Following the recent case of Hunt v Singh [2023] EWHC 1784 (Ch), Lauren Hartigan-Pritchard, Head of Restructuring & Insolvency at Higgs LLP, explains the considerations directors ought to have with regards to the duties owed to creditors.

What is creditor duty?

As directors navigate through challenging financial landscapes, understanding the creditor duty is crucial as it can inform the directors decision making process and significantly reduce any personal liability in the event of company insolvency.

Broadly speaking, when determining their duties to creditors, directors ought to consider the following:

Fiduciary duties of directors

Section 172 of the Companies Act 2006 states that directors must act in the way they consider, in good faith, would likely promote the success of the company for the benefit of its members as a whole. However, when a company faces insolvency or is on the brink of it, the directors' obligation shifts, and they must prioritise the company's creditors' interests. This principle is often referred to as the 'creditor duty'.

The trigger point

In the Supreme Court decision of BTI v Sequana [2022] UKSC 25 the pivotal moment, termed the 'trigger point', was identified as the time at which the directors knew or ought to have known that the company was actually insolvent (either on a cash flow or balance sheet basis), bordering on insolvency (when insolvency is both imminent and inevitable) or likely to go into insolvent liquidation or administration.

It's crucial for directors to realise that once the trigger point is reached, they should:

• seek professional insolvency advice
• re-evaluate the company's activities to focus on creditor interest
• make decisions that do not chip away at potential repayment to creditors
• minimise additional debt
• maintain open communication with all creditors to manage expectations

Despite guidance from the Supreme Court the identification of this trigger point can still be complex as it is circumstantial. It is imperative that directors seek early advice from an insolvency professional if they are in any doubt as to the likely insolvency of the company.

Creditor duty and its implications

The duty owed to creditors does not mean that directors are individually responsible to each creditor. Rather, it's an overarching obligation, meshed within the directors' fiduciary duties. It merely shifts the perspective of decision making from shareholder interests to creditor interests.

The purpose of the creditor duty is to prevent directors from taking actions that might worsen the financial position of the company and increase the creditor liability. Obtaining credit, disposing of assets at an undervalue, or giving preferential treatment to creditors are actions which could give rise to personal liability for the company director.

Hunt v Singh [2023] EWHC 1784 (Ch)

Hunt v Singh [2023] EWHC 1784 (Ch) provided further clarity on the creditor duty, specifically in the context of whether the duty arises where a company is in fact insolvent, but the directors wrongly believe the liability giving rise to the insolvency has been effectively avoided.

The facts

In May 2019 the liquidator of Marylebone Warwick Balfour Management Limited commenced proceedings against seven former directors in relation to their operation of a complex tax avoidance scheme. The company had paid over £54m to its senior management via the scheme in circumstances in which PAYE and NIC would have been payable had those sums been treated as remuneration.

Shortly after HMRC became aware of the scheme, enquiries were raised and HMRC ultimately found PAYE and NIC, including interest and penalties, in excess of £36m was owed by the company. That sum went unpaid, and the company entered liquidation.

The arguments

The appointed liquidator claimed that the use of the scheme amounted to a breach of the directors’ fiduciary duties, specifically the creditor duty, under Section 212 of the Insolvency Act 1986 and further that the payments made under the scheme were transactions defrauding creditors within Section 423 of the Insolvency Act 1986.

These claims were dismissed at first instance on the basis that the scheme had been entered into for commercial reasons and because the company had sought and relied on professional advice. The Judge held that the “purpose” of the scheme had to be distinguished from the “consequence” of the scheme; the fact that moneys were put beyond the reach of HMRC, it was held, was a consequence of the scheme but not its purpose. The liquidator of the company appealed.

The outcome

On appeal the Judge considered the decision in Sequana and noted a key difference between the two cases, commenting as follows:

“The principal question raised by the appeal is when, following the decision of the Supreme Court in BTI 2014 LLC v Sequana SA, does a director’s duty to take into account the interests of creditors arise, in circumstances where the company is at the relevant time insolvent, but its insolvency is due to a tax liability which the directors (wrongly, as it later turned out) believed at the relevant time had been avoided by a valid tax avoidance scheme entered into by the company.”

It was unsurprising, therefore, that a ‘forensic’ approach was adopted when determining the questions around when creditor duties arise.

The appeal Judge concluded that, whilst the judgement in Sequana (which held that the creditor duty hadn’t arisen) was based on the time before the company was actually insolvent, this case, concerned a company that was either solvent (if the directors and their professional advisers were correct in their assessment of the tax avoidance scheme) or insolvent (if HMRC was correct about the tax position), which later transpired to be the case. The appeal Judge commented:

“…. there is now no doubt that the Company was in fact insolvent (indeed substantially insolvent) throughout the relevant period. Having regard to the liabilities for NIC alone, it is established that by September 2005 (the start of the relevant period) the Company owed in excess of £3.65 million but had either no or negligible net assets from which it could pay that sum. Thereafter, the position got steadily and substantially worse as the amounts due to HMRC increased each year, but no assets were retained to cover the liability.”

The appeal Judge held that, as the company’s solvency was dependent on it successfully challenging HMRC’s claim for NIC, PAYE and interest thereon, the creditor duty would be triggered if the directors “knew or ought to know that there was at least a real prospect of the challenge failing”.

This is different to the “real risk of insolvency” test which the Supreme Court rejected in Sequana. The “real risk” the directors needed to be aware of here was that they (and their tax advisors) were wrong, and the tax liability would be found to be due.

Whilst deciding to allow the liquidators appeal the appeal Judge declined, however, to make a finding on whether, the creditor duty having arisen, had been breached – that question was sent back to the Insolvency and Companies Court for consideration.

Summary

Ultimately, as directors, it's paramount to acknowledge the balancing act required when a company teeters on the verge of insolvency. Directors must identify the trigger point and act accordingly to shift their responsibilities towards the company creditors in order to avoid the risk of personal liability.

The decision in Hunt v Singh provided welcome clarification following the decision in Sequana, specifically in the context of what directors ought to be aware of when assessing risk. However, the final decision of the Insolvency and Companies Court on whether the creditor duty was actually breached in this case is eagerly anticipated.

In all such situations, seeking professional advice can provide clarity amidst the uncertainty.

About the author

Lauren Hartigan-Pritchard is the Legal Director and Head of Restructuring & Insolvency of Higgs LLP. She specialises in restructuring and insolvency, advising insolvency practitioners, business owners and private individuals on both contentious and non-contentious insolvency matters.

See also

Place an insolvency notice

Court of Appeal clarifies interpretation of s423 of Insolvency Act 1986

Monthly UK insolvency statistics - August 2023

Find out more

Hunt v Singh [2023] EWHC 1784 (Ch) (BAILII)

Companies Act 2006 (Legislation)

BTI v Sequana [2022] UKSC 25 (BAILII)

Insolvency Act 1986 (Legislation)

Images

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Publication date

27 September 2023

Any opinion expressed in this article is that of the author and the author alone, and does not necessarily represent that of The Gazette.