Do company directors owe duties to the company’s creditors?

By Alex Tharby

16 December 2022

Company directors owe duties to the company but do they owe duties to creditors? What if the company is close to insolvency? In October 2022, in BTI 2014 LLC v Sequana SA [2022] UKSC 25; [2022] 3 WLR 709 (BTI), the Supreme Court of the United Kingdom had cause to consider these questions.

The Court considered the inaptly described ‘creditor duty’: whether directors in the discharge of their duty to a company must consider the interests of creditors. This was a ‘momentous’ first opportunity for the United Kingdom’s highest court to consider this question.

In doing so, the Court held that:

1. a director’s duty to act in the best interests of the company may include an obligation to consider the interests of creditors as a whole (but not necessarily particular creditors);
2. this requirement applies when a company is ‘insolvent’, ‘bordering on insolvency’ or ‘financially distressed’, or when insolvency is ‘probable’ or ‘imminent’;
3. if the creditor duty is engaged, the relative strength or weakness of the company’s financial position will influence the degree of consideration to be given to creditors’ interests.

This case supports the generally accepted view in Australia and, if Australian courts are called upon to determine whether the ‘creditor duty’ exists, is likely to be followed.

This article reviews the BTI decision and considers its likely effect on directors’ duties in Australia.

The facts behind the BTI decision

In 2009, the directors of a company called AWA declared a dividend of €135 million to its sole shareholder, Sequana, which had the effect of reducing a debt owed by Sequana to AWA. The dividend was lawful and AWA was solvent on both a balance sheet test and a cash flow test. However, AWA held an insurance portfolio of uncertain value and had significant long-term contingent liabilities. There was an appreciable risk that AWA might become insolvent in the future, but this was not imminent or probable.

Approximately nine and a half years later, AWA went into administration and its assignee, BTI sought to recover the dividend from AWA’s directors, alleging a breach of a duty to the company to consider creditors’ interests.

The England and Wales High Court and the Court of Appeal each dismissed BTI’s claim on the basis that the so-called ‘creditor duty’, if it arose, only arose when the company was close to insolvency. This was not the case when the dividend was declared and so there was no breach of any such duty.

The decision of the UK Supreme Court

In summary, each of their Lordships and her Ladyship held that the interests of creditors must be taken into account by company directors when considering whether they are acting in the interests of the company.

If the company is financially healthy and solvent, then the directors will not need to give consideration to the interests of creditors when making decisions on behalf of the company (unless a contemplated transaction itself would financially imperil the company).

On the other hand, the Court found, where a company is bordering on insolvency the company’s directors will need to give due consideration to the interests of creditors when considering whether they are acting in the interests of the company. The closer the company is to insolvency, the greater the need to consider the interests of creditors in the discharge of the director’s duty to the company.

The consideration to be given to creditors’ interests

Lord Reed gave the following explanation of the consideration to be given to creditors’ interests at [11]:

In summary, I reject the contention, raised in some of the authorities, that there is a “creditor duty” distinct from the directors’ fiduciary duty to act in the interests of the company … The duty remains the director’s duty to act in good faith in the interests of the company. The effect of the rule is to require the directors to consider the interests of creditors along with those of members. The weight to be given to [creditors’] interests, insofar as they may conflict with those of the members, will increase as the company’s financial problems become increasingly serious. Where insolvent liquidation or administration is inevitable, the interests of the members cease to bear any weight, and the rule consequently requires the company’s interests to be treated as equivalent to the interests of its creditors as a whole.

Lord Hodge put it this way (at [207]):

When a company is insolvent or bordering on insolvency its creditors are recognised as having a form of stakeholding in the company, and its directors from that point must have a proper regard to the interests of the company’s creditors as a body.

Lord Briggs (with whom Lord Kitchin agreed) explained the relationship between the company’s financial position and the degree of consideration to be given to the interests of creditors at [176]:

This is likely to be a fact sensitive question. Much will depend upon the brightness or otherwise of the light at the end of the tunnel; i.e. upon what the directors reasonably regard as the degree of likelihood that a proposed course of action will lead the company away from threatened insolvency, or back out of actual insolvency. It may well depend upon a realistic appreciation of who, as between creditors and shareholders, then have the most skin in the game: i.e. who risks the greatest damage if the proposed course of action does not succeed.

Lady Arden would have gone further. Her Ladyship imposed a requirement to consider creditors’ interests but would have also required directors to “not materially harm them either (and this protects creditors against “insolvency-deepening” activity)” (at [250]), but was the sole member of the Court to propose this.

All members of the Court held that once a company was insolvent, the directors would have to give the interests of creditors paramount consideration in the discharge of their duties to the company.

The rationale for the requirement to consider creditors’ interests

Lord Hodge persuasively explains one rationale for this shift in focus of the director’s duty to the company at [238], recognising that acting in the interests of shareholders of a near-insolvent company might involve the directors taking ‘a last roll of the die’ on a risky transaction if the alternative was formal insolvency from which shareholders would derive nothing:

A requirement that the directors consider and, if the facts of the particular case require it, give priority to the interests of the company’s creditors in their decision-making in such circumstances appears to be a necessary constraint on the directors.

Similarly, Lord Briggs justified the imposition of a requirement to consider creditors’ interests in the director’s discharge of duties to the company at [148] as follows:

When it is borne in mind that, once liquidation is inevitable, the directors face personal liability … if they do not treat minimising loss to creditors as their paramount responsibility, the prospect that creditors may eventually attain the status of paramount stakeholders in a statutory liquidation process once the company is exposed to liquidation by insolvency seems to me to be a very sensible justification for the existence of a common law duty to the company at least to consider creditors’ interests at that (usually earlier) stage.

Lord Reed at [12] explained that

the company’s creditors have an economic interest in the company, based upon their entitlement to be paid the debts owed to them, ultimately enforceable against the proceeds of realisation of the company’s assets, which is distinct from the interests of its members and requires separate consideration.

At what point do directors have to consider creditors’ interests?

The UK Supreme Court gave varying though overlapping descriptions to the point at which the requirement for directors to consider creditors’ interests will apply.

Lord Reed at [12] identified the point at which the ‘creditor duty’ arises in these terms:

when the company is insolvent or bordering on insolvency, or where an insolvent liquidation or administration is probable, or where the transaction in question would place the company in one of those situations.

Lord Briggs gave a similar explanation at [203] and gave some explication of how ‘probable’ insolvency might need to be in order to engage the ‘creditor duty’:

I would prefer a formulation in which either imminent insolvency (ie an insolvency which directors know or ought to know is just round the corner and going to happen) or the probability of an insolvent liquidation (or administration) about which the directors know or ought to know, are sufficient triggers for the engagement of the creditor duty. It will not be in every or even most cases when directors know or ought to know of a probability of an insolvent liquidation, earlier than when the company is already insolvent. But that additional probability-based trigger may be needed in cases where the probabilities about what lies at the end of the tunnel are there for directors to see even before the tunnel of insolvency is entered.

Lady Arden also introduced the concept of ‘financial distress’ at [250]:

[T]his Court should now approve the rule of law that requires directors of financially distressed companies to consider, as one of the relevant factors, the interests of creditors.

In setting these limits, the Court declined to require directors to consider the interests of creditors when there is a ‘real’ risk of insolvency as the appropriate ‘trigger’ for the engagement of the creditor duty as this would be setting the bar too high for directors. Lord Briggs at [191] described this as an unsound principle which

assumes that creditors of a limited company are always among its stakeholders, so that once the security of their stake in the company (ie their expectation of being repaid in full) is seen to be at real risk, there arises a duty of the directors to protect them.

The outcome of the BTI case

In summary, the UK Supreme Court found that the ‘creditor duty’ exists and will apply when the company is, or as a result of a transaction would be:

1. insolvent;
2. bordering on insolvency;
3. ‘imminently’ or ‘probably’ about to become insolvent; or
4. financially distressed.

However, directors do not need to consider the interests of creditors just because there is a real and not remote risk (i.e. the company might be at risk) of insolvency.

On the facts of BTI, the UK Supreme Court unanimously dismissed BTI’s appeal. When AWA declared the €135 million dividend to Sequana there was a real risk of insolvency given AWA’s uncertain asset value and long-term contingent liabilities, however AWA was not close to insolvency. The ‘creditor duty’ did not arise and therefore AWA’s directors did not breach their duties owed to AWA in declaring the dividend.

So, what does this mean for Australian company directors?

The generally understood position in Australia has been that:

1. directors owe a duty to the company, and not to shareholders or creditors;¹
2. directors owe a duty (not) to act (other than) in good faith in the interests of and for the benefit of the company as a whole;
3. directors of a company in discharging their duty to the company must consider the interests of its shareholders and its creditors;²
4. if a company’s financial position is precarious, the interests of the creditors may become the dominant factor in what constitutes the ‘benefit of the company as a whole’;³ and
5. the director’s duty to the company as a whole extends in an insolvency context to not prejudicing the interests of creditors.

While these propositions may be accepted, they have not been conclusively settled by an appellate court in Australia. Evidently, the Australian position is very similar to the approach adopted in BTI. The speeches in BTI in fact refer to and rely upon various Australian decisions, including some of those referred to in this article. However, a decision of the UK Supreme Court represents the law of the United Kingdom. Such a decision is not binding on Australian courts but is highly persuasive. As the High Court of Australia described in Cook v Cook (1986) 162 CLR 376 at 390:

The history of this country and of the common law makes it inevitable and desirable that the courts of this country will continue to obtain assistance and guidance from the learning and reasoning of United Kingdom courts just as Australian courts benefit from the learning and reasoning of other great common law courts.

Leeming JA (writing extra-judicially) helpfully observes that “one aspect of assessing [a foreign case’s] persuasive value turns on the extent to which the foreign law has diverged from the Australian law”⁴, which assists to assess whether BTI is likely to be followed here.

There is a significant degree of comity in principles of company law between the jurisdictions, particularly in relation to directors’ duties and insolvency, and Australian courts generally regard company law decisions by courts in the United Kingdom as persuasive. Accordingly, BTI is likely to be highly persuasive to lower, intermediate and appellate level courts in Australia.

When the ‘creditor duty’ inevitably rises for consideration in Australia, BTI will likely be followed.

Special thanks to my colleague, Laura Cohn for her valuable assistance in preparing this article.

1. Percival v Wright [1902] 2 Ch 421; Crawley v Short (2009) 76 ACSR 286 at 289.
2. Walker v Wimbourne (1976) 137 CLR 1 at 6-7 (Mason J)
3. Kinsela v Russell Kinsela Pty Ltd (in liq) (1986) 4 NSWLR 722 at 732; Vrisakis v Australian Securities Commission (1993) 9 WAR 395 at 450 (Malcolm CJ).
4. Mark Leeming, ‘Equity in Australia and the United Kingdom: dissonance and concordance’ (Institute of European and Comparative Law, Oxford Law Faculty, 25 October 2019) 2 <https://www.supremecourt.justice.nsw.gov.au/Documents/Publications/Speeches/2019%20Speeches/Leeming_20191025.pdf>.

Disclaimer: The information published in this article is of a general nature and should not be construed as legal advice. Whilst we aim to provide timely, relevant and accurate information, the law may change and circumstances may differ. You should not therefore act in reliance on it without first obtaining specific legal advice.