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Directors: When should you consider creditors’ interests?

Amidst the current economic uncertainty, directors of distressed businesses may find themselves having to balance conflicting interests. When acting in good faith and in the best interests of the company facing increasing financial difficulty, at what point do directors have to consider the creditors’ interests against shareholders’ interests? It is a vital point for directors to consider given their personal liability for any breach of their duties.

It had long been established that directors had a duty to consider creditors’ interests prior to a company becoming insolvent, by which point any equity held in the company is nominal in any event. However, caselaw had not provided specific guidance as to when exactly directors had to give due consideration to the interests of creditors of the company.

A recent case decided in late 2022 in the Supreme Court, BTI 2014 LLC v Sequana SA, has helped to provide some guidance to directors facing this issue. In this case, directors had caused a sizeable dividend to be paid to the company’s sole shareholder. The company was solvent at the time and the dividend was paid lawfully given the company had sufficient distributable reserves, although the company had liabilities that gave rise to the potential that it would become insolvent at a later date.

In this instance, the directors had accounted for the liabilities – relating to historic river pollution – but had underestimated their full extent. The company became insolvent nearly 10 years later, and the appellant sought to recover an amount equal to the dividend payment from the directors, alleging that they had breached their duties to the company’s creditors. Whilst the appeal was dismissed, the case provided useful guidance to directors going forwards.

The Court deviated from previous guidance that creditors’ interests be considered when there is a ‘real’ possibility of insolvency, as it considered this too wide a definition. Instead, directors can consider the duties to trigger at two distinct points:

  1. Directors should begin to consider creditors’ interests when they know, or ought to know, that insolvency is probable. The greater the likelihood of insolvency, the greater weight should be attached to creditors’ interests. Inevitably, this creates some ambiguity as to when insolvency becomes ‘probable’.
  2. When insolvency or administration becomes inevitable, creditors’ interests become paramount against shareholders’ interests.

The company had liabilities that gave rise to the potential that it would become insolvent at a later date.

Practically, this means that directors should use a sliding scale, with the more weight attached to creditors interests as the risk of insolvency increases from the point it becomes probable. If you would like further guidance through this process or how to protect your business through uncertain times, contact our restructuring team for more information.

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Disclaimer
This information is for guidance purposes only and should not be regarded as a substitute for taking legal advice. Please refer to the full General Notices on our website.

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