When does a director owe a primary duty to creditors?

Frank Bouette

Frank Bouette


The Supreme Court recently confirmed when a director’s duty to creditors comes into effect, if their company is in the ‘twilight’ zone of potential insolvency.  The ruling Sequana confirmed that the Court will adopt a commercial approach:
  • When a company is insolvent, or bordering on insolvency, a director’s duty to act in the interests of the company, includes the interests of its creditors. A mere risk of insolvency does not trigger this duty, it must be insolvent or bordering on it;
  • When the duty arises, a director should balance the interests of creditors against those of shareholders on a sliding scale - the greater the financial difficulties the more weight should be given to creditor interests.  This may well “…depend upon the brightness or otherwise of the light at the end of the tunnel”;
  • Where insolvent liquidation or administration is inevitable, creditor interests become paramount, because shareholders cease to retain any valuable economic interest;
  • Where the duty arises, shareholders cannot ratify a transaction in breach of it.  The duty applies when directors are considering the payment of a dividend, even if the relevant accounts demonstrate sufficient distributable reserves; and
  • The interests of creditors for the purpose of this duty are those of creditors as a general body, not particular creditors in a special position.

This decision is welcome news to boards that the Court will be commercial, which allows directors a degree of pragmatic latitude based on the realities of their actual situation.  It means directors must consider creditor interests from the point at which the company is bordering on insolvency, but not merely because it is at a risk of insolvency at some time in the future. 

Directors no longer find themselves forced to instigate an insolvency process when they can reasonably demonstrate that there is a realistic light at the end of the tunnel.  However, they must still monitor the position carefully – the precise tipping is difficult to pin-point.  Real time financial information, regular monitoring of it and proper records of decisions (including professional advice on and the rationale for them) are essential to ensuring directors protect themselves; and to ensure they quickly identify when the balance shifts and duty is triggered.  

In the current climate there is likely to be a push by shareholders for companies to declare and pay out dividends as soon as possible, to maximise cash to shareholders. Directors must not assume that just because there are sufficient distributable reserves shown in the relevant account to allow this, that they are automatically safe to do so – remember that in some cases those accounts may be months old.  Care should be taken to assess the position of the company at the actual time the dividend is proposed and ensure the company is neither insolvent, nor bordering on insolvency.  If it is, care should be taken to appropriately balance the interests of shareholders (i.e., paying the cash dividend out) against the interests of creditors (keeping the cash in the company to pay them).

From a lender’s perspective, this does mean their protection as a creditor is watered down slightly where a company is in financial difficulty, but insolvency is not inevitable – as their interests will not automatically take precedence to shareholders.  The Court recognised that the purpose of limited liability is “to encourage risk taking as an essential part of commercial enterprise”; and stated that creditors are broadly expected to be the “guardians of their own interests”.

However, reminding directors of the duty – and the fact it is a sliding scale that can change quickly – is a useful tool to lenders faced with borrowers who are facing financial distress; and who aren’t fully engaging and / or are trying to extract cash to shareholders.  A reminder of the duty, and the speed with which that tipping point can occur, may be enough to bring them to the table. 

If you require practical advice, please feel free to contact us. 

[1] BTI 2014 LLC v Sequana S.A. and others [2022] UKSC 25

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