The Creditor Duty: What Directors Need To Know

• Published date: 20 October 2022
• Subject Matter: Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, Corporate and Company Law, Directors and Officers, Insolvency/Bankruptcy, Shareholders
• Law Firm: Gowling WLG
• Author: Ms Jasvir Jootla, Tom Pringle, Julian C. Pallett and Catherine Naylor

On 5 October 2022, the Supreme Court handed down its decision in the case of BTI 2014 LLC v Sequana SA and others¹. This is the first time that the Supreme Court has addressed the questions of whether there is a duty owed to creditor where a company may be at risk of insolvency, and the point at which that duty is triggered.

The decision raises important issues for company directors, with judges at the highest level commenting on their expectations of directors where a company is likely to face distress. We consider these comments and the issues which they now pose in our overview and Q&A below.

Is there a creditor duty?

When does the creditor duty arise?

What is the scope of the creditor duty?

What does the creditor duty mean in practice?

Can members ratify acts of directors committed in breach of the creditor duty?

Can the creditor duty apply to a decision by the directors to pay a lawful dividend?

Does the creditor duty impact on other statutory duties of directors?

Does the creditor duty conflict with statutory provisions on wrongful trading and preferences?

Does the creditor duty conflict with the rules on transactions defrauding creditors?

What should we take away from this judgment?

The creditor duty: an overview

Is there a creditor duty?

The judgment confirms that there are circumstances in which directors would need to consider the interests of the creditors to the company and this was described in the judgment as a "creditor duty". It forms part of the common law duty owed by the directors to the company, but it is not a free standing duty owed direct to creditors.

When does the creditor duty arise?

The creditor duty will be triggered when the directors know, or ought to know, that the company is insolvent or bordering on insolvency or that an insolvent liquidation or administration is probable.

It is worth noting that, although all five judges agreed on the outcome of the decision in Sequana, there are four distinct voices in the judgment that, in places contain some differences in reasoning. This is a case in point as only three of the Lords referenced the knowledge of directors as being part of the trigger.

What was clear however, is that the trigger is not based upon a company being at a "real risk" of insolvency, nor that the company is "likely" at some point in the future to become insolvent on either a cash flow or balance sheet basis. In handing down the judgment, Lord Briggs also commented that "it is not enough that insolvency itself from which the company may well recover is probable".

What is the scope of the creditor duty? The sliding scale

Directors should consider the scope of the creditor duty in the context of three stages of a company's life cycle:

1. Before a company is bordering on insolvency or is insolvent.

No creditor duty.

2. Where a company is insolvent or bordering on insolvency but prior to the time when insolvent liquidation or administration becomes inevitable.

At this point the creditor duty is triggered and directors have a duty to "consider creditors' interests, to give them appropriate weight, and to balance them against shareholders' interests where they may conflict"²

A sliding scale applies so that the interests of creditors assume an ever increasing importance among the company's stakeholders as the likelihood of...