Tough Trading – whose interests should directors put first?
This is a very difficult time for companies of all sizes – economic and political uncertainty, rising costs and pandemic hangovers have made for tough trading conditions, and, as this BBC article shows, there has been a sharp rise in companies on the verge of collapse.
However, there is always cause for optimism, and many companies come back strongly from hard times – but how should directors take decisions when the financial future is uncertain?
Company directors will be well aware of their statutory duties – especially what most would consider the primary duty found in section 172 Companies Act 2006, to promote the success of the company in the interests of its members. However, it is not as well known that this duty is subject to common law rules relating to the interests of creditors when the company is in financial trouble. The common understanding of the position was that, if a company was insolvent, the interests of creditors took over completely from the interests of the shareholders, so the directors had to act accordingly and pay no mind to the shareholders’ interests.
The Supreme Court recently considered this point in the case of BTI 2014 LLC v Sequana SA & Others, and (as a very brief summary of a long judgment) held that where a company is insolvent or bordering on insolvency (but not necessarily inevitably facing insolvent liquidation or administration) the directors did have a duty to consider the interests of the company’s creditors, but this was on a sliding scale, so the directors need to engage in a balancing exercise between shareholder and creditor interests – the worse the financial difficulties become, the more weight should be given to the creditors’ interests – until insolvent liquidation or administration becomes inevitable, and the creditors’ interests entirely displace the shareholders’ interests. The court also made clear that this duty continues to be owed to the company, not to any particular shareholder or creditor.
This is preferable to the binary position requiring directors to act in only shareholder or only creditor interests based on a technical definition of insolvency. For instance, just because a company may be technically insolvent on its balance sheet is no reason to entirely forego consideration of the shareholders’ interests if the directors consider that there is a good chance of recovery. The court also specifically pointed to start-ups that are often insolvent on the balance sheet test during product development, but if the directors can trade out of that position they can succeed in generating huge value for shareholders and repay creditors, the best result for everyone.
Directors of struggling companies will therefore have to consider at all points how far the balance has tipped towards one side or the other, and whether their decisions take proper account of that balance.
The risk of personal liability for directors resulting from insolvent trading are significant, so it would be wise for directors of companies that are experiencing difficulties to take financial and legal advice, to ensure they are considering all the necessary factors and to protect themselves from claims.
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https://www.bbc.co.uk/news/business-64303338