying the dividend and the insolvency did not in itself matter. What was important was that at the time the directors declared the dividend, the prospect of the  future, contingent, liability arising, putting the company into an insolvent position, was real but was remote. The duty to the creditor had not arisen so directors were not personally liable for its loss.

How does the decision affect directors?

The court’s decision reflects an understanding that in business there are times when there seems to be a real risk of insolvency but often business trade out of that difficulty. Directors should not have to worry about decisions made which have the best interests of the company, its shareholders and employees at heart during times when insolvency is at best no more than a future probability.

The duty to creditors and the risk of directors becoming personally liable for decisions they make which put creditors interests behind those of the company, only arises when directors know, or should know, that there is an imminent prospect of insolvency of the company.

With that in mind, all directors should ensure that they are kept fully up to date with the current financial position of the company, are fully informed and have access to reasonably reliable information about the company’s financial position.

Stephensons' insolvency and commercial teams are available to advise and assist directors and their companies on their duties and responsibilities. Call us on 0161 696 6170.