Real risk not enough?

The Companies Act 2006 established the principle that directors must consider creditors’ interests when insolvency is anticipated, a principle which has long been upheld by case law. It was hoped that the highly anticipated Supreme Court decision in Sequana would provide greater clarity on this, however not even the Supreme Court justices could agree on all points.

The key rulings in Sequana are as follows:

• The duty for directors to consider creditors’ interests when an insolvency event is approaching is enshrined in director’s duties to act in the best interests of the company, it is not owed to the creditors directly.
• This duty will only arise when the directors know, or ought to know, that the company is bordering on insolvency or insolvency is probable (i.e. more likely than not) (“Imminent Insolvency”), or already insolvent (“Actual Insolvency”), such terms to be considered by reference to the cash flow or balance sheet of the company. Interestingly the duty will not arise if the company simply has a real risk of insolvency in the future, Actual Insolvency or Imminent Insolvency are required.
• The scope of the duty will depend on the financial position of the company at the relevant time. The more distress the company is under, the greater weight should be given to the creditors’ interests.
• Where insolvent liquidation or administration is inevitable, the creditors’ interests become paramount as the shareholders cease to retain any valuable interest in the company.

It must be noted that there are some differences in the rulings of the Supreme Court justices, particularly the principle that when insolvency is unavoidable, the interests of the creditors are paramount and the shareholders’ interests cease to hold any weight. The question of when a company’s insolvency is unavoidable will be determined on the individual facts of the case, so the common law will develop this principle over time.

The judgment further affirms that directors must keep themselves informed about the financial position of the company and should seek legal advice at the earliest opportunity if they suspect a company risks insolvency. The coming months are likely to difficult for many businesses and seeking professional advice at an early stage could not only protect directors against personal liability, but also give companies the greatest chance of survival. The FSP insolvency and restructuring team would be happy to discuss matters with you should you have any concerns and have strong links with local and national firms of insolvency practitioners which we readily utilise for the benefit of our clients, so please do not hesitate to get in contact with us.