Directors duty to consider creditors interests on the road to insolvency

On 5 October 2022, the UK Supreme Court handed down its decision in BTI 2014 LLC v Sequana SA [2022] UKSC 25. Whilst this decision is not binding in Jersey, it will nevertheless be highly persuasive given the similarities of Jersey’s companies law.

They key question the court had to grapple with was:

1. Does the duty to act in the best interests of a company require directors to consider and act in the interests of creditors rather than shareholders, only when the company becomes insolvent or even before insolvency?
2. If the duty arises before insolvency arises, at what point does this duty arise; is it when a company approaches insolvency or when there is a real risk of insolvency

A director’s fiduciary duty to act in good faith in the interests of a company is owed to the company as a whole and not to its shareholders individually.

There is earlier English law (West Mercia Safetywear Limited (in liquidation) v Dodd [1988] BCLC 250 (which has been cited before the Royal Court in Nigel John Halls (Liquidator of Chiltmead Limited) v Stewart and Stewart [1991]JRC 093)) that accepted that once a company is insolvent, the interests of creditors override the shareholders as the creditors effectively become the real stakeholders of the company, entitled to the company’s assets on its winding up, whereas the shareholders no longer have an economic interest in the company. It was noted that even though creditors already have an economic interest in the company indebted to them, the significance of that interest grows when a company enters insolvency or is likely to become insolvent, and the directors duty to consider those interests grows accordingly. However it is important to note that this decision did not confirm that this duty existed but simply recognised that at the point of insolvency the company’s best interests meant the interests of the creditors.

Decision

The Supreme Court unanimously affirmed that directors do have a duty to consider the interests of creditors.

It held that the duty is engaged when the directors know or ought to know that the company is insolvent or bordering on insolvency or that a form of formal insolvency proceedings is probable. It does not apply when there is only a risk of insolvency.

It explained that where the interests of creditors are engaged and diverge from the shareholders:

• If formal insolvency proceedings are inevitable, the interests of the creditors are paramount; and
• Prior to that, there will be a fact-sensitive balancing exercise to weigh up the competing interests by reference to the degree of distress.

Comment

This decision is likely to mean little practical change for boards of stressed businesses already following existing best practice, namely:

• Properly documenting board decision-making around material transactions even before the creditor duty is engaged (albeit taking care not to inadvertently overstate the proximity of insolvency);
• Closely monitoring the financial position of the company to ensure directors are positioned to respond to periods of turbulence and adapt to changing (and competing) shareholder demands;
• Engaging professional advice sooner rather than later; the right advice may help to avert a distress scenario from ever arising (or from worsening), but failing that, as Jersey’s company law provides statutory relief for directors who have acted honestly and reasonably in the circumstances, evidence of reliance upon independent advice could make all the difference.
• Whilst shareholders cannot ratify the decisions of directors once the creditor duty is engaged, it is available before that, so in cases of uncertainty it may be better to err on the side of caution.
• Directors should ensure that appropriate insurance cover is in place and premium payments kept up to date; after all litigation can become very expensive and personal liability significant and the right insurance policy may help to limit that potential exposure.