Companies in financial difficulty – directors' duties to creditors

Subscribe

Two recent court cases have clarified directors’ obligations to creditors when there is a doubt as to whether their company is insolvent.

BTI v Sequana

This case went through to the Supreme Court and a majority confirmed:

• when the directors know or should have known the company is insolvent or bordering on insolvency, there is a duty to consider the interests of creditors;
• where the interests of creditors diverge from those of shareholders:

            - if liquidation is inevitable, creditors' interests 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.

Directors can take some comfort that the Supreme Court has declined to hold that the duty to have regard to creditors' interests is engaged where there is only a risk of insolvency. To do so would have increased the scope for potential personal liabilities, regarding directors, to an earlier time when companies encounter distress but there is only a mere risk of insolvency.

In September 2023, the court applied the Sequana guidance in the context of a liquidator’s claim against a director of a company which was said to be insolvent at the relevant time on the basis of a substantial (disputed) tax liability.

Hunt v Singh 

In this case a tax scheme was entered into. Subsequently HMRC cracked-down on such schemes and there was a landmark tribunal decision in favour of HMRC relating to a very similar scheme. Despite this, the directors continued to pay into the scheme, resulting in payments to directors of more than £50m. The company subsequently went into liquidation and the liquidators brought a claim against the former directors for a breach of creditor duty.

Here, the company was either solvent, if the directors were found to be right on the tax position, or it wasn't if HMRC was right about the tax position. The “real risk” the directors needed to be aware of here was if they and their tax advisers were wrong and the tax liability would be found to be due. This is an example of where the directors would have been expected to employ that fact-sensitive balancing act and give more weight to the interests of creditors.

What can directors take from these judgements?

The insolvency of a company is not a black-and-white matter. Over time there appears to be a sliding scale towards insolvency. Directors must use their judgement as to where their company is positioned on the scale to determine where the balance of competing interests between the company's various stakeholders should lie.

If your company is in financial distress there are steps you can take to demonstrate your duty to creditors:

1. Ensure you have up to date, accurate financial information. This is even more important when a company is in financial distress as having these facts to hand will allow you to make well-informed decisions as to future transactions.
2. Thoroughly document board decisions regarding material transactions. This should include the state of the company’s finances when the discussion takes place, the projected effect of the board’s strategy and the risks/rewards of this action.
3. You must be mindful of payments to creditors, ensuring that no one creditor is preferred over others. There are circumstances where a payment may have to be made, for example, to complete a contract where goods can be sold for a profit, for the benefit of all creditors. Also, it may be important to pay an insurance premium, as without this company assets may be put at risk. The thinking behind these transactions should be documented.

If you do not feel confident regarding the above, it may be wise to engage professional advice. The experience of an Insolvency Practitioner may ensure the survival of the business and the avoidance of an insolvency event. In any event their help ensures that as a director you are showing the correct level of responsibility to creditors which could be a godsend in the future if any transactions are investigated.