When should directors consider creditors’ interests? The Supreme Court speaks

The Supreme Court has clarified the law on the duty owed to creditors by directors of companies in financial trouble – a move which will be welcomed by many in these currently challenging economic times.

All five judges confirmed that a common law duty to creditors exists but that it operates on a sliding scale. The more perilous the financial position of the company, the more the directors should prioritise the interests of creditors.

The decision highlights the need for obtaining specialist legal advice at the earliest opportunity, particularly when a company is facing an uncertain future and decisions, including the payment of dividends, need to be made.

Why is this ruling so important when it comes to directors’ duties to creditors?

Before this decision, which unanimously confirmed the existence of the duty to creditors, there was a lack of clarity about the exact point at which directors needed to consider creditors’ interests.

In a 160-page judgement, the Supreme Court highlights how the interests of shareholders and creditors may differ and explains how directors should balance those interests.

It puts the onus on directors to always act in good faith in the interests of the company, but the worse the financial position of the company, the more important considering creditors’ interests becomes.

What now triggers the directors of a UK company to consider creditors’ interests?

The duty to consider creditors’ interests has two parts.

The first is where the company is ‘insolvent (on the basis of cash flow or balance sheet insolvency) or is bordering on insolvency’ and where an insolvent liquidation or administration is probable, but not inevitable.

In these cases, the directors should consider the interests of creditors balanced against the interests of shareholders where they might conflict

The second part is where directors know, or ought to know, that an insolvent liquidation or insolvent administration is inevitable, in which case the creditors interest are paramount.

What dispute was the Supreme Court looking at when it reached its decision?

In BTI 2014 LLC v Sequana SA, the court examined a dispute stemming from a 2009 decision in which a UK-registered company facing a large environmental clean-up bill, distributed nearly all its assets to its parent company rather than creditors.

At the time, these liabilities gave rise to a risk, but not an inevitability, that the company might become insolvent at a later but not imminent date. This ultimately happened – but not for 10 years.

Like the High Court and the Court of Appeal before it, the Supreme Court dismissed the claim that the company’s directors had breached their creditor duty and in doing so, provided key clarification on the law in this area.

Get in touch

Solicitor Sophie Driscoll specialises in contentious insolvency disputes covering a wide range of issues, acting for companies, directors, creditors, office holders and individuals.

To talk to her about the fast-changing legislation around companies and insolvency, you can:

Email Sophie: Sophie.Driscoll@wards.uk.com

Phone Sophie: 01934 413535