Ben Gold, partner in RPC’s professional and financial risk team, explains how a recent Supreme Court case (BTI v Sequana) confirms company directors owe a duty to creditors if the company nears balance sheet or cash flow insolvency.
This ‘creditor duty’ is of increasing significance as insolvencies rise.
On latest government figures, there were 22,109 registered insolvencies in 2022, the highest number since 2009 and 57% higher than in 2021.
The overarching duty on directors is to act “in the way [the director] considers, in good faith, would be most likely to promote the success of the company for the benefit of its [shareholders]…” (section 172(1), Companies Act 2006). This imports a duty to creditors in certain circumstances. As with directors’ duties generally, the duty is owed only to the company. Only the company (or a liquidator or administrator or an assignee) can sue for breach, not individual creditors.
The creditor duty is engaged either when the company is insolvent or insolvency is imminent, or when insolvent liquidation or administration is probable. A company can be actually or imminently insolvent, but still have good prospects of trading out, hence why the test has two limbs. A majority of the Supreme Court held that the creditor duty would not be triggered, unless the directors knew, or ought to have known, of the insolvency position.
Ominously, the minority did not rule out the duty being engaged, even when the directors did not know and reasonably could not have known of the insolvency position.
When there is actual or imminent insolvency:
- Directors must consider the interests of creditors, and (if they conflict) attempt to balance them against the interests of shareholders. Moreover, the duty is to strike the right balance between these potential competing interests, of the company’s shareholders and creditors.
- The greater the company’s financial difficulties, the more the directors should prioritise the interests of the creditors over those of the shareholders.
- If the directors do not consider the interests of the creditors at all, they will automatically be in breach of duty. This is illustrated by a number of judgments, that have already been handed down since BTI vs Sequana finding directors liable.
- If the directors do consider creditors’ interests and attempt the balancing exercise (with shareholders’ interests) in good faith, but objectively get it clearly wrong, this would be a breach of the creditor duty. It is of concern that this appears to broaden the overarching director duty, from a good faith duty into a reasonable care duty, when the creditors’ interests are to be taken into account in decision making. Previously that was not, or was not clearly, the law.
When insolvent liquidation or administration is probable, the position is even more onerous for directors:
- The interests of creditors then become paramount. The shareholders’ interests are no longer to be recognised or promoted.
- Failing to consider creditors’ interests, and/or having any regard to the interests of shareholders, will be a breach of the duty.
- By analogy with ‘wrongful trading’ (under section 214, Insolvency Act 1986), to avoid breach, the directors must take every reasonable step with a view to minimising the potential loss to the company’s creditors, seemingly even if the company in fact avoids being wound up. This appears, again, to be a development in the law.
- Although in the minority, one of the judges stated that this heightened duty to creditors should apply even when an actual insolvency procedure was not probable, provided the company was either actually insolvent or insolvency was imminent.
Since the Supreme Court’s decision, three High Court cases (all in 2023) have succeeded against directors, for breach of the creditor duty, illustrating how BTI vs Sequana may well cause an increase of claims against directors.
The Supreme Court will likely be looking at the creditor duty again, in the near future. The D&O market should closely monitor developments.
This article was first published in Insurance Post.