The Supreme Court has this month provided guidance on the relationship between statutory directors’ duties and the interests of a company’s creditors.
Under the Companies Act 2006 (CA 2006), company directors must, among other things, act in the way they consider, 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 so doing have regard to a list of relevant factors and stakeholders. This duty is laid out in section 172(1) of the CA 2006.
The list of stakeholders to whom directors must have regard does not expressly include the interests of creditors. However, it is well established that this list is non-exhaustive and the explanatory notes to the CA 2006 recognises the need for modification in the event of insolvency.
In addition, common law principles have established a rule, known to many as the “creditor rule” which requires directors of an insolvent company to have regard to the interests of creditors. This rule was debated at length in particular a case in 1988, West Mercia Safetywear Ltd v Dodd (1988). Subsequent cases to the West Merica case suggested that companies need not be insolvent for the creditor rule to apply, albeit there remains no consensus on exactly when it kicks in.
Because of its uncertainty and lack of codification in the CA 2006, there is much debate on the existence of the creditor rule and how exactly it is to apply if it does. This is the question posed in the recent Supreme Court case, BTI 2014 LLV v Sequana [2022] UKSC 25. Whether there is a common law rule to the effect that, when a company is insolvent or bordering on insolvency, the company's directors must have regard to the interests of its creditors in addition to, or instead of, its members (shareholders); and, if such a rule exists, precisely when it is engaged and its scope and content.
All members of the Supreme Court upheld the existence of the rule, putting to rest any ambiguity of its actuality.
It then went on to discuss some of the parameters around the use of the rule. In handing down its judgement the Court concluded that the interest of creditors should be considered when the directors know, or ought to know, that either:
- The company is insolvent or bordering on insolvency. Lord Briggs used the expression "imminent insolvency", meaning an insolvency which directors know or ought to know is just round the corner and going to happen.
- An insolvent liquidation or administration is probable.
The final question around how much weight directors should give to creditors interests was not however brought to conclusion. Though, in discussions, the court has detailed that a sliding scale was perhaps most appropriate. Allowing the question of paramountcy to be determined on a case-by-case basis depending on the gravity of the company in question’s financial difficulty. As an example, a company insolvent or bordering on insolvency but not faced with an inevitable liquidation or administration may need to consider creditors’ interests and give them appropriate weight but still balance them with member’s interest. Whereas where an insolvent liquidation or administration is inevitable, creditors interests should be paramount.
Whilst this doesn’t put specific parameters around the question, it allows directors to formulate their own fact specific and, importantly, explainable conclusions.
For further information on directors’ duties in general and duties in insolvency please contact our corporate lawyers.