Ever since the modern insolvency era began with the passing of the Insolvency Act 1986, there has been a debate about how and when the responsibilities of Directors change as their company moves towards a formal insolvency.
In broad terms, the mantra has been that they owe their primary duty to the shareholders until an insolvency filing becomes inevitable, after which point they must shift their focus so that the interests of the creditors become paramount. Of course, pinpointing that moment is as much a matter of commercial opinion as it is a scientific exercise.
Now we have a decision in the UK’s Supreme Court, which provides some much-needed clarity both for Directors and those who may subsequently sit in judgment of their actions after their company has entered a formal insolvency process.
The facts in BTI v Sequana case
The judgment concerns a dividend paid by an English company, AWA, in May 2009. The dividend was lawful under the Companies Act and was paid when AWA was solvent. However, AWA had an uncertain contingent liability for pollution clean-up costs. This meant there was a genuine risk that AWA might become insolvent at an unknown but not imminent date in the future. This was not considered to be probable at the time. In fact, AWA went into Administration a full ten years after the dividend was paid. A claim was then made against the former Directors for return of the dividend, on the basis that the decision to pay it was in breach of the Directors’ duty to AWA’s creditors because insolvency was a real risk at the time.
Both the High Court and the Court of Appeal rejected the claim because the risk of insolvency fell short of being probable. The claimant, BTI, appealed to the Supreme Court, saying that the duty arises where there is a real (but not remote) risk of a company becoming insolvent at some point in the future.
Related article: Which sectors are most affected by corporate insolvencies?
The Creditor Interest Duty
The Supreme Court confirmed that a ‘creditor interest duty’ exists in such a situation and that:
- it is not a free-standing duty, it is part of the director’s duty owed to the company which requires them to consider both creditor and shareholder interests;
- it is a recognition of the creditors’ interest in the company when it is ‘bordering on’ insolvency or is insolvent, and
- it is owed to the creditor body as a whole.
The triggers that change the Directors’ responsibilities
Stage 1: Where a company is insolvent, or bordering on insolvency, or where an insolvent Liquidation or Administration is probable but not inevitable, or else where a transaction would place the company in one of those situations, the Directors must balance the interests of both creditors and shareholders if and when they conflict.
They must do this by applying a ‘sliding scale’. For example, many start-up companies are, by their very nature and their funding structures, insolvent from their inception, so that their Directors should balance the risk to creditors from the outset, giving steadily greater priority to their interests as and when the financial difficulties increase. Similar considerations would apply where a company’s major customer ran into trouble and doubts were developing over a period of time about their ability to settle their debts and if this threatened the company’s survival.
Stage 2 Where an insolvent liquidation or administration is inevitable, the Directors must treat the creditors’ interests as paramount as the shareholders cease to retain any valuable interest in the company. Incidentally, this is also the point at which the Wrongful Trading duty to protect the interests of the creditors is triggered.
The Supreme Court decision
The appeal was unanimously dismissed because the Creditor Interest Duty at AWA had not been triggered at the time that the dividend was paid, based on the facts of the case. AWA’s insolvency had not yet become even probable.
What are the lessons for Directors?
The decision provides welcome clarity on the trigger points after which creditors’ interests must be taken into account, but this will still depend on the facts in each case. Accurately assessing when a company is ‘bordering on’ insolvency will inevitably remain difficult.
Getting shareholder ratification for the payment of a dividend will not protect Directors once the creditor interest duty has been triggered.
The Supreme Court judgment does not address the key point as to what degree of knowledge exposes a Director to liability, nor whether there may be circumstances where the interests of an individual or a class of creditor might have to be taken into account separately from the overall creditor body.
Staying on top of a Company’s affairs
Most importantly of all, Directors are under a general duty to keep themselves informed about their Company’s affairs and especially its finances and solvency. This decision reinforces that duty and emphasises its importance. All Directors should take a cautious approach about when their creditor interest duty may have been triggered. An effective way to do this is to document the background to and reasons for their decisions at all times and seek independent professional advice when in doubt.
If you are affected by financial challenges, Opus is here to help. You can speak to one of our Partners who can discuss options with you. We have offices nationwide and by contacting us on 020 3326 6454, you will be able to get immediate assistance from our Partner-led team.