Directors’ duties and creditors’ interests.

A few days ago, Rose J handed down her judgment in the case of BTI 2014 LLC v Sequana SA. The case dealt with a number of legal issues, but the issue I will focus on in this post is the extent to which directors’ have to take into account the interests of creditors.

Under s 172 of the CA 2006, directors are under a duty to ‘promote the success of the company for the benefit of its members as a whole.’ Section 172(1) contains a list of relevant factors that the directors must have regard to when fulfilling this duty (e.g. employees, the community and the environment, suppliers etc). A notable omission from this list are the creditors of the company. This omission is remedied by s 172(3) which provides that s 172 ‘has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company’.

As regards the common law, there exists a well-established string of authority that states that the directors should take into account the interests of the company’s creditors. Unfortunately, the courts have not been clear in terms of exactly when this duty arises.

Over the years, various points in time have been advocated. In Re Pantone 485 Ltd, the company in question was actually insolvency. In Re Horsley & Weight Ltd, Templeman LJ stated that the duty was triggered when the company was ‘doubtfully solvent.’ In Grove v Flavel, the court referred to the duty arising when liquidation was a ‘real possibility.’ Other cases refer to the company being on the ‘verge of insolvency.’ However, in the case of Re HLC Environmental Projects Ltd, the court moved away from seeking to establish a definite point in time when the duty arises, and instead stated that:

‘It is clear that established, definite insolvency before the transaction or dealing in question is not a pre-requisite for a duty to consider the interests of creditors to arise. The underlying principle is that directors are not free to take action which puts at real (as opposed to remote) risk the creditors’ prospects of being paid, without first having considered their interests rather than those of the company and its shareholders. If, on the other hand, a company is going to be able to pay its creditors in any event, ex hypothesi there need be no such constraint on the directors. Exactly when the risk to creditors’ interests becomes real for these purposes will ultimately have to be judged on a case by case basis.’

Which leads us to BTI 2014 LLC v Sequana SA. Here, Rose J stated that ‘[t]he essence of the test is that the directors ought in their conduct of the company’s business to be anticipating the insolvency of the company because when that occurs, the creditors have a greater claim to the assets of the company than the shareholders.’

It is contended that the approach in HLC Environmental Projects is preferable to that evidenced in BTI and the other cases that attempt to determine the trigger point of the duty by reference to closeness of insolvency. The principal disadvantage of this approach, other than its lack of clarity, is that it usually resulted in the duty coming into effect too late to be of any aid to creditors – once a company is close to insolvency, the creditors’ chances of being paid may be minimal or non-existent. The HLC approach, by focusing on the effect on the creditors’ chances of payment, avoids this criticism (although one could question how significant the risk of non-payment must be for the duty to trigger). However, in practice, the issue may not be significant in the majority of cases. Cases involving a possible breach of the failure to consider creditors’ interests (which are rare) tend to arise in relation to insolvent companies that were then liquidated. Accordingly, in most cases, it will be clear that the duty to consider creditors’ interests has indeed been triggered, but a definitive ruling would still be of use to deal with those cases where the company is not insolvent and the creditors’ interests might not have been given sufficient consideration.

One thought on “Directors’ duties and creditors’ interests.

  1. Pingback: Summary of updates (11-17 July 2016). | Company Law and Corporate Governance

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