Sequana: UK Supreme Court Rules Directors’ “Creditor Duty” Exists – Arises When a Company is Bordering on Insolvency (But Not Before)

By Kate Stephenson (Kirkland & Ellis International LLP)

At a Glance

The UK Supreme Court recently delivered its long-awaited verdict in Sequana, on directors’ fiduciary duties in the zone of insolvency, ruling that:

• When a company is “insolvent or bordering on insolvency”, or an insolvent liquidation or administration is probable, the directors’ duty to act in good faith in the interests of the company should be understood as including the interests of its creditors as a whole (the creditor duty). A “real risk of insolvency” is not sufficient to trigger this duty.
  • When the creditor duty arises, the directors should consider creditors’ interests, balancing them against shareholders’ interests where they may conflict. The greater the company’s financial difficulties, the more the directors should prioritise creditors’ interests.
  • Where an insolvent liquidation or administration is inevitable, creditors’ interests become paramount as the shareholders cease to retain any valuable interest in the company.
• The relevant interests of creditors for this purpose are the interests of creditors as a general body: the directors are not required to consider the interests of particular creditors in a special position.
• Where the directors are under a duty to act in good faith in the interests of the creditors, the shareholders cannot authorise or ratify a transaction which is in breach of that duty.
• The creditor duty can arise when directors are considering the payment of an otherwise-lawful dividend.
• On the facts of Sequana, the creditor duty was not engaged, because insolvency was not even probable at the relevant time.

Implications

This judgment is of considerable practical importance, especially in the current business environment.

• Directors of English companies must have regard to creditors’ interests from the point at which the company is bordering on insolvency (but not merely because the company is at a real risk of insolvency at some point in the future). From that point, shareholders cannot authorise or ratify a director’s breach of the creditor duty.
• This duty applies where directors are considering the payment of a dividend, even where the accounts demonstrate sufficient distributable reserves.
• The judgment recognises that the rationale of limited liability is “to encourage risk taking as an essential part of commercial enterprise”. Creditors are broadly expected to be the “guardians of their own interests”. But — as ever — directors must keep the solvency of the company under careful review.

(*) This article was previously published on the website of Kirkland & Ellis.