Will Paying That Dividend Affect the Director’s Duty to Creditors?

Small business accountants examine sheets of reports and are engrossed in a discussion regarding financial affairs featuring graphical representations, a calculator, and a laptop on a table.

Do company directors have a duty to their creditors? They do have a duty to their shareholders.

A recent UK Supreme Court case (its highest court) confirmed the existence of a duty owed by directors of a company to creditors of that company in certain circumstances (creditor duty) and this has implications for Australian companies and their directors.

When can a company pay a dividend?

Section 254T (1) of our Corporations Act 2001 states that a company must not pay a dividend unless:

  1. the company’s assets exceed its liabilities immediately before the dividend is declared and the excess is sufficient for the payment of the dividend; and
  2. the payment of the dividend is fair and reasonable to the company’s shareholders; and
  3. the payment of the dividend does not materially prejudice the company’s ability to pay its creditors.

Before the decision in BTI (2014) LLC v Sequana SA and Others [2022] UKSC 25 there was still some uncertainty whether directors of a solvent company owed any duty to the creditors or only a duty to the company and its shareholders.

In this case a large dividend was paid by a company to its only shareholder at a time when the company was solvent, but there was a risk that the company might become insolvent in the medium-to-long term future.

The company became insolvent 9 years later and BTI (2014) LLC, one of the company’s creditors, sought to recover the dividend on the grounds that the director’s decision to pay the dividend was a breach of their duty to creditors.

What factors are relevant for creditor duty?

The UK Supreme Court held that the creditor duty is extended to the director’s decision to pay a dividend and that the relevant factors to determine whether the creditor duty exists include:

  • whether a proposed course of action will enable the company to return to being solvent,
  • whether shareholders or creditors will suffer the greater damage if a course of action does not succeed,
  • the closer a company is to insolvency, the greater the weighting to the creditor duty.

On the facts of this case, the court held that, notwithstanding a creditor duty does exist, in this case it was not relevant or actionable as the company was solvent at the time of the dividend being declared and nowhere near being insolvent as the company did not enter liquidation until 9 years after the payment of the dividend. A relief for the directors in this case!

Other implications for directors

While this case was found for the directors, one possible implication from the case was that creditors who are not paid in full by an insolvent company in liquidation may be able to pursue the directors personally for their loss in circumstances where the insolvent company has paid excessive dividends in prior years, especially if they had been paid in recent years. This could further expand the potential for directors to be held personally liable for the debts of the company.

If you are concerned as to whether a decision to declare a dividend may expose you to a duty to creditors don’t hesitate to contact your client manager to discuss.

Kreston Stanley Williamson

Author – Zane Grigg

*Correct as of 25 January 2023

*Disclaimer – this article has been produced by Kreston Stanley Williamson as a service to its clients and associates. The information contained in the article is of general comment only and is not intended to be advice on any particular matter. Before acting on any areas contained in this article, it is imperative you seek specific advice relating to your particular circumstances. Liability limited by a scheme approved under professional standards legislation.

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