Director’s Duties: where to draw the line with creditors?

Directors play a crucial role in the governance and management of companies in Hong Kong. As fiduciaries entrusted with significant responsibilities, they are bound by a set of duties designed to ensure transparency, accountability, and the protection of shareholders’ interests.

But where do we draw the line where creditors are in the background? Do directors owe duties to them during the course of making business decisions? A revisit of the landmark case of BTI 2014 LLC v Sequana SA and others [2022] UKSC 25, the UK Supreme Court establishes the existence, triggering conditions, and the content of the directors’ duty to consider or act in the interest of the company’s creditors (labelled by Lord Briggs as the “Creditor Duty”).

Q1. What is the landmark case governing these principles?

In BTI 2014 LLC v Sequana SA and others [2022] UKSC 25, the company in question paid a substantial dividend of nearly all its net assets to its parent company. At the time the dividend was declared and paid, there was a potential future liability (the exact amount of which was unknown, and therefore a contingent liability) in respect of environmental / pollution clean-up costs. The dividend was paid in accordance with the Companies Act 2006 in the United Kingdom and the company was solvent at the relevant time.

At the time the company declared dividends, and whilst the company was solvent, there was a real risk, although not a probability, that it might become insolvent at an uncertain but not imminent date in the future.

9 years later, the company went into insolvency. The claimant sought to recover an amount equivalent to the dividend from the company’s directors on the basis that their decision to distribute the dividend was a breach of their duty to consider the interests of the creditors. As the claimant could only show that there was a real risk of insolvency when the dividends were made, the Creditor Duty was not engaged in this case and the Court declared that the dividend was lawful (§161).

As soon as the Creditor Duty arises, directors should have regard to creditors’ interests but creditors’ interests do not become paramount until insolvency is inevitable (§176).

Q2. How have these principles been considered in Hong Kong?

Yes – under Hong Kong case law, the same concept and decision was considered and accepted in Cyberworks Audio Video Technology Ltd (in Compulsory Liquidation) v Mei Ah (HK) Co Ltd. [2020] where The Hon. Coleman J stated the following:

• “…it is important to identify at what point commercial considerations other than the fact of actual or near balance sheet insolvency come into play. On the authorities, I accept that once the directors of a company know or ought to know that the company is or is likely to become insolvent, the creditors’ interests duty is triggered. But, it is then necessary to consider whether there has been any breach of the duty. It may be that the creditors’ interests were best served by a continuation of trading, for example where negotiations for a refinancing or debt restructuring continued. But the directors’ view of matters such as that go only to whether or not the duty was breached, not to whether it was triggered.” (71)
• “That is because the existence of the duty and potential breach of it are two separate matters. The duty arises on a given set of facts, namely that the directors of a company know or ought to know that the company is or is likely to become insolvent. The duty, once it arises, cannot be ignored. But it might be addressed in a way which identifies that the duty has not been breached. Those ways might include looking at the bigger commercial picture and the commercial realities.” (72)

Q3. How has this principle been expanded in Hong Kong?

Yes – this principle was also considered in Wing Hong Construction Ltd v Hui Chi Yung and Others [2020] where DHCJ Abraham Chan SC stated:

“On the “likely to become insolvent” trigger, the parties agree that “likely” in this context goes beyond the mere possibility of insolvency and means “probable”. So at its lowest reach, the triggering threshold for the creditors’ interests duty is where the directors objectively should know that the company’s insolvency is probable. It is unnecessary to prove actual knowledge of present insolvency. It suffices that a reasonable person in the directors’ position at the time would have appreciated that the company was likely to become insolvent.” (163)

Q4. What about case law in other jurisdictions?

In Yan v Mainzeal Property Construction Limited (in liquidation) [2023] NZSC 113, the Supreme Court of New Zealand set out helpful guidance on directors operating financially distressed businesses. The Supreme Court of New Zealand provided guidance on what directors must do or not do to avoid potential liability for breach of the statutory duties engaged on a company’s insolvency. Briefly, the decision has set out, inter alia, the following principles for directors:

• Directors have a continuing obligation to monitor the performance and prospects of their company; (§270)
• Directors should squarely address the future of the company if that monitoring reveals that by reason of the company’s solvency position, or other adverse factors, there is:
  1. potential for substantial risk of serious loss to creditors; or
  2. doubt as to whether there is a continuing reasonable basis for belief that obligations to be incurred will be able to be honoured; (§270)
• Should any such potential or doubt exist, directors must decide how the potential for breach of their duties can be avoided; (§271)
• Directors may need to take professional or expert advice from sources independent of the company; (§271)
• If deciding what course of action to take, directors should deal directly with the issues that have given rise to the concern. They should determine whether the associated risks can be eliminated or sufficiently managed and mitigated under a plan for continued trading that offers a reasonable basis for concluding that:
  1. there is not a substantial risk of serious loss to creditors; and
  2. they can be confident that obligations incurred will be honoured; (§271)
• The courts must apply a standard of reasonableness when assessing the decisions of directors, such that:
  1. in relation to decisions to trade on, the courts will accept that business judgment is involved; and
  2. the courts will allow a reasonable time for directors to assess risk, review the options to meet that risk and decide what course to take, including time to take advice. (§273)
• Where advice has been taken, this must be factored into an assessment of the reasonableness of the directors’ actions. (§273)

Q5. What are the most important takeaways?

It is prudent for directors to take into account liabilities of the company when making business decisions which may affect the company’s ability to satisfy their future payment obligations, creating risk of serious loss to existing creditors – professional or expert advice should always be sought and obtained before any such decision is implemented. As a general rule, directors have a continuing obligation to monitor the performance and prospects of the company, ensuring that good corporate governance is maintained, ensuring transparency, accountability, and the protection of shareholders’ interests. Given the current ever-changing economic climate, these considerations will become highly relevant for companies operating in Hong Kong.