Crystal Ball Not Required

Company directors owe several fiduciary duties, one of which is to act in the best interest of shareholders. But to what extent does that duty to shareholders apply in the context of the financial health of the company? The award-winning commercial and litigation lawyers at ParrisWhittaker are experienced in advising company directors on their duties, including where there are concerns around the lawfulness of paying dividends.

The Company Law Act 2006 in England and Wales preserves the common law duty of directors to have regard to the interests of creditors – a duty also imposed by company law in The Bahamas. A significant ruling from the Supreme Court, the highest court in the UK, has provided important clarification on the limited nature of this duty. Directors will welcome the ruling, which has important persuasive authority on the courts here in The Bahamas.

What’s the background?

In 2009, the directors of a company facilitated payment of a €135m dividend to the sole shareholder (a company), with the result that the shareholder’s debt to the company was virtually wiped out. The company was solvent at the time, nor was insolvency imminent or probable.

However, circumstances prevailed which meant that there was a real risk the company could later become insolvent. The company eventually went into administration in 2018 and the assignee of the company’s claims issued proceedings to recover the amount of the dividend paid almost a decade earlier. 

At issue for the court were matters around what’s known as directors’ ‘creditor duty’ – to consider or to act in accordance with the interests of the company’s creditors when the company becomes insolvent or is at real risk of insolvency.  

The assignees argued that the company had breached the creditor duty in making the dividend, as the directors had failed to consider or act in the creditors’ interests. The Supreme Court (SC) and the lower courts all rejected the claim. 

The SC upheld the appeal judges’ ruling that it was not until a company is insolvent or likely to become insolvent that the creditor duty arises. Therefore, the duty had not arisen at the time the dividend was made.

The judges clarified that directors’ duties are owed to the company as a whole so, for example, the creditor duty is not a free-standing duty owed to creditors. While creditors always have an economic interest in the company’s assets, the importance of that interest increases where the company is insolvent or nearing insolvency (including when the directors ought to have known this). 

Once the company is insolvent (or insolvency is probable), the creditor duty is paramount and creditors’ interests are to be prioritised.  But that duty had not been engaged here.

What does this mean?

It is important that directors understand the nature and extent of the creditor duty. But it’s reassuring that this ruling clarifies that directors are not required to prioritise creditors’ interests at all times – only from the point that the company is insolvent or is approaching insolvency.

1BTI 2014 LLC v Sequana SA [2022] UKSC 25

Click here to view the original post.