A ruling on the responsibility of directors towards creditors has been welcomed as companies face challenging economic times ahead.
The long-awaited ruling on the so-called ‘creditor duty’ in BTI 2014 LLC v Sequana SA is important in clarifying the legal duties of directors to consider, or act in accordance with, the interests of creditors as a company approaches insolvency.
When a company is financially secure, corporate decisions are largely made on the basis of the best interests of the shareholders. As these are likely to be the pursuit of stability and profitability, the interests of creditors are generally aligned with those of the shareholders.
However, when a company is in a difficult financial position, the interests of creditors become increasingly important: the question tackled by the Supreme Court was the point at which that shift occurred.
The court held that the ‘creditor duty’, which is also known as the ‘rule in West Mercia’ after the 1988 case of West Mercia Safetywear v Dodd, would apply where the company insolvency or administration is unavoidable. At that point, the interests of creditors take priority over those of shareholders and become “paramount”. But that duty did not arise while insolvency was only imminent or probable, because at this point the interests of shareholders and creditors may still be aligned.
The Supreme Court judgement effectively gives companies more time to trade through financial difficulties by pushing back the point at which the interests of creditors must be given priority by directors.
“As explained in the judgement, this appeal raised questions of considerable importance for company law, being the first opportunity for the Supreme Court to consider the existence, content and engagement of the so-called creditor duty,” comments Daniel Gresswell, Partner and Commercial solicitor at Wollens.
“But while the headline news is that this pushes back the point at which directors must focus foremost on the interests of creditors, the court emphasised that directors are under a duty to keep themselves well informed on the company’s affairs at every stage.
“This means challenging themselves over each decision they make when working through any financial difficulties and getting advice at the right time and each stage. There is no simple one-size-suits-all that informs the point at which the burden shifts. It will be down to individual circumstances and directors will need to demonstrate they are working to save a struggling company, not engaging in activities that could deepen the threat of insolvency where there is little chance of avoiding the inevitable.”