The Supreme Court in England in BTI v Sequana  UKSC 25 has clarified when directors owe duties to the company that should take into account creditors’ interests. The decision will be highly persuasive in the Cayman Islands on directors’ duties.
In office, directors should consider whether or not the company (i) is insolvent, (ii) is bordering on insolvency, or (iii) whether insolvency is probable. If so, then they must take into account creditors’ interests to a greater or lesser degree. If the company is insolvent or insolvency is inevitable, then creditors’ interests are paramount and override those of members. Short of that threshold, a balance must be struck between the interests of creditors and those of members, depending on the precise financial situation. In terms of when the duty arises, it is clear that it is insufficient that the company is ‘likely to become insolvent at some point in the future’.
In Sequana, a dividend was declared and paid by its board of directors. At the time the company was solvent on both a balance-sheet and commercial (or cashflow) basis. However, the company had long-term contingent liabilities of an uncertain amount and an insurance portfolio of an uncertain value. There was a ‘real risk’ that the company might become insolvent in the future, though insolvency was not imminent, or even probable.
The company eventually went into administration, ten years later, and creditors sought to sue the directors for the value of the dividend that had been paid. The Supreme Court held that no creditor duty arose on the facts.
When do directors of Cayman companies need to consider creditors’ interests?
Directors owe their duties to the company, rather than directly to individual shareholders or creditors. In certain situations, the company’s interests are taken to include the interests of the company’s creditors as a whole. The creditor duty is not a free-standing duty that is owed to creditors; rather it is an aspect of the director’s duty to the company.
The majority of justices held that the creditor duty is engaged when the directors know, or ought to know, that the company is insolvent or bordering on insolvency, or that an insolvent liquidation is probable. A minority left open whether or not it was necessary that the directors have such knowledge for the duty to be triggered.
The duty will not be engaged merely because of a real and not remote risk of insolvency.
What does the creditor duty involve?
It follows that directors should consider whether or not the company (i) is insolvent, (ii) is bordering on insolvency, or (iii) whether insolvency is probable. Directors will need to consider creditor interests to a greater or lesser degree if (i)-(iii) apply.
Where an insolvent liquidation is inevitable, the creditors’ interests become paramount as the shareholders cease to retain any valuable interest in the company.
Short of that threshold, a balance has to be struck. Where the company is insolvent, or bordering on insolvency, but is not faced with an inevitable insolvent liquidation, the directors should consider the interests of creditors, balancing them against the interests of shareholders where they may conflict. The greater the company’s financial difficulties, the more the directors should prioritise the interests of creditors.
No shareholder ratification
Where the directors are under a duty to act in good faith in the interests of the creditors, the shareholders cannot authorise or ratify a transaction which is in breach of that duty. This is because there can be no shareholder ratification of a transaction entered into when the company is insolvent, or which would render the company insolvent.
Light at the end of the tunnel
This is a developing area of the law where further cases will refine when the creditor duty arises and its scope.
It is important to bear in mind that insolvency in this context may mean commercial (i.e. cashflow) insolvency or balance-sheet insolvency. Either may (but need not) be fatal to a company’s prospects. Temporary commercial insolvency may result from a temporary adverse balance between the liquidity of assets and the maturity of debts. Similarly, a company that is a start-up may be insolvent on a balance-sheet basis for a long period of time before a product is brought to market. In both cases, as explained by Lord Briggs, the directors may perceive that there is a reasonable prospect that the company will be able to trade out of insolvency, for the benefit of both creditors and shareholders – “seeing light at the end of the tunnel”. In such circumstances, even if creditors’ interests must be balanced against members’ interests, the interests of creditors will not have become paramount, since the situation is not one of irreversible insolvency.