Difficult decisions might arise at board level as duties shift to interests of creditors - Jordan Gray
In December, the British Chambers of Commerce (BCC) said it did not expect the UK economy to return to growth until the final quarter of 2023. While inflation is forecast to slow to around five per cent by then, the BCC predicted a sluggish recovery with business investment, exports and household consumption all expected to remain subdued until later this year.
In the face of this continuing economic uncertainty and fresh on the heels of the turbulence created by the global pandemic, many companies have come under huge pressure with some inevitable consequences. More than 5,500 insolvencies were recorded in England and Wales in the third quarter of 2022, a 40 per cent increase year-on-year from the same period last year. Meanwhile a smaller yet still significant rise in Scottish insolvencies - up nearly 20 per cent in the third quarter of 2022 compared to the previous year – highlights the challenging trading conditions and wider market volatility that many businesses here currently face.
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Hide AdWith the BCC and other organisations forecasting tough times ahead for at least the first half of 2023, the risk of rising insolvencies remains a major concern. Directors face difficult decisions within a challenging and complicated landscape driven by both domestic and global factors.
The current energy crisis fuelled by the war in Ukraine continues to impact UK companies. The Government’s announcement that it will cut around 85 per cent of UK business energy aid at the end of March could bring added financial woes.
Brexit also continues to increase pressure on businesses and their supply chains while inflation currently remains at its highest rate in decades, putting a squeeze on household spending and leaving the UK with the biggest reduction in disposable incomes since the 1950s.
These factors combined with skills shortages that some key sectors are facing make for a difficult enough start to the new year. Now a further emerging issue for many businesses to contend with is the increase in regulatory burdens and obligations related to ESG (Environmental, Social, and Governance) requirements driven by both corporate customers and consumers. These can often carry significant legal implications which require careful management.
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Hide AdIn October, the Supreme Court handed down a decision in the long awaited Sequana case. This marked the first time that the UK’s highest court had been asked to reflect on the proposition that directors are, in certain circumstances, under a duty to consider creditors’ interests as distinct from shareholders’ interests.
The judgement ruled that the ‘creditor duty’ is not engaged when a company only faces a risk of insolvency but rather when it is insolvent or bordering on insolvency. With that said, it remains open to argument how probable insolvency needs to be to trigger the duty. The directors’ knowledge of a company’s financial position is a key factor to be considered when assessing their duties in such circumstances.
Following on from this case, a director’s duty has now shifted. When a company is on the verge of insolvency, a director is duty-bound to consider the best interests of its creditors in addition to its shareholders and, possibly, to give them priority. Directors must balance the steps they must take to keep the company going with their obligations to creditors. This is challenging when a company faces conflicting demands from its customers, supply chain, shareholders, and creditors.
We now operate in a world where ESG requirements, along with other socially-focused obligations, come attached to business loans, commercial property leases and equity investments. While adhering to these is demanding enough for a company that is commercially viable, the current economic landscape and the rising costs that many businesses are facing will make this a significant burden for those which are struggling. If compliance does not improve a company’s bottom line it may not be in the best interests of its creditors.
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Hide AdDifficult decisions and disagreements might arise at board level as duties shift to the interests of the creditors. It’s therefore crucial that directors seek early advice to help them navigate through this increasingly complex landscape and avoid the prospect of legal sanctions.
Jordan Gray is an Associate at CMS