A Director’s Duty


Author: Tom Bolam, Joshua Bennett


Tom Bolam, Senior Associate, Fladgate LLP (tbolam@fladgate.com)

Joshua Bennett, Trainee Solicitor, Fladgate LLP (jbennett@fladgate.com)


 

When a company is solvent, the primary duty imposed on directors is to promote the success of the company for the benefit of its shareholders.  This duty is codified at section 172(1) of the Companies Act 2006. However, that position changes when a company is insolvent, or close to insolvency.

In that latter instance, directors must take note of section 172(3) of the Act and consider the interests of creditors of the company. Those interests may diverge from the interests of shareholders.

So, for example, while it may be in the interests of the shareholders of a failing company to take on a risky, but potentially profitable, contract, if the risky contract will potentially increase the amount owing to creditors, a director will have to carefully consider to whom they owe their primary duty: shareholders or creditors?

The recent Court of Appeal decision in BTI 2014 LLC v. Sequana SA & Ors[1], considered when the duty on directors to consider the interests of creditors, as opposed to shareholders, is engaged.

The Court of Appeal considered the jurisprudence on this question, which established that:

  • the duty imposed on directors to consider the interests of creditors is engaged short of actual insolvency;
  • the imminence of insolvency in temporal terms is not determinative as to whether the duty to consider the interests of creditors is engaged; and
  • there is no binding authority on the question of precisely when, short of actual insolvency, the duty on directors to consider the interests of creditors is engaged
  • the answer to the questions is, “a difficult amalgam of principle, policy, precedent and pragmatism”.

The Court of Appeal held that directors are under a duty to consider the interests of creditors at the point in time when they knew or should have known that the company was or was likely to become insolvent.  ‘Likely’ in this context meant ‘probable’.

The question of whether a company is likely to become insolvent is often unclear. The answer may depend on the outcome of events which are impossible to predict with any certainty. This can place company directors in an invidious position. The sensible course for directors in this position is to take expert advice and to be logical in their decision making processes. In particular, directors must consider the likely consequences of their decisions, in particular: will those decisions increase the amount owed to creditors?

If a company director is advised by an expert professional that insolvency is not likely, they should be entitled to rely on that advice, even if it was mistaken. If the same director forms their own, erroneous conclusion as to the likelihood of insolvency, they expose themselves to personal liability if they increase the company’s indebtedness to creditors and the company later becomes insolvent.


[1] [2019] EWCA Civ 112


 

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