The UK Supreme Court has recently handed down a decision in a case of “considerable importance for company law…concern[ing] the fiduciary duty of directors to act in good faith and in the interests of the company.”
It is common knowledge that directors owe duties to their company, including the duty to act in good faith and in the interests of the company. Generally speaking, the directors’ duty to act in the interests of the company have been treated as acting in the interests of the company for the benefit of members as whole. Courts have also long accepted that in cases of insolvency, the focus of directors’ duties may involve consideration of the interests of the company’s creditors.
The recent U.K. Supreme Court decision in BTI 2014 LLC v. Sequana S.A.  UKSC 25 (hereafter referred to as Sequana) provides the parameters for when the duty to account for creditors’ interests arises, and what this duty may look like.
In a question raised for decision for the first time, the Supreme Court considers whether a duty in respect of creditors’ interests arises prior to insolvency.
Overview/Background to Directors Duties
Directors owe a common law duty to act in the interests of the company (and generally speaking, not to third parties). As traditionally understood, a directors’ duty to act in the interests of the company broadly equates to acting in the best interests of the company’s shareholders – not its creditors.
This common law duty has developed such that directors’ duties will also at times include taking into account the interests of the creditors of the company in considering how the company should be managed, particularly as companies approach or enter insolvency.
The general duty which corresponds to the common law duty to act in good faith and in the interests of the company is the duty that is now set out in section 172 of the U.K. Companies Act 2006, which provides in key part:
A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to—
- the likely consequences of any decision in the long term,… and
- the need to act fairly as between members of the company.
Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members, subsection (1) has effect as if the reference to promoting the success of the company for the benefit of its members were to achieving those purposes.
The Decision in Sequana
In the Sequana case, the Supreme Court confirms the existence of the section 172 duty, discusses the content of the duty and, crucially, demarcates when such a duty arises.
Is there a duty?
The Supreme Court confirms that there is a firmly established duty for directors to consider the interests of the company’s creditors in cases where a company faces financial difficulties.
The Supreme Court holds that the duty to consider creditors’ interests is not a separate and distinct duty owed to creditors – rather, it is a development of the directors’ longstanding fiduciary duty to act in good faith and in the interests of the company. In certain circumstances, the interests of the company includes consideration of the interests of its creditors as a whole. The Court states at paragraph 77:
“Where the rule applies, the way in which the company’s interests are understood, for the purposes of that duty, is extended so as to encompass the interests of the general body of creditors as well as the interests of the general body of shareholders. That reflects a recognition that the traditional identification of the interests of the company with those of its shareholders, although satisfactory when the company is financially stable, needs to be widened when insolvency is imminent. The interests of the creditors as a whole should then also be taken into account and given appropriate weight…. If insolvent liquidation or administration is unavoidable, the interests of the shareholders drop out of the picture, and the company’s interests can be treated as equivalent to those of the creditors alone.”
What is the duty?
Although the Court was not required to determine the content of the duty in detail for the purpose of determining the appeal, the Court expressed its provisional views and provided general comments on the content of the duty, asking: “what is the content of the duty? Is it a duty to treat the creditors’ interests as paramount, or are they merely to be treated as a relevant consideration, along with others?”
The Court surmised that the content of the duty is to consider the interests of creditors as a whole balanced against the interests of other stakeholders and the circumstances of the company at the time. Once insolvent liquidation is inevitable, creditors’ interests are paramount and the interests of the company’s shareholders are supplanted.
When does the duty arise?
Perhaps the most important element of the Court’s decision is the question of when the directors’ duty to consider the interests of creditors arises.
In answer, the Court states that the duty arises when the directors know or should know the company is or is likely to become insolvent, or insolvency is probable. The Court rejects the proposition (derived from some Australian case law) that the duty arises whenever there is a real and not remote risk of insolvency – in other words, there must be more than ‘a real risk of insolvency’.
The introduction of the creditors’ interests is premised on the rationale that there is a shift in the economic interest in the company and consequently in the distribution of the risk of loss. At paragraph 83, the Court explains:
“…as long as the company is financially stable, its shareholders will normally have a predominant economic interest in the manner in which its affairs are managed, and their interests will normally be aligned with those of its creditors. When the company is in financial difficulties, however, the economic interest of its creditors become distinct from those of its shareholders, and are liable to become increasingly predominant as the company’s situation deteriorates.”
The Sequana case is likely to remain a case of considerable importance in the insolvency world.
Despite the differences between section 172 of the U.K. Companies Act 2006 and the similar provisions reflected at section 97 Bermuda’s own Companies Act 1981, it would be unsurprising if the Bermuda Courts were quick to adopt the Supreme Court’s judgment in the years to come.
Whether or not the Bermuda Court decides to apply this case in Bermuda, directors of companies and insolvency practitioners would be wise to familiarise themselves with the decision in Sequana on the duties of directors of companies in financial difficulties.
Article written by: Tina Herrero
Tina Herrero is a Senior Associate in the Firm’s Litigation and Advice Team