The Legal Position of a Director Is That of Creditor

As noted above, directors and officers generally have fiduciary duties to the Corporation and its shareholders. However, if the company becomes insolvent, creditors also have fiduciary duties. The standard of care for managing directors and executives is not clear in extended insolvency situations. Some courts have applied the commercial judgment rule to the actions of directors and officers in such situations, while others have concluded that the best interests of creditors prevail. The Delaware Court of Chancery has held that the commercial judgment rule applies even though the law recognizes that the duties of directors and officers include the interests of creditors.9 The commercial judgment rule creates a presumption that the actions of directors and officers are in good faith and in the best interests of the Corporation. The commercial judgment rule therefore provides directors and officers with some protection against liability risk under the deepening insolvency theory. However, the rule cannot fully protect directors and officers from liability, especially since directors and officers in the insolvency area may be subject to a different standard. It was agreed that the obligation to creditors should be to treat creditors as a class. This is partly because individual creditors are in different positions and may even have conflicting interests.

It also recognizes that the composition of creditors as a whole can change as long as debts are incurred and settled. However, the content of the obligation to creditors is not the same in all these circumstances. In the event of imminent insolvency or participation of the company in insolvency proceedings, the obligation to creditors is at the forefront. Thus, when acting in the best interests of the company, the interests of creditors and not the interests of shareholders must be taken into account. Section 172(1) of the Companies Act 2006 requires directors to act in a manner that they believe to be in good faith and to promote the success of the corporation for the benefit of its members as a whole. The creditor rule is a customary legal obligation and does not replace this legal obligation, but amends it (in the above circumstances) to require directors to consider the interests of creditors as well as the interests of shareholders. Documentation of relevant decisions, including the facts considered (including, where applicable, the financial situation of the company and its creditors). Diversified portfolios often mean companies in several different jurisdictions (and this may even be the case within a corporate group), so differences in the standard of directors` duties between these jurisdictions can be very relevant. With all the signs of a global economic slowdown, these tariffs could soon be put to the test. Of course, the clarity this brings is important, but not necessarily revolutionary. The existence of this so-called “creditor`s obligation” was already as good as confirmed in cases such as West Mercia.

[3] The Supreme Court`s decision therefore represents the culmination of this development of the common law. However, what the court gave less certainty and deliberately left room for future development was the decision on the content and scope of the creditors` obligation. The existence of this obligation vis-à-vis creditors implies that the directors of companies in financial difficulty must ensure that the interests of creditors are taken into account alongside shareholders and that the interests of creditors take precedence over the interests. Expert insolvency advice is becoming increasingly important as the financial situation deteriorates. However, the SC`s apparent preference for analyzing potential violations on a case-by-case basis should give administrators some respite. If a reasonable, fact-based argument can be made for decision-making, directors` decisions need not be held liable. Of course, the interests of creditors will not replace the interests of shareholders at the first sign of financial difficulties. At this stage, the interests of creditors are at the forefront. The Supreme Court recently considered the existence of the “creditor`s obligation” and the timing of its appearance in BTI v. Sequana. The obligation of creditors is the duty of the directors of the company to consider the interests of the company`s creditors if the company becomes insolvent or is effectively threatened with insolvency.

Can members ratify the acts of directors in violation of creditors` obligations? Let us say you are a director of a distressed company that owns and operates a small business that has suffered significant losses over the last three years and is struggling to keep up with its creditors. She and the other directors, as well as management, are considering seeking bankruptcy protection, but believe that if the company can continue to operate for another 12 months, it will break even and its prospects will be brighter. You and the rest of the board approve certain measures, including taking on additional debt secured by the company`s last remaining unencumbered assets, which will allow the company to limp for another 12 months. Unfortunately, these measures proved unsuccessful a year later and the company is worth much less in terms of liquidation value than a year earlier. Did you create personal liability by prolonging the agony of the business, which resulted in a loss of value for its creditors in bankruptcy proceedings? This is due to a director`s duty to act in good faith and exercise discretion in good faith and in the best interests of the corporation as a whole. The Supreme Court of the United Kingdom recently handed down a decision in BTI v. Sequana, which deals with the powers and duties of corporate directors. The appeal was expected to be of considerable significance. It should be borne in mind that there is some uncertainty as to whether (and if so, how and to what extent) the COVID-19 pandemic – arguably a truly unique event with extreme global implications – may influence the court`s approach to creditors` rights (or otherwise). It is also possible that, in the face of the pandemic, legislation will be adopted that affects the rights of creditors.

Given the rapidly evolving events related to the pandemic, we expect that there will soon be further developments that will feed into the analysis – and current findings may need to be updated based on these subsequent developments. Directors and officers must also understand and closely monitor the Corporation`s financial position as insolvency approaches. In this regard, directors and officers should apply realistic market values and be wary of accounting irregularities. The comprehensive insolvency theory was originally recognized as a theory of harm. Recently, more and more courts have recognized it as a separate cause of action – the growing bankruptcy crime. In Official Committee of Unsecured Creditors v. R.F. Lafferty & Co., the Court of Appeals for the Third Circuit held that the Pennsylvania Supreme Court could recognize the tort of aggravating bankruptcy as “a violation of the debtor`s business property by fraudulently increasing the company`s debt and extending the life of the business.” 2 In that case, it was alleged that certain third-party traders had fraudulently induced two leasing finance companies involved in a pyramid scheme to issue fraudulent bonds, which led to a worsening of their insolvency and bankruptcy.3 The court gave three grounds for recognizing aggravation of insolvency as a separate plea. He first noted that the theory was essentially valid because fraudulent and hidden debts can damage the value of the company`s assets by forcing an insolvent company into bankruptcy, creating legal and administrative costs for the business, creating operational constraints that affect the company`s ability to operate profitably and the trust of other parties dealing with the business.

shocked. Harm the company`s relationship with its employees, customers and suppliers and disperse the company`s assets.