What Is The Creditor Duty?

The Creditor Duty is the duty a company Director must have regard for when a company is insolvent or when insolvency is not at remote risk. The Creditor Duty says that when a company is insolvent, the interests of creditors will outweigh those of the shareholders.

If you are a Director of a Limited Liability Company you have duties because you are in a position of trust. One of those is the Creditor Duty.

Directors’ statutory duties are set out in Chapter 2 of Part 10 of the Companies Act 2006. Those duties have also been recognised and further developed in court cases that have assessed the interpretation of this legislation.

Origin Of The Creditor Duty

The origin of the Creditor Duty has its roots in two cases.

Kinsela v Russell Kinsela Pty Ltd

The case of Kinsela v Russell Kinsela Pty Ltd (1986) 4 NSWLR 722 was the first major reference point to that which is now known as the Creditor Duty.

In that case, a company entered into a transaction with the approval of shareholders when it was balance sheet insolvent and when its collapse was around the corner:

In a solvent company the proprietary interests of the shareholders entitle them as a general body to be regarded as the company when questions of the duty of directors arise. If, as a general body, they authorise or ratify a particular action of the directors, there can be no challenge to the validity of what the directors have done. But where a company is insolvent the interests of the creditors intrude. They become prospectively entitled, through the mechanism of liquidation, to displace the power of the shareholders and directors to deal with the company’s assets. It is in a practical sense their assets and not the shareholders’ assets that, through the medium of the company, are under the management of the directors pending either liquidation, return to solvency, or the imposition of some alternative administration.

West Mercia Safetywear Ltd v Dodd

The Creditor Duty was a position that was firmly given recognition in the UK via the case of West Mercia Safetywear Ltd v Dodd [1988] BCLC 250 as part of those Director duties.

In general terms, it is important that a Director does not trade on simply because the creditors have not started beating down on the door for their money. A creditor’s forbearance is not a waiver of liability. A creditor that does not chase is still a creditor, as is a creditor that may not act with perceived restraint through enforcing their legal rights to the limit.

That means the decisions a Director has to consider must take adequate account of creditors as a whole. A further deterioration in trading, when insolvent Liquidation is largely inevitable, can cause the problem of Wrongful Trading to sprout. This can give rise to the risk of some personal liability for a Director for the period of Wrongful Trading. Once a company is insolvent the interests of creditors can supersede those of the Shareholders.

How Is The Creditor Duty Defined?

The Creditor Duty was considered in detail and confirmed in the Supreme Court’s Sequana decision (BTI 2014 LLC v Sequana SA & Ors [2022] UKSC 25).

One matter that the Supreme Court had to decide upon was if indeed there was a Creditor Duty. It said the Creditor Duty did exist.

The Creditor Duty was said to be as follows:

• Where the company is insolvent, or bordering on the verge of it the interests of creditors arise.
• The interests of creditors are the interests of creditors as a general body.
• The directors are not required to consider the interests of particular creditors in a special position.
• Where an insolvent liquidation or administration is inevitable, the creditors’ interests become paramount as the shareholders cease to retain any valuable interest in the company.
• 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 or administration is more likely than not.

In the press release of that decision, the following was said:

Where the company is insolvent, or bordering on insolvency, but is not faced with an inevitable insolvent liquidation or administration, 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 …

The extent of the Creditor Duty is a developing area of law so watch this space.