The importance of being considerate – when should company directors consider the interests of creditors?

What the UK Supreme Court in BTI found

The BTI case principally concerned whether directors breached a duty to its creditors when making a decision to pay a dividend to shareholders. The dividend was paid in May 2009 at a time of solvency; however, in October 2018 the company became insolvent due to the realisation of long-term pollution related contingent liabilities that were known, but of an uncertain amount, at the time of the payment of the dividend.

At the heart of the case were three key questions considered, in detail, by the Court for the first time:

1. Is there a common law duty owed by company directors to creditors?
2. If so, what is the content of that duty?
3. If there is a creditor duty, when is it engaged?

Do company directors owe a common law duty to creditors?

The UK Supreme Court held that in certain circumstances (set out below), a director’s fiduciary duty to act in good faith in the interests of a company is extended by common law such that the company’s interests include those of the general body of the company’s creditors.

What is the content of that duty?

The relative weight of interest to be apportioned to creditors, shareholders, and other interests of the company in the event of insolvency was an issue that divided the Supreme Court; however, the majority held that:

• the weight to be given to creditors’ interests, insofar as they may conflict with those of the members, increases as the company’s financial problems become increasingly serious (with one judge suggesting that directors must not only consider creditors’ interests but not materially harm them either); and
• at the most extreme, in the event of insolvency directors may be required to treat creditors’ interests as paramount.

Significantly, the Supreme Court further held that the creditor duty can apply to a decision by directors to pay a dividend which is otherwise lawful.

When is this duty engaged?

Finally, the majority of the Supreme Court held that the creditor duty is engaged when a company is insolvent or bordering on insolvency, or when an insolvent liquidation or administration is probable. They considered that the duty does not apply to the ostensibly less imminent circumstances of a company being “at a real and not remote risk of insolvency”.

Separate judgments of the majority leave some uncertainty as to whether the duty applies when directors know, or ought to know, of the status of the company in question.

The BTI decision in Australia

BTI is relevant in an Australian context because it reinforces that the “creditor duty” – something long recognised by successive Australian case law – applies to Australian company directors. There are however two important issues that are still unclear.

How important are creditors' interests?

The content of the “creditor duty” in Australia largely reflects what the majority held in BTI – there is no independent duty enforceable by creditors. Rather, directors must consider the interest of creditors as a corollary of, and a conditional modification to, the duty to act in the best interests of a company.

Nonetheless there remains some uncertainty in Australia – as in BTI – as to the paramountcy of the consideration to be afforded to creditors and whether the duty extends to directors not doing anything to prejudice or materially harm creditors’ interests rather than simply considering those interests.

When does the duty apply?

There is no doubt that the creditor duty applies in Australia at the time of insolvency. The more difficult question for both directors and legal practitioners is ascertaining how much earlier in time the duty applies.

Critically, and unlike in BTI, the time at which a “creditor duty” is enlivened in Australia likely arises earlier than when a company is simply “bordering on insolvency”. Instead, it appears to apply at least when there is a “real and not remote risk of insolvency”, according principally to certain Australian authorities which were rejected by the Supreme Court in BTI.

One judge explained in BTI that this rejection follows from the rationale of the duty: it is premised on a shift in the economic interest in the company, and consequently in the distribution of the risk of loss, from the shareholders to include the creditors. He explained that as long as a company is financially stable, its shareholders will therefore 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.

It is the Supreme Court’s rejection of Australian authority on the timing of the imposition of the duty that will likely have the greatest significance for future Australian jurisprudence. If Australian courts reassess this aspect of the duty, then it is possible that they will find that directors do not have to consider the interests of creditors until insolvency is more imminent.

Key takeaways for Australian directors

BTI is relevant in an Australian context because it reinforces that the “creditor duty” – something long recognised by successive Australian case law – applies to Australian company directors. There are however two important issues that are still unclear.

Special leave is currently sought before the High Court in Australia in a matter concerning directors’ breach of section 180 of the Corporations Act by failing to act with reasonable care and diligence in considering whether the payment of dividends would have complied with section 254T of the Corporations Act. That section says a company must not pay a dividend unless the payment of the dividend does not materially prejudice the company's ability to pay its creditors.

Until we have greater guidance from the Court, directors should bear in mind the following practical considerations:

1. As a starting point, if there is any real and not remote risk that a company is insolvent, then directors should give proper consideration to the potential impact of any transactions entered into by the company on creditors and be in a position to provide evidence of that consideration.

2. Directors should exercise their best judgment when considering and apportioning weight to creditors’, and shareholders’ interests having regard to the nature of their company’s business. Useful guidance can be found in Kinsela v Russell Kinsela Pty Ltd (in liq) (1986) 4 NSWLR 722, where Chief Justice Street observed:

“Courts have traditionally and properly been cautious indeed in entering boardrooms and pronouncing upon the commercial justification of particular executive decisions. Wholly differing value considerations might enter into an adjudication upon the justification for a particular decision by a speculative mining company of doubtful stability on the one hand, and, on the other hand, by a company engaged in a more conservative business in a state of comparable financial instability. Moreover, the plainer it is that it is the creditors' money that is at risk, the lower may be the risk to which the directors, regardless of the unanimous support of all of the shareholders, can justifiably expose the company.”

3. The greater a company’s financial difficulties and its proximity to insolvency, the more directors should take professional advice to assist them to take into account and, potentially, prioritise the interests of creditors above shareholders (where there is any conflict). When a company is insolvent, the interest of creditors – at least with respect to shareholders – will likely be paramount.

4. Directors should, as ever, properly inform themselves about a decision that may affect the interests of creditors to the extent they reasonably believe to be appropriate.