The Irish courts have long recognised the principle that directors of companies that are insolvent must have regard to the interests of the creditors of the company as a matter of Common Law.
The European Union (Preventive Restructuring) Regulations 2022 (the "Regulations"), which were signed into law last year, have reinforced and refined this principle in certain respects.
The Regulations have, amongst other things, inserted a new section 224A into the Companies Act 2014 (the "Act")1, which provides that a director who believes, or has reasonable cause to believe that a company is, or is likely to be unable to pay its debts2, must have regard to:
(a) the interests of the creditors;3
(b) the need to take steps to avoid insolvency; and
(c) the need to avoid deliberate or grossly negligent conduct that threatens the viability of the business of the company.
These duties are expressly stated to be owed to the company (and the company alone) as opposed to the creditors. This means that creditors do not have a right of action against the directors for breach of the duties. Rather it is the company, potentially acting through its liquidator, that can hold the directors to account for any loss or damage resulting from a breach.
Directors' duties under section 224A are in addition to the fiduciary duties set out in section 228(1) of the Act, to which the Regulations have now also inserted an additional duty for directors to have regard to the interests of the company's creditors when they become aware of the company's insolvency.
Early Warning Tools
In practical terms, it is often difficult to identify at precisely what point a company is or is likely to become insolvent. The Regulations provide, by way of a new section 271A of the Act, that directors may have regard to certain early warning tools to alert them to circumstances that may give rise to a future insolvency.
Following a public consultation period, the Corporate Enforcement Authority ("CEA") published an information note on the Regulations, early warning tools and restructuring frameworks on 3 January 2023 (the "Information Note"), which provides a non-exhaustive list of indicators of actual, or potentially approaching, financial difficulties4.
The Information Note comments that "…having regard to the challenging environment within which companies are currently operating – in which increasing interest rates, significant currency fluctuations, supply chain challenges, energy pricing/supply constraints and uncertainty in the UK’s economic outlook etc. are all features – it would be responsible of directors to incorporate consideration of these matters into the review and assessment of current and future likely profitability, cash generation and capacity to discharge debts etc. as they fall due."
Although it is not mandatory for directors to have regard to the early warning tools, they should be mindful of this description by the CEA of what a responsible director should consider in an increasingly difficult trading environment.
Sequana Judgment
A significant decision addressing when directors' duties to consider creditors may be triggered in the course of a company's financial decline was handed down by the UK Supreme Court in BTI v Sequana in October 2022.
In that case a company, AWA, had distributed an interim dividend of €135 million to its sole shareholder, Sequana, in May 2009 by way of set-off against an intra-group receivable. AWA was solvent on both a balance sheet and cash-flow basis at the time of the distribution. However, it was also subject to contingent environmental liabilities of an uncertain amount. The company subsequently went into insolvent administration in October 2018 and it was argued by the assignee of AWA's claims, BTI, that the directors of AWA had breached their duties by failing to take AWA's interests as a creditor into account at the time of the distribution when there was a "real risk" of insolvency in the future, even if insolvency was not considered at that time to be probable.
The Supreme Court ultimately found that the creditors' interest duties were not engaged as a real risk of insolvency was not sufficient. Rather, the test was one of probability such that the directors must "know or ought to know, that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable"5.
While the Sequana decision has not been considered by the Irish courts as yet, the conclusion reached by the Supreme Court with regard to when creditors' interests are required to be considered appears to approximate what is provided in this regard in the Regulations.
For further information in relation to this topic, please contact our Corporate Restructuring and Insolvency lawyers or your usual Matheson contact.
References
1We reviewed certain key changes introduced by the Regulations in our previous briefing here.
2Under section 509(3) of the Act, a company is deemed unable to pay its debts if it is unable to pay its debts as they fall due, the value of its assets is less than the amount of its liabilities (including contingent and prospective liabilities); or certain conditions are met concerning unsatisfied statutory demands for payment or unsatisfied judgments or court orders in favour of creditors.
3This provision reflects an existing common law obligation described in particular in the decision of the Supreme Court in Re Frederick Inns Ltd [1994] 1 ILRM 387 (and reiterated in Re Swanpool Ltd [2006] 2 ILRM 217) which may inform judicial interpretation of section 224A
4See Appendix 1 of the Information Note
5Although the Sequana decision is not binding in Ireland it is likely to be persuasive here.