In the intricate realm of corporate governance and insolvency law, directors hold a position of immense responsibility.
The recent UK High Court ruling in Hunt v Singh has provided significant insight about the interplay between a director’s knowledge and the creditor duty when a company faces insolvency.
The case involved Marylebone Warwick Balfour Management Limited, a company that faced insolvency as a result of a likely tax liability.
The pivotal issue before the court was whether mere insolvency, regardless of a director’s awareness of the company’s financial state, should automatically trigger the creditor duty.
The creditor duty is the point at which the directors of an insolvent or near-insolvent company are obliged to consider the interests of the company’s creditors when making decisions.
This question has lingered unanswered since the English Supreme Court’s decision in BTI v Sequana, where the distinction between a director’s duty to shareholders and creditors during insolvency was initially clarified.
There remains no binding authority from the Bermuda Court on Sequana or the issue raised in Hunt and we expect that both decisions will carry significant weight when issues like these arise here.
Mr Justice Zacaroli, who gave the judgement in the Hunt case, found that the creditor duty activates when a company confronts a claim to a current liability substantial enough that its solvency hinges on successfully challenging that claim. This duty is triggered when directors “know or ought to know that there is a real prospect of the challenge failing”.
In Hunt, the directors had been aware that the tax authorities did not share their view on the taxability of the company’s payroll scheme in 2005 and, while there was still a chance the company’s view might be vindicated, the judge concluded that they had sufficient knowledge to know their claim might fail, with the result that the tax would fall due.
The case draws heavily from the Supreme Court’s decision in Sequana, which underscored that the duty arises when directors are aware, or should be aware, that the company is, or is likely to become, insolvent.
However, Hunt added a new layer to this duty by addressing the scenario where a company is actually insolvent, but the directors erroneously believe that the liability causing insolvency has been circumvented.
The judge took the view that the duty to consider creditors’ interests activates when directors become aware of a “real risk” that a scheme or liability may fail — a distinctly different test from that of the “real risk of insolvency”, which was rejected by the Supreme Court in Sequana.
This critical development places the onus on directors to be vigilant about potential liabilities, even if they believe they have taken measures to avoid them.
The question of whether knowledge forms a crucial component of the creditor duty in cases of actual insolvency remains partially unresolved. While Zacaroli J was willing to assume its relevance, the judgment does not provide a definitive answer.
The nature of any knowledge test, if indeed it is required, also becomes a significant point of contention. If a “real risk of the company’s defence failing” is the correct criterion, as the judge suggested, this sets a relatively low bar.
It raises the question of how directors should consider the liability if there is a real risk of failure, even if the defence is more likely than not to succeed. This creates a challenge in determining whether the creditor duty is owed.
Moreover, the judgment introduces uncertainty regarding the position of a director who refrains from seeking advice and thus fails to appreciate the real risk of the company’s defence failing.
Practically speaking, this judgment poses significant implications for company directors and their decision-making processes.
Here’s what directors need to keep in mind:
- Timely awareness is vital. Directors must vigilantly monitor potential liabilities and promptly assess any that could lead to insolvency.
- Awareness is a double-edged sword. Directors must not only acknowledge liabilities they are personally aware of (subjective test), but also those they should reasonably be aware of (objective test). Ignorance is not an option.
- Impartial assessment is key. Directors must set aside personal motivations when assessing likelihood and potential impact of a liability.
- Maintain proactive decision-making. The duty to consider creditors’ interests is not a passive obligation. Directors must proactively assess and take appropriate action in a timely manner.
- Professional advice is critical. Seeking professional advice provides an unbiased perspective and ensures that decisions are made in the best interests of the company and its creditors.
The Hunt case has firmly established that the creditor duty is a dynamic concept, intricately tied to the company’s financial health and the directors’ awareness of potential challenges.
It is essential to note that not all disputed claims will fit neatly into the parameters set by this case. Each claim must undergo individual scrutiny to ascertain the nature of the underlying liability.
As we move forward, the implications of this decision will continue to shape the contours of directorial responsibility in the face of insolvency, not only in England and Wales, but potentially in jurisdictions worldwide, including Bermuda.
First Published in The Royal Gazette, Legally Speaking column, September 2023
For further information, please contact:
Ligaya Sanchez-Wilson, Appleby
LSanchez-Wilson@applebyglobal.com
