Newsletter May 2023

Director Duties in Landmark Law Case

Are there circumstances in which directors must act in, or at least consider, the interests of the company’s creditors?

In a significant verdict for company directors, the Supreme Court has addressed this question for the first time. The case turned on a dividend payment made before the company involved went into insolvent administration. Some ten years before, in fact. More important than the detail of the case, however, is the take-away message for directors.

Directors normally have a fiduciary duty to act in good faith in the interests of the company, for the benefit of its members as a whole. But if a company is insolvent or nearing insolvency, this is modified. ‘As the financial position of the company deteriorates, the shareholders’ interests decrease in importance, and those of creditors increase.’ Once insolvency is inevitable, the interests of creditors become paramount.

This landmark case has a clear message. It warns that directors must ‘stay informed’. Noting that ‘progress towards insolvency may not be linear’, it suggests the need for:

• directors to ensure they are told if cash reserves or the asset base of the company have been eroded such that creditors may or will not get paid when due
• director access to reliable information about company finances
• the maintenance of up to date accounting information (note that companies can instruct others to do this on their behalf)
• appropriate training for directors about their responsibilities and penalties for failure to comply.

The underscoring of director responsibilities is particularly important at a time of recession, when many companies are feeling financial strain. We are always on hand to help with advice during challenging trading conditions.