The Creditor Duty post Sequana: Lessons for Legislative Reform
Throughout its common law development, the duty of directors to consider the interests of creditors has suffered from lingering uncertainties regarding when the duty is triggered and what the duty requires of directors. Despite the duty’s detailed consideration by the UK Supreme Court in the Sequana case, many of these questions remain unresolved. While the expectations placed upon directors ought not be circumscribed too narrowly, greater certainty would benefit directors seeking to understand their obligations while navigating the precarities of financial distress. Given the taciturn common law efforts at resolving these questions, one may understandably ask whether legislative reform of the creditor duty would provide a preferable path towards legal certainty. To shed light on the potential for legislative reform in this area, our article contrasts the position of UK common law following Sequana with the recently codified duty now found under s 224A of the Irish Companies Act 2014. The newly enacted Irish position can provide lessons when considering UK legislative reform, both for its successes and its failures as a statutory blueprint.
In Sequana, the Supreme Court only addressed one issue directly, that is whether directors are obliged to consider the interests of creditors when the company faces a real but not remote risk of insolvency. While finding in the negative for that particular issue, the court went on to outline more broadly the nature of the creditor duty, or more precisely the rule which modifies the director’s pre-existing duty towards the company’s interests to become inclusive of creditor interests in financial distress. Some broad consensus can be found across the four judgments, for instance in stating that the trigger for the creditor duty involves some imminent financial distress, this being more than a possibility of insolvency but less than actual insolvency itself. The court also distinguishes between companies facing financial distress but whose continuation remains viable and companies whose insolvency is irreversible and there is no light at the end of the tunnel. Since in the latter scenario share value cannot be recouped, it is only then that the interests of creditors become the paramount consideration of the directors and the interests of shareholders become an obsolete consideration. The Sequana court declined to further outline the creditor duty, meaning that what precisely triggers the duty, what creditor paramountcy entails, or how the interests of creditors and shareholders are to be balanced are all issues which retain some ambiguity.
We argue that since further common law development of this duty is unlikely to be forthcoming, there is a benefit in reconsidering the codification of the creditor duty. Such legislative reform can effectively balance deference to directorial judgment and business context whilst providing greater certainty than that evidenced in the post-Sequana jurisprudence. An example of this is found in the newly enacted Irish statute. In adapting the framework found in the EU Preventive Restructuring Directive, the Irish Companies Act now states the following:
224A. (1) A director of a company who believes, or who has reasonable cause to believe, that the company is, or is likely to be, unable to pay its debts (within the meaning of section 509(3)), shall have regard to – (a) the interests of the creditors, (b) the need to take steps to avoid insolvency, and (c) the need to avoid deliberate or grossly negligent conduct that threatens the viability of the business of the company.
Whereas the Sequana court disagreed over whether the duty was triggered only by the director’s belief that the company was facing insolvency, the Irish framework deftly offers a compromise by predicating the duty’s trigger on the director’s belief as to the company’s likelihood of insolvency but also on the reasonable grounds for said belief. Likewise, the statute offers guidance into the expectations upon directors in navigating commercial viability while also confirming the deferential standard of review by impugning directors for deliberate or grossly negligent conduct detrimental to corporate viability.
While the Irish framework cannot be transposed directly into the UK Companies Act, its attempts at balancing legal certainty and deference to directorial business judgment within a statutory rubric provide useful guidance. The Irish model does however suffer from some internal inconsistencies as our article details. These inconsistencies are likewise a learning opportunity for future UK reform providing a cautionary tale for legislative drafters. Given that the UK position is unlikely to receive any significant forthcoming judicial clarification, hesitation over legislative reform has become less convincing. The lessons to be learned therefore from the recent Irish experience are all the more valuable from the UK perspective post-Sequana, both as a blueprint and as a general example of moving beyond the common law in this area.
* The complete article, “The Creditor Duty Post Sequana: Lessons for Legislative Reform,” is available here open-access in the Journal of Corporate Law Studies. A version of this post has also been made available at the Oxford Business Law Blog.