Directors only owe duty to creditors on real risk of insolvency, UK’s Supreme Court rules

The UK’s Supreme Court has dismissed a claim calling for the law to be changed to force company directors to start taking creditors into account at the first risk of insolvency.

The Supreme Court ruling reaffirms the current position in law, in stating company directors are only required to begin prioritising creditors if it is “probable” their company will actually plunge into insolvency.

The ruling clarifies the current legal position under which directors’ duties to creditors are triggered only when a company is either insolvent or on the brink of bankruptcy, rather than at an earlier point in time, when the first signs of insolvency risks appear.

The case comes after debt collector BTI filed a lawsuit against French paper maker Sequana seeking to reclaim a €135m (£188m) dividend paid out to it by its subsidiary AWA in May 2009.

Although AWA was solvent at the time, the Scottish paper manufacturer had long-term pollution related liabilities that meant there was a real risk it might become insolvent in the future.  

BTI later sought to reclaim the €135m debt from Sequana following AWA’s in October 2018 – almost a decade after it first paid out the dividend.

The debt collector had sought to argue that AWA’s decision to pay Sequana a dividend was taken in breach of its creditor duties due to the risk of potential insolvency.

Lawyers speaking to City A.M. said the Supreme Court’s ruling will likely be welcomed by company directors due to it clarifying directors only have a duty to begin considering creditors’ interests when there is a real risk of insolvency.

“As before, directors need to heed the shadow of insolvency only when it becomes more likely than not,” commercial barrister David Drake said.

However, Drake noted the court’s ruling may come as a “bitter pill” for creditors “who feel that directors have been given a licence to fritter away assets, ignoring an obvious risk of creditors being left short-changed.”

Ashurst partner Olga Galazoula said the extra clarity provided by the ruling “particularly helpful… at the current time when we are seeing increased distress in the market”.  

Edward Smith, a partner in Travers Smith’s restructuring and insolvency practice, said: “The Supreme Court judgment recognises that there may be a sliding scale of distress, where the more parlous the financial state of the company, the more the directors should prioritise the interests of creditors.”