The director’s duty to consider creditor interests
By Charles McConnell (White & Case LLP)
In Foo Kian Beng v OP3 International Pte Ltd (in liquidation) [2024] SGCA 10 (OP3 International), the Singapore Court of Appeal considered the trigger for when the director's duty to consider the interests of creditors is engaged (referred to in the judgment as the Creditor Duty).
The Court held that: (i) the Creditor Duty is engaged if the company is imminently likely to be unable to discharge its debts or the company's insolvency is inevitable at the time of the transaction or as a result of the transaction; and (ii) a two-step sequential approach should be applied: (a) first, the court should objectively examine a company's solvency at the time the transaction happened; and (b) second the court should consider whether the director subjectively believed he/ she acted in the best interests of the company in authorising the transaction.
Facts
Mr Foo was the sole director and shareholder of OP3 International Pte Ltd (OP3). He had authorised the payment of dividends and the repayment of loans to himself at a time when OP3 was facing a claim brought by Smile Inc Dental Surgeons Pte Ltd against it (Suit 498).
In OP3 International Pte Ltd (in liquidation) v Foo Kian Beng [2022] SGHC 225, the lower court held that, notwithstanding that final judgment had not yet been obtained in respect of Suit 498, a contingent liability arose from Suit 498 and that, based on the facts and circumstances known to Mr Foo then, such contingent liability should have been taken into account in assessing the solvency of OP3 at the times at which Mr Foo had made the relevant payments – this was affirmed by the Court of Appeal.
Background
Directors have a duty to act in the best interests of the company under the common law and a duty to act honestly under s 157(1) of the Companies Act.
The difficulty lies in whose best interests a director must act and in delineating the point in time at which the interests of creditors become more significant than the interests of the shareholders. As the Court of Appeal noted: "When a company is financially healthy, the interests of creditors are, in the usual course, sufficiently protected, and directors may be entitled to treat the interests of shareholders as a sufficient proxy for those of the company. On the other hand, the interests of the creditors will come to the fore when the company is insolvent because, at that point, the directors are effectively trading and running the company's business with the creditors' money …. Any outflows at that point eat into the estate that is available to meet the claims of the creditors."
The Court noted that there is no distinct duty that directors owe to creditors or any duty separate from the directors' fiduciary duty to act in the best interests of the company.
The Court reiterated that the Creditor Duty is a fiduciary duty that directors owe to the company. This duty is not one that directors owe directly to creditors and creditors therefore cannot sue directors for breach of the Creditor Duty. Rather, the proper plaintiff in an action for breach of the Creditor Duty is presumptively the company and any financial award resulting from a successful action for breach of the duty inures for the benefit of the company, though it may in practical terms be subsequently distributable among the company's creditors.
The decision
In its judgment, the Court set out the following tests in determining whether the Creditor Duty is engaged:
- As a first step the court should objectively determine which of three financial stages the company was in at the time the transaction was entered into or that was likely to arise as a result of the company entering into the transaction9. The Court noted that in "ascertaining the company's solvency at the time a particular transaction was entered into is… done with a view to determining whether a director had breached the Creditor Duty. The court is not concerned with the question of whether the company was technically insolvent or whether it would have been appropriate to liquidate the company. Hence, whilst the "going concern" test and the "balance sheet" tests provide useful indicia of the financial health of the company, a strict and technical application of these tests should be eschewed" and "the court should be alive to the reality that prompt payment may not always be insisted on by creditors".
- Having ascertained the financial state of the company at the material time, the court should then examine the subjective intentions of the director and determine whether he/ she acted in what he/ she considered to be the best interests of the company. The financial state of the company provides a useful analytical yardstick against which the subjective bona fides of the director may be tested. In as much as the court is, at this latter stage, scrutinising the business judgment of a director, it will not substitute its own decisions in place of those made by directors in the honest and reasonable belief that they were for the best interests of the company, even if those decisions turned out subsequently to be wrong ones.
The process can be summarised as follows:
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Step 1 – objective determination if duty triggered |
Step 2 – subjective determination if duty breached |
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Category one |
Where all things, including the contemplated transaction, having been considered, the company is solvent and able to discharge its debts. |
Where a company is, all things considered, financially solvent and able to discharge its debts, a director typically does not need to do anything more than act in the best interests of the shareholders to comply with his/her fiduciary duty to act in the best interests of the company. |
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Category two |
Where a company is imminently likely to be unable to discharge its debts: this category encompasses cases where a director ought reasonably to apprehend that the contemplated transaction is going to render it imminently likely that the company will not be able to discharge its debts. |
In this intermediate zone, the court will scrutinise the subjective bona fides of the director with reference to the potential benefits and risks that the relevant transaction might bring to the company. The court will be slow to second-guess the honest, good faith commercial decisions made by a director to afford the company the best possible chances of revitalising its fortunes. If a director considers in good faith that he/ she can and should take action to promote the continued viability of the company, and that there is a way out of the company's financial difficulties which will benefit shareholders and creditors, he/ she is not obliged to treat creditors' interests as the exclusive or primary determining factor in determining what the company should do next. Conversely, transactions undertaken at this time which appear to exclusively benefit shareholders or directors will attract heightened scrutiny. The greater the extent to which the transaction is one which exclusively benefits shareholders or directors (and does not benefit the company as an entity), the more closely a court will scrutinise the decision of the director to determine whether he/ she had breached the Creditor Duty. |
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Category three |
Where corporate insolvency proceedings are inevitable: a clear shift in the economic interests in the company (from the shareholders to the creditors as the main economic stakeholders of the company) would occur where insolvent liquidation or judicial management is inevitable. |
Where corporate insolvency proceedings are inevitable, there is a clear shift in the economic interests in the company (from the shareholders to the creditors as the main economic stakeholders of the company) because the assets of the company at this stage would be insufficient to satisfy the claims of creditors. In the context of liquidation, shareholders as residual claimants will stand to recover little or nothing. Consequently, the Creditor Duty operates during this interval to prohibit directors from authorising corporate transactions that have the exclusive effect of benefiting shareholders or themselves at the expense of the company's creditors, such as the payment of dividends. |
* This article was originally published by White & Case LLP.