This post has been contributed by Professor Christopher Riley, Module Convenor for Company law.
When a company is in good financial health, the directors’ loyalty is to shareholders. So, under s172 Companies Act 2006, directors must promote the success of the company ‘for the benefit of its members’ – meaning its shareholders.
UK law recognises, however, that this preference for shareholders is inappropriate when a company is in financial difficulties. The clearest illustration of this is found in the wrongful trading regime (in s214 Insolvency Act 1986). This requires directors, effectively, to do whatever is best for creditors – to take all steps to minimise the losses creditors may suffer as the company fails. This is a precise and demanding obligation on directors, but it arises only once the company’s difficulties are so severe that insolvent liquidation is inevitable. And this ‘point of no return’ may arise only quite late in a company’s descent into financial ruin.
It is important to remember, however, that there is another provision in UK company law that also requires directors of financially distressed companies to protect their creditors. This comes from s172 itself, because s172 changes once a company is in difficulties to include a ‘duty to creditors’. And, as the Supreme Court ruled in the important Sequana case, s172 undergoes this change as soon as insolvent liquidation is merely ‘probable’ (even if it is not yet inevitable).
The significance of this earlier ‘trigger point’ for the s172 duty to creditors (compared to the later trigger point for the wrongful trading regime) is well illustrated by recent litigation against the directors of the group of companies which ran ‘British Home Stores’, a large chain of high street shops in the UK. The main judgement in this litigation is reported at Wright v Chappell [2024] EWHC 1417 (Ch).
In April 2016, after many months of financial difficulties, BHS finally collapsed and liquidators were appointed to various companies within the group. The liquidators then brought proceedings against their directors, including both for wrongful trading and for breach of the creditors’ duty under s172.
In relation to the wrongful trading action, the court found that it was only comparatively late in the company’s difficulties – on 8th September 2015 – that the directors knew, or should have known, that insolvent liquidation had, finally, become inevitable. The directors’ wrongful trading, therefore, ran only from that date, and resulted in their having to contribute a fairly modest £6.5 million to the company’s assets.
By contrast, although insolvent liquidation became ‘inevitable’ only in September, it nevertheless was already ‘probable’ more than two months earlier, on 26 June 2015. And so, by that date directors were already subject to the creditors’ duty, under s172, exposing them to a much earlier risk of liability. On the facts, the directors were found to have breached the creditors’ duty, and for this breach they were liable to pay the company a significantly larger sum – over £110 million.
Now, it is worth noting that whilst the directors’ duty to creditors under s172 does begin earlier, it is also usually less demanding of directors (than the single-minded focus on protecting creditors that the wrongful trading provision demands, once insolvent liquidation becomes inevitable). The duty to creditors under s172 requires directors only to ‘balance’ creditor and shareholder interests, with the weight accorded to each depending on the severity of the company’s financial problems. Directors might well, for example, be found to have satisfied the duty to creditors despite having taken steps which risked leaving creditors worse off, provided their actions represented a reasonable balancing of creditor and shareholder interests.
Nevertheless, the duty on creditors is a powerful additional weapon for liquidators, and significant threat to directors, as those running the BHS group learnt to their cost.