Creditor Duty | Understanding Company Directors’ Responsibilities to Creditors
Company directors are required to act in good faith to promote the success of their company for the benefit of its members as a whole. However, when that company is insolvent or faced with the possibility of insolvency, that obligation may well be superseded by a duty to act within the best interests of the company’s current and future creditors.
Effectively, the obligation shifts a directors decision making from prioritising shareholder interests to creditor interests. This ‘creditor duty’ is intended to prevent directors from acting in a manner which might worsen the company’s financial position and increase liability to its creditors.
Understanding this principle of creditor duty when a company faces challenging circumstances is essential, as it may influence the decisions directors make. Transactions such as obtaining credit, disposing of assets at an undervalue, or giving preferential treatment to other creditors may, if found to be improper, result in directors being held personally liable and even director disqualification proceedings.
This creditor duty is controlled by both Statute and Case Law which Stuart Southall of KANGS explains.
The Relevant Statutory Law
S.172 of The Companies Act 2006 provides that:
A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to the:
- likely consequences of any decision in the long term,
- interests of the company's employees,
- need to foster the company's business relationships with suppliers, customers and others,
- impact of the company's operations on the community and the environment,
- desirability of the company maintaining a reputation for high standards of business conduct, and
- need to act fairly as between members of the company.
This duty has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.
S.214 of The Insolvency Act 1986 provides that:
Where a person, who is or has been a director of a company which:
- has gone into insolvent liquidation and
- at some time before the commencement of the winding up proceedings that person knew or ought to have concluded that there was no reasonable prospect of avoiding such proceedings
the court, on the application of the liquidator, may declare that that person is to be liable to make such contribution (if any) to the company’s assets as the court thinks proper.
However, the court may not make a declaration if it is satisfied that that person took every step with a view to minimising the potential loss to the company’s creditors.
Relevant Case Law | BTI 2014 LLC v Sequana Sa & Others [2022] UKSC 25
In a strongly contested dispute between BTI 2014 LLC v Sequana Sa & Others, that reached the Supreme Court, produced an extensive Judgment which included considerations as to:
- the very existence of any rule of law requiring directors to consider the interests of creditors[CP1.1], given the duty to promote the success of the company as required by s.172 of the Companies Act 2006.
- the point at which the engagement of the interests of creditors becomes prevalent.
In the Judgment, the Supreme Court determined, amongst other issues that:
- the success duty, being a director’s duty to act in the interests of the company under section 172 of the Companies Act 2006 might, in some circumstances, include the interests of creditors,
- creditor duty is not a self-standing duty owed to creditors, but merely one aspect of a director’s fiduciary success duty,
- it is at the point that the company enters insolvent liquidation that creditors gain the main economic stake in the company. However, it is the likelihood of such liquidation, that justifies the existence of a common law duty to consider creditor interests at that earlier stage,
- if the directors are able to evidence that they had reason to believe the insolvency would be temporary, described as there being a belief that there is a ‘light at the end of the tunnel’, then they would still be required to consider the interests of the creditors, but would have to balance them against the interests of the shareholders.
Accordingly:
- there is a duty to consider the interests of creditors once a company becomes financially distressed, bordering on insolvency,
- at the point that insolvent liquidation or administration becomes unavoidable, the interests of creditors become paramount,
- directors ought to know and understand the company’s financial situation. If they claim not to be aware of its insolvency, in order to avoid personal liability, it is for them to show why they should be excused.
Balancing Creditors’ and Shareholders’ Interests
Managing a company’s financial affairs can become challenging in certain circumstances, for example, a significant debtor ceases to trade, creating uncertainty as to whether the outstanding debt can be recovered to support continued trading, or whether insolvency proceedings should be considered.
As the case above demonstrates, the court showed that a company’s economic interests may be taken into account when conducting a balancing exercise between shareholders’ and creditors’ competing interests.
Each scenario will create its own uncertainties, and the directors’ subjective judgement is important. However, it is essential that directors act in good faith and not adopt a reckless path. If such a course leads to failure and increases liabilities to creditors, is quite likely that the directors concerned may face personal liability for all or part of the company’s debts.
How Can We Assist You?
The insolvency of a company can be an extremely challenging and stressful experience for everyone involved. During this critical period, swift and decisive action is often required, such as exploring opportunities to rescue the business or to ensure that as a director, you act in accordance with the company's constitution and legal obligations.
At KANGS, we understand the pressures that insolvency can place on directors and businesses. Having successfully guided clients through countless insolvency matters, our insolvency solicitors are experienced in acting against Insolvency Practitioners and the Insolvency Service on behalf of company directors.
If you become the subject of an Insolvency Service investigation, asked to attend an interview or if you have concerns about your creditor duty, our team is here to help.
Our solicitors provide immediate support, strategic advice and practical solutions to company directors facing insolvency proceedings, director disqualification and authority investigations. Contact us using the details below:
Tel: 0333 370 4333
Email: info@kangssolicitors.co.uk
We provide initial no obligation discussion at our three offices in London, Birmingham, and Manchester. Alternatively, discussions can be held through video conferencing or telephone.
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