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Directors' Duties to Consider Creditors' Interests - Landmark Supreme Court Ruling

The primary duty of directors is to promote the success of the companies they serve for the benefit of their shareholders – but do they also owe a duty to creditors? The Supreme Court's answer to that question is bound to herald a sea change in the boardrooms of financially troubled companies.

The directors of a company caused it to distribute a dividend of 135 million euros to its only shareholder. The company entered insolvent administration almost 10 years later. An assignee of the company's rights later sought to recover the full amount of the dividend from the directors on the basis that they had acted in breach of their duty to consider the interests of the company's creditors. The assignee's claim was rejected by both the High Court and the Court of Appeal.

Ruling on the assignee's challenge to that outcome, the Supreme Court noted that the case raised issues of considerable importance for company law. It provided the first opportunity for the Court to consider the existence, content and engagement of the so-called 'creditor duty'.

Section 172(1) of the Companies Act 2006 requires directors to act in the way they consider, in good faith, would be most likely to promote the success of a company for the benefit of its shareholders. However, the Court ruled that, in certain circumstances, that duty is modified by the common law rule that the company's interests are taken to include the interests of its creditors as a whole.

In affirming the existence of the creditor duty, the Court noted that it had a coherent and principled justification and was consistent with a long line of case law. The duty assumes particular importance when the company concerned is insolvent or nearing insolvency. In such circumstances, directors should manage a company's affairs in a way which takes creditors' interests into account and seeks to avoid prejudicing them.

Turning to the content of the creditor duty, the Court found that, where a company is insolvent or bordering on insolvency, but is not faced by inevitable collapse, directors should consider the interests of creditors, balancing them against the interests of shareholders where they may conflict. The greater a company's financial difficulties, the more directors should prioritise creditors' interests. Where insolvent liquidation or administration is inevitable, the creditor duty becomes paramount.

Dismissing the assignee's appeal, the Court found that the creditor duty was not engaged on the particular facts of the case. The dividend was lawfully paid and the company was solvent at the time, both on a balance sheet and cash flow basis. It had long-term pollution-related contingent liabilities of uncertain amount. There was a real risk that it might become insolvent in the future but, when the dividend was distributed, insolvency was not imminent, or even probable.

The contents of this article are intended for general information purposes only and shall not be deemed to be, or constitute legal advice. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of this article.