Directors’ Duties In Respect Of Creditors When Insolvency Looms


Directors will need to monitor their company’s financial position more closely, following a recent decision of the Supreme Court.

To paraphrase section 214 of the Insolvency Act 1986 relating to wrongful trading, the court may require a contribution to be made to the funds of an insolvent company by a director who, when he ought to have known that the company could not avoid insolvent liquidation, failed to take every reasonable step to minimise the potential loss to creditors.

Further, to paraphrase section 239 of the same Act relating to preferences, the court may require a contribution to be made or a repayment where, within six months prior to the start of insolvency proceedings, at a time when the company had been unable to pay its debts, funds or assets were transferred by a director out of the company with the intention of preferring the recipient over the general class of creditors.

In addition to the statutory provisions referred to above, the Supreme Court has recently decided that the common law fiduciary duty which is owed by directors to their companies, essentially requiring directors to act in good faith in the interests of the company as a whole, can extend beyond considering the interests of shareholders, so as to become a duty to consider the interests of the creditors as a whole (referred in this note as ‘the creditor duty’).  

In summary, the duty is to refrain from harming creditors’ interests. The more perilous the financial position, the more onerous the creditor duty becomes.  If the creditor duty is breached, the court may, on the application of the company, require the director personally to make good the loss arising.

The type of situation covered by the creditor duty which is not already covered by sections 214 and 239 might typically involve a director of a company which is bordering on insolvency entering into a risky transaction as ‘a last roll of the dice’.  The shareholders might have little to lose from such a course, but creditors could be severely prejudiced economically.

The creditor duty has only recently become established and its parameters are still being developed.  The Supreme Court’s decision is therefore of considerable importance to directors and their D&O Insurers.

The facts

In May 2009, AWA distributed a dividend of €135m to its only shareholder, Sequana SA, thereby discharging some intra-group liability. This payment was lawful in that it complied with the regulations governing dividends contained in Part 23 of the Companies Act 2006 and with rules relating to capital maintenance.  AWA was at the time unquestionably solvent on both a balance sheet and a cash flow basis.

However, AWA had long term pollution-related contingent liabilities of a very uncertain amount.  The company had made provision for these in its accounts albeit that there was uncertainty as to the value of one class of its assets (insurance).  This gave rise to a real risk, although not a probability, that AWA might become insolvent at an uncertain but not imminent date in the future.

Subsequently, BTI 2014 LLC, as assignee of AWA, brought proceedings claiming that the directors who had authorised the dividend had acted in breach of their duty to have regard to the interests of AWA’s creditors.

Finally in 2018, some nine years after the dividend was paid, AWA entered insolvent administration. 

The decision

BTI’s case was that the creditor duty had arisen by the date of the dividend distribution because by then there was a real and not remote risk that AWA may in the future become insolvent. 

However, the Supreme Court found in favour of the directors and held that, by the date of the distribution, the creditor duty had not yet arisen.   

In order to reach their decision, the judges of the Supreme Court considered the justification for the creditor duty and made provisional findings as to what it consists of and when it arises.  Their findings are summarised as follows.

Position prior to insolvent liquidation being probable – It is to be noted that liability for wrongful trading under section 214 only arises when there is a subsequent insolvent liquidation. The rationale for this restriction be may that creditors are not the main stakeholders at any earlier stage than when the company enters insolvent liquidation.  It is the prospect of insolvent liquidation, in which creditors will have an economic interest in the sense of a right to receive a distribution of the assets of the insolvent estate,  that entitles creditors to have their interests considered earlier, when liquidation appears likely. 

Prior to insolvent liquidation appearing likely and as the present case illustrates, there may be a lengthy period and a major difference between a company being subject to a real risk of insolvency on the one hand, and probable or imminent insolvent liquidation on the other. Insolvency may be temporary and there may genuinely be light at the end of the tunnel. For example, many start-up companies may be in this position.  Applying these and other considerations,  the Court held that the existence of a real risk of insolvency is too far removed from the liquidation process to give rise to the creditor duty. 

Position when insolvent liquidation is probable, albeit the situation is not necessarily irretrievable – The content of the creditor duty at this stage is to consider creditors’ interests, to give these appropriate weight, and to balance the creditors’ interests against shareholders’ interests where they may conflict.  The evaluation thus undertaken is likely to be highly fact-sensitive.

As to when the creditor duty arises, a majority of the Court considered that this would be either on ‘imminent’ insolvency (i.e. an insolvency which directors know or ought to know is just round the corner and going to happen) or when there is the ‘probability’ of an insolvent liquidation ‘about which the directors know or ought to know’. Another formulation is when the company is ‘bordering on insolvency’.  There are also different ways of  defining  the term ‘insolvency’ itself, as the case may require. 

Position where insolvent liquidation is inevitable – Here the economic interest lies with the creditors.  The interests of shareholders cease to carry any weight and the company’s interests have to be treated as equivalent to the interests of its creditors as a whole.   That gives rise to the duty to treat the interests of creditors as paramount. 

Limits on the principle of ratification – Shareholders have the power to authorise or ratify acts committed by directors in breach of their duties as long as these are within the powers of the company.  However, the Court held that this principle applies only to solvent companies.

Lovetts’ Comment

This case is helpful in clarifying numerous aspects of the creditor duty.  However, there may be some difficult judgment calls for directors in determining when a company is ‘bordering on insolvency’ or when insolvent liquidation is ‘imminent’ or ‘probable’ and therefore when directors become subject to the creditor duty.  Directors will need to monitor their company’s financial position  and prospects with care, take professional advice when necessary and make a careful record of their assumptions and decisions.

For further information, please contact Wendy Miles, Chris Earl or William Sturge at Lovetts.

20 January 2023