Supreme Court Ruling Could Trigger Surge in Claims Against Directors

22 May 2023

A recent Supreme Court case (BTI v Sequana) has confirmed that company directors owe a duty to creditors if the company approaches balance sheet or cash flow insolvency.

This ‘creditor duty’ is becoming increasingly significant as insolvencies rise.

According to the latest government figures, there were 22,109 registered insolvencies in 2022, the highest number since 2009 and 57% higher than in 2021.

Directors have an overarching duty to act “in the way [the director] considers, in good faith, would be most likely to promote the success of the company for the benefit of its [shareholders]…” (section 172(1), Companies Act 2006). This encompasses a duty to creditors under certain conditions. As with directors’ duties generally, this duty is owed only to the company, meaning only the company (or a liquidator, administrator, or assignee) can sue for breach, not individual creditors.

The creditor duty is activated when the company is insolvent or nearing insolvency, or when insolvent liquidation or administration is probable. A company may be insolvent or close to insolvency but still have prospects of recovery, hence the test has two limbs. The majority of the Supreme Court held that the creditor duty would not be triggered unless the directors knew, or ought to have known, of the insolvency position.

However, the minority did not rule out the duty being engaged even when the directors did not know and could not reasonably have known of the insolvency position.

When there is actual or imminent insolvency:

• Directors must consider the interests of creditors and balance them against the interests of shareholders if they conflict.
• Directors must strike the right balance between these competing interests.
• The greater the financial difficulties, the more directors should prioritise creditors’ interests over those of shareholders.
• If directors do not consider creditors’ interests at all, they will automatically be in breach of duty, as demonstrated by judgments following BTI vs Sequana, holding directors liable.
• If directors consider creditors’ interests and attempt to balance them with shareholders’ interests in good faith but objectively get it wrong, this would be a breach of the creditor duty. This potentially broadens the director duty from a good faith duty to a reasonable care duty when considering creditors’ interests. Previously, this was not clearly the law.

When insolvent liquidation or administration is probable, the position becomes even more onerous for directors:

• Creditors’ interests become paramount, and shareholders’ interests are no longer to be considered or promoted.
• Failing to consider creditors’ interests, or considering shareholders’ interests, will be a breach of duty.
• By analogy with ‘wrongful trading’ (under section 214, Insolvency Act 1986), to avoid breach, directors must take every reasonable step to minimise potential loss to creditors, even if the company ultimately avoids winding up. This appears to be a development in the law.
• One judge in the minority stated that this heightened duty to creditors should apply even if an actual insolvency procedure is not probable, provided the company is either actually insolvent or insolvency is imminent.

Since the Supreme Court’s decision, three High Court cases in 2023 have succeeded against directors for breach of the creditor duty, indicating that BTI vs Sequana may lead to an increase in claims against directors.

The Supreme Court will likely revisit the creditor duty soon. The D&O market should closely monitor developments.