Directors' duties: when to take account of creditors

The courts have recently taken a look at the question of when company directors need to take into account the interests of the company’s creditors as well as the members.

The law:

Directors owe statutory duties to the company.  In particular, section 172 Companies Act 2006 requires them to promote the interests of the company for the benefit of its members as a whole.  This duty is expressed to be subject to the common law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.

What circumstances might cause creditors’ interests to have priority over those of members?

In BTI 2014 LLC v Sequana SA [2016] EWHC 1686 (Ch) the company had an obligation under indemnity arrangements to pay the costs of a US environmental clean-up operation.  The directors had made a provision in the accounts to reflect their best estimate of that liability.  When the company reduced its share capital and subsequently paid dividends, their actions were challenged in court on a number of grounds.  One of the grounds relied on was that the actions were in breach of their duties, since they ought to have taken account of the interests of creditors as well as members.     

Did the existence of a large provision in respect of an unknown liability trigger the duty to take account of creditors’ interests?  The court said no.  The judge summarised the essence of the test as being that, while directors should always have an eye to possible insolvency, here there was a real possibility that the company would never become insolvent or even close to it.  The judge continued:

“It cannot be right that whenever a company has on its balance sheet a provision in respect of a long term liability which might turn out to be larger than the provision made, the creditors’ interests duty applies for the whole period during which there is a risk that there will be insufficient assets to meet that liability…..To hold that the creditors’ interests duty arises in a situation where the directors make proper provision for a liability in the company’s accounts but where there is a real risk that the provision will turn out to be inadequate would be a significant lowering of the threshold….”

This approach was refined in a subsequent case, Dickinson v NAL Realisations (Staffordshire) Ltd [2017] EWHC 28 (Ch) In Dickinson, the company was under threat from the risk of environmental claims being made against it, and the managing director and controlling shareholder initiated transactions, such as a buyback of shares and sale of a subsidiary, that extracted £2.5 million of net assets from the company and were alleged to have been motivated by a desire to place the company’s assets beyond the reach of creditors.  The court held that, while the transactions were successfully attacked on other grounds as undervalue transactions or made without proper authority, they were not made in breach of directors’ duties.  The fact that there was a recognised risk of adverse events such as the environmental claim that might result in a large liability and lead to insolvency did not mean that the creditors’ interests took priority over those of members. 

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Lucy Walker, Tim Carter

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