Ultimately you are the boss: Directors’ Duties

Posted on: May 21st, 2021

When you become a company director you commit to a number of duties, including the obligation to act in good faith for the benefit of its members as a whole. But what if the company is no longer solvent or no longer operating profitably?

In a situation where a company is insolvent or where there is a threat of insolvency, the duty owed by a director shifts from what would be in the best interests of its shareholders, to what would be in the best interests of its creditors. Once a company is insolvent its shareholders are no longer able to benefit from its assets. The assets are instead held for the benefit of its creditors.

A creditor is a person or company to whom money is owed to. Insolvency is where you are unable to pay your debts.

The guidance on this obligation is provided in the form of the judgment of the Court of Appeal in Sequana SA and others (Sequana).

The Judgment

The Court of Appeal reaffirmed the decision of the High Court that a dividend was, in this scenario, a transaction at an undervalue for the purposes of the Insolvency Act 1986. It was held that the dividend was made with the intention of putting assets beyond the reach of the company’s creditors.

The case involved an English company that had inherited liability for historic river pollution that occurred in the 1950s and 1960s in the US.  Back in 2008 and 2009, having made a genuine attempt to estimate the realistic quantum of the clean-up liability, but before the liability had crystallised, the company declared two substantial dividends.  The dividends were declared ‘lawfully’ in the sense that the company had sufficient distributable reserves for the purposes of Companies Act 2006 requirements.

Therefore, even though the dividends were declared lawfully, there was a culpability for the directors to restore the dividends to the company. The transaction at an undervalue meant that the directors breached their duties to their creditors.

When do directors have a duty to consider the interests of creditors rather than the members?

  1. On actual insolvency;
  2. When the company is on the verge of insolvency;
  3. When the company is likely to go insolvent; or
  4. When there was a “real” risk of insolvency as opposed to a remote risk.

With few exceptions, a director should not resign from a company in financial difficulties until those difficulties are resolved or the company enters formal insolvency proceedings.

In the news

Recently there was a case in the news (Byers and others v Chen Nanning). The UK Privy Council considered the duties of a director of an insolvent British Virgin Islands company. Applying the above principle regarding the shift between director’s duty from the companies’ shareholders to its creditors, it was held that Ms Chen, a shadow director, made significant payments out of the company without justification.

Although Ms Chen delegated the task of arranging the payments to someone else, she had a fiduciary duty to prevent such payments knowing that the company was insolvent. By delegating, authorising, and failing to take any action to prevent the payments, Ms Chen was the reason that those payments were made. It was held that Ms Chen was “ultimately the boss.”

Directors must be aware of their duty to act in the interests of their shareholders in good times, and the company’s creditors in bad times. They are ultimately the boss, and the responsibility falls with them.

If you have any questions regarding directors’ duties both when your company is solvent, or if you are concerned that your business might become insolvent, please do not hesitate to contact us.