In the past few years, Australian companies have faced unprecedented challenges against the backdrop of a global pandemic and ongoing international tensions. In the ordinary course, these challenges would have resulted in significant financial issues and an increase in formal insolvency appointments. However, support from both Federal and State governments has allowed many companies to continue through these difficult times. Given that government support has now by and large been withdrawn, it is appropriate for directors to reconsider the financial position of their companies and ensure they are complying with their duties.
Australian courts have acknowledged that in times of distress a director’s duty to act in good faith in the best interests of a company is likely to require a director to also have regard to creditors’ interests. However, the courts have struggled to provide clarity as to when during a period of distress a director is required to balance creditors interests with the interests of shareholders.
Recently, the Supreme Court of the United Kingdom delivered its long awaited judgment considering this precise question in the matter of BTI 2014 LLC v Sequana SA [2022] UKSC 25 (BTI). Although this decision is not binding on Australian courts, we anticipate it is likely to be influential.
Duty to act in the best interests
Section 181(1) of the Corporations Act 2001 (Cth) (Corporations Act) requires directors to exercise their powers and discharge their duties ‘in good faith in the best interests of the corporation’. A failure to comply with this obligation constitutes a civil penalty and may result in a director being personally liable.
The Corporations Act does not define the ‘best interests’ of a corporation. Generally, compliance with section 181(1) requires directors to consider the interests of shareholders of the company, including any competing interests between shareholders. However, in certain circumstances, directors may be required to consider creditors’ interests either above, or in balance with, shareholders’ interests.
To clarify, directors do not have a duty to creditors themselves. Rather, a director’s duty to the company may, in certain circumstances, require directors to consider creditors’ interests. The moment when a director’s duty to act in the best interests of the corporation expands to require consideration of the interests of creditors is currently unclear in Australia.
Accordingly, directors must often make judgment calls amid less-than-clear requirements as to when to consider the interests of creditors.
The UK Supreme Court case of BTI
BTI concerned proceedings brought against the directors of AWA for a breach of duty in failing to consider the interests of AWA’s creditors. Relevantly, the Supreme Court considered:
- first, if a creditor duty existed;
- secondly, if it did exist, when the duty arose; and
- thirdly, what the creditor duty requires from directors.
Does a creditor duty exist?
In the UK, as in Australia, there is no separate duty owed by directors to creditors. Nevertheless, both countries accept that a director’s duty owed to the company extends to the company’s relationships with its creditors in times of distress. The issue has been in identifying precisely when the scope of the duty will be expanded in that way.
When does a creditor duty arise?
The UK Supreme Court has now stated that a director’s duty to consider creditors’ interests arises when the company is insolvent or bordering on insolvency, or where an insolvent liquidation or administration is probable.
The majority of the Supreme Court also required that the directors know, or ought to know, of the above circumstances for the duty to arise.
Notably, the decision required more than a ‘real or mere risk’ of insolvency for the duty to arise.
What does a creditor duty require?
The Supreme Court considered that directors should consider creditors’ interests as paramount when it is inevitable that a company will fall into liquidation or administration. At this point members no longer retain any valuable interest in the company.
Conversely, where liquidation or administration is ‘probable’ (as opposed to inevitable), then directors should balance the interests of creditors with the interests of members. If the interests are in conflict, the weight applied to the interests should reflect the gravity of the company’s financial difficulties, such as the likelihood of a decision drawing the company away from insolvency.
Impact in Australia
As noted, the BTI decision is not binding in Australia and the differences in insolvency regimes between the countries must be considered. For example, unlike the UK, Australia has introduced the safe harbour provisions which may afford directors with protection from a claim for insolvent trading should the relevant entry hurdles be satisfied (more information on the safe harbour can be found here).
Nevertheless, considering the UK is also a common law jurisdiction, it is likely BTI will be influential on future Australian decisions on directors’ duties to consider creditors’ interests.
Particularly, the UK court’s finding that a mere risk of insolvency does not trigger a duty to creditors may influence the scope of section 181(1) of the Corporations Act and whether a director needs to consider creditors’ interests to strictly comply.
From a practical perspective, directors of companies that are near distress need to be mindful of creditors’ interests, especially when considering the decision to continue to trade, the ‘better outcome’ as required by the safe harbour provisions, or indeed the appropriate time to appoint administrators should that be required. It is also incumbent on directors to strategically consider and decide when to proactively engage with creditors, especially secured creditors, in times of distress to facilitate the best outcome for all stakeholders – be that through an informal or formal work-out to the extent that is achievable.
The decision of BTI is however a timely reminder for directors to remain cautious and vigilant against the ongoing uncertainty both domestically and internationally, including:
- continuously monitoring a company’s financial position;
- maintaining clear documentation in relation to all decisions made; and
- in circumstances where there is a real risk of insolvency, obtaining professional advice in relation to their duties, particularly as to whether the interests of creditors should be considered.
For more information, please contact Mark Schneider, Brit Ibanez or Nick Edwards.
