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New Test: When directors’ duties shift to be owed to creditors in Insolvency

In the recent decision of the Court of Appeal (CA) in BTI 2014 LLC v Sequana SA & Ors, Lord Justice David Richards shed clearer light on the common law test to determine the point in time when the directors’ duties shift to be owed to creditors rather than to the shareholders in insolvency.

The appeal arose from a dispute between a division of BTI and the directors of Sequana’s subsidiary regarding the liability for the contamination of a river in the USA. The directors of Sequana made a dividend payment in circumstances when there was a contingent liability. The Court of Appeal upheld the finding at first instance that the dividends were caught by s. 423 of the Insolvency Act as a transaction at an undervalue; there was no appeal against the finding that the dividends were otherwise lawful.

Where a company is insolvent, the directors’ primary duties are owed to creditors (instead of shareholders) and directors must consider the interests of the creditors as a whole and take those interests into account when carrying out their duties to the company. 

The CA agreed with previous authorities that the duty may be triggered when a company falls short of actual established insolvency. Previous authorities suggested that the trigger takes place when the company is “nearing insolvency”, “on the verge of insolvency”, “in a parlous financial state”, “precarious” and “dubious insolvency”. However, the CA considered that these phrases are “too vague to serve as a useful test for the important step of engaging the creditors’ interests duty”.

BTI submitted that the duty is triggered when there is a real, as opposed to a remote, risk of insolvency. However, the CA considered that this is a significantly lower threshold than being either on the verge of insolvency or likely to become insolvent.

Accordingly, the CA held that directors’ duties to creditors arises at the time upon which the directors know or ought to know that the company is or is likely to become insolvent. In this context, “likely” means probable, and not some lower test. Although there is no ratio on whether the interests of the creditors are paramount or are to be considered, the CA commented “where the directors know or ought to know that the company is presently and actually insolvent, it is hard to see that creditors’ interests could be anything but paramount.”

New Test: When directors’ duties shift to be owed to creditors in Insolvency

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