Can Directors Pay Dividends If The Company Could Become Insolvent?
The fiduciary duties owed by company directors to the shareholders are vital to the relationship requiring trust, confidence and financial proprietary. One of these is the so-called ‘creditor duty’ which requires directors to act in the interests of creditors when the company becomes insolvent or is at real risk of insolvency.
Thankfully, an important ruling shows that directors do not need a crystal ball while exercising this duty when deciding whether to pay out dividends. The duty is limited.
What’s the background?
Back in 2009, the directors of a world-leading premium paper producing company paid a €135m dividend to the sole shareholder (its parent company). This meant the shareholder’s existing debt to the company was virtually wiped out. The company was solvent but there were ‘background’ circumstances relating to contingent indemnity liabilities which meant there was a real risk the company could become insolvent in future.
The company did go into administration, but not until almost a decade later in 2018. The assignee of the company’s claims brought proceedings under s423 Insolvency Act 1986 seeking repayment of the amount of the dividend. It argued that the company directors had breached the creditor duty when it made the dividend by failing to consider or act in the creditors’ interests.
The courts all rejected the claim. The Supreme Court upheld the appeal judge’s decision that it was not until a company is insolvent or likely to become insolvent that the creditor duty arises. When the dividend was made in 2009, the duty had not arisen. Insolvency was not likely or probably, even if was a possibility at some later point.
The Supreme Court justices also clarified that directors’ duties are owed to the company as a whole - the creditor duty is not a free-standing duty owed to creditors. Though creditors always have an economic interest in the assets of the company, the importance of that interest increases where the company is insolvent or nearing insolvency.
Once the company is or is probably insolvent, the creditor duty is paramount and creditors’ interests should be prioritised. It is a reasonable approach that strikes the balance between the duties and interests of directors and the interests of the company creditors and shareholders.
What does this mean?
Directors should ensure they understand the nature and extent of their fiduciary duties but will be relieved that those duties do have their limits. Directors do not need always to prioritise creditors’ interests, but once the company is insolvent or is approaching insolvency – their priorities must shift to the creditors’ interests.
Importantly, this includes when the directors ought to have known the company is/is approaching insolvency.
1BTI 2014 LLC v Sequana SA [2022] UKSC 25
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