Directors’ duties in times of economic uncertainty: an Anglo-French comparison

For companies in financial difficulty, there is added scrutiny on how their businesses have been conducted and, in particular, the extent to which directors have complied with their duties. In a worst-case scenario, directors are potentially exposed to personal liability for their actions following an insolvency event. It is therefore critical that directors understand the scope of their duties, how to comply with them, and the various steps they can take to minimise the risk of claims being made against them.

On 5 October 2022, the UK Supreme Court handed down its judgment in the case of BTI v Sequana. This marked the first time that the Supreme Court had ruled on whether a “creditor duty” exists in English law. Described in the judgment as a momentous decision, the court confirmed that such a duty does exist. Delivered at a time of widespread global economic challenges, the judgment also serves as a timely reminder of the importance of considering directors’ duties, their potential personal liability and at what point the need for directors to consider the various stakeholder interests shifts.

In those circumstances, we consider the position under English law and French law and the various differences in directors’ duties and liabilities in each jurisdiction.

Whose interests should directors be concerned about? 

In the normal course of running a company, under English law, the Companies Act 2006 is clear that directors must act in a way that they consider, in good faith, would be most likely to promote the success of the company for the benefit of its shareholders as a whole. Due to this duty, it has widely been accepted that when discharging their duties, the interests of the shareholders should generally be the directors’ primary consideration.

In Sequana, the Supreme Court held that this duty is modified in certain circumstances by the common law, so that the company’s interests are taken to include the interests of its creditors as a whole. The Supreme Court stressed that this is not a new free-standing duty, but a modification to the existing duty directors owe to the company. That modification is not engaged until the directors know or ought to know that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable.

The Supreme Court suggested that once the creditor duty is engaged, it can be viewed in terms of a “sliding scale”, meaning that the weight to be given to the interests of creditors will increase as the company's financial difficulties become increasingly serious, and only once an insolvent liquidation or administration is inevitable are creditors' interests paramount. Nonetheless, the judgment was not clear on exactly how close to insolvency this duty is triggered and there was some disagreement on whether the directors’ knowledge of the company’s financial position should be a factor. As each matter is likely to be fact specific to the relevant company in financial distress, prudent directors will need to seek advice at the appropriate time on the scope of their duties, whose interests are to be preferred in the particular circumstances and how that balance may shift as the position improves or deteriorates.

Under French law, while directors must act in good faith, their most important duty is to act in the best interests of the company itself. 

They are also bound by a duty of loyalty towards shareholders of the company. This duty requires directors to provide the shareholders with all necessary and adequate information on the conduct of the business of the company. 

Directors should also consider the interests of third parties, even if ostensibly the directors are making decisions for the company and in its name only. If an interested third party suffers loss that arises from its interests being wrongly disregarded by the directors, the company may be liable to that third party. 

The personal liability of the directors will only be engaged in specific circumstances. 

Can directors be personally liable when a company is in financial difficulties and on what grounds?

Under English law, limited companies exist as separate legal entities.  A company, not its directors, is responsible for its own debts and liabilities. Should a director, however, be found to have breached any of their duties or responsibilities, the administrator or liquidator can bring a claim against the director in the name of the company. Such claims may be brought against registered directors and de facto directors (a person who assumes responsibility to act as a director, although never actually appointed as such).

Sequana concerned a situation where directors approved a distribution to shareholders without having regard to the interests of creditors. The Supreme Court found that at the relevant time, the creditor duty had not arisen, and so the distribution decision could not be impugned. If, however, the company had been insolvent or bordering on insolvency, or had an insolvent administration or liquidation been probable, at the time of the decision the directors should have had regard to creditors’ interests, and hence it is likely that approving the distribution would have been a breach of duty. That breach would have given rise to claims by the liquidator against the directors personally.

There are also other grounds under which directors can be held personally liable under English law when a company is insolvent or approaching insolvency and these include, but are not limited to:

Wrongful Trading – If a director knows or ought to know that there is no reasonable prospect of the company avoiding an insolvent liquidation or administration, they continue to allow the company to trade after reaching that conclusion, and do not take every step to minimise the loss to the creditors, the director can be held personally responsible for the company’s debts.

Fraudulent Trading – If a director manages a company with the intention of defrauding creditors, and it can be shown that there was actual dishonesty on the part of the director, the director may be required to contribute to the company’s assets available for distribution to creditors. The director may also face criminal charges as fraudulent trading is a criminal offence.

Misfeasance – If a director has misapplied, retained, or become accountable for company assets, or has wrongly exercised their authority, the English court may order the director to repay, restore or account for the money or property with interest or contribute such sum to the company's assets by way of compensation as the court thinks just.

In France, once the company becomes insolvent, the directors’ liability can be sought in order to sanction them in the event of misconduct that contributed to the cessation of payments (the point when the company is not able to pay its debts with its available assets). The action will be brought by the judicial administrator or liquidator on behalf of the company against the legal directors or the de facto directors, if it is demonstrated that the person has indeed had an influential and independent leadership role. 

Under French law, as soon as the insolvency procedure is commenced, the creditors are all represented by the judicial representative who has sole power to pursue the directors’ liability on behalf of the creditors or third parties. 

However, an independent creditor can pursue a director for personal liability if they can demonstrate that (i) they have suffered from a loss that is distinct from the loss suffered by the community of creditors (i.e. a loss that is different from a simple debt recovery, or loss of value of company shares in relation to the insolvency procedure); and that (ii) the director committed misconduct detachable from their functions (i.e. misconduct outside the normal exercise of their functions as a director). 

Upon insolvency, the liability of directors can be pursued on several grounds: 

Liability action for lack of assets (as provided for in articles L. 651-2 to L. 651-4 of the Commerce code) – this action is an indemnity action, the purpose of which is to repair the damage suffered by the legal person, with the aim of punishing the director who led the company to default, by ordering them to cover fully or partially the company’s debts. This claim can, however, only be brought in cases of liquidation. 

In this context, the lack of assets is defined as the difference between liabilities and assets, by taking into account all liabilities with all assets, whether contingent or actual. 

The fault committed by the director that led to the lack of assets may be any fault committed in the general management of the company (i.e. either an action or omission), but it must have been committed before the start of the insolvency proceedings. 

For instance, the payment of dividends in the context of a takeover operation exposes the director to liability for lack of assets when the distributing company is subsequently placed into judicial liquidation because of the resulting reduction in reserves (Com., 9 September 2020, n°18-12.444). 

However, the director will not be liable if the act is merely simple negligence, or if a loss-making activity is continued while another activity of the company compensates for it. 

This action cannot be sought in conjunction with a general civil liability action against the director, but it can be exercised in parallel with the individual action of the creditor for the individual damage suffered as a consequence of the personal fault of the director that is distinct from the normal exercise of their function. 

Personal insolvency bankruptcy (as provided for in articles L. 653-4 and L. 653-5 of the Commerce code) is a personal sanction for the director, which entails a ban on directing, managing, administering or controlling, directly or indirectly, any commercial enterprise. Such a sanction can be applied when a director (i) has entered into, on behalf of others, without compensation, commitments that are too substantial at the time of their conclusion, given the situation of the company; or (ii) has paid a creditor, after the cessation of payments and with full knowledge of the facts, to the prejudice of the other creditors; or (iii) has abstained from cooperating with the elements of the procedure, which has obstructed its smooth running.

“Banqueroute” or bankruptcy (as provided for in articles L. 654-2 to L. 654-6 of the Commerce code) is a criminal offence that requires the existence of an insolvency or liquidation procedure. A person will be found guilty of bankruptcy if they have either embezzled or concealed all or part of the debtor's assets, fraudulently increased the debtor's liabilities, kept fictitious accounts or caused accounting documents to disappear, or kept manifestly incomplete or irregular accounts. The prosecution is carried out by the public prosecutor's office before the criminal court. 

Do all creditors need to be treated equally?

Under English law, during the insolvency process, the insolvency practitioner has a set priority order that must be followed when distributing the assets of the company. There are a certain number of classes to which payments must be distributed (i.e. secured creditors, floating charge creditors, unsecured creditors), ensuring that equal payments are made to each creditor in any given class.

Prior to any insolvency, the directors have a similar duty to ensure that they do not pay any creditor in preference to any other, in order to safeguard the principle that all creditors in a specific class have a right to be treated equally.

Under the Insolvency Act 1986, a company is said to have given a preference if the company does anything which has the effect of putting a creditor into a position, which, in the event of the company going into insolvent liquidation, will be better than the position he would have been in if that thing had not been done, and thus, becomes a detriment to the other creditors who have equal rights. Payments within two years of the date of insolvency could be preferential if made to a connected party. Otherwise, the time limit is six months. The English courts will consider both the timing and the value of the action, which could include releasing a guarantee, repaying a debt that is guaranteed by the director and repaying a loan to a person connected to the company.

The preference might be given to the timing of the payment as well as to the value.

Upon insolvency, the insolvency practitioner can apply to the court for any preferential payments to be set aside, resulting in the director becoming personally liable for those debts.

Under French law, there is a difference between creditors whose claim appeared before or after the commencement of the insolvency procedure. 

Creditors whose claims are posterior to the commencement of the proceedings are considered to be undertaking services that make it possible for the company to continue operating. They are therefore paid with preference, on the date the claim is due. For instance, there is a “super-privilege” for employees who are to be paid first and justice fees also benefit from a privilege, so that they are paid with priority. 

Creditors with a claim that arose before the start of the insolvency procedure should declare their claim within two months of the commencement of the procedure, so that the validity of their claim can be verified. Once the admissibility of the claims has been confirmed by the judge, there is a specific order in which assets must be distributed, as provided by article L. 643-8 of the Commerce code. Employees, the tax administration, and creditors who already benefit from a guarantee or a security attachment are considered priority creditors. 

With regards to the directors’ duties specifically, certain similarities can be drawn between the English duty against preferential payments and the aforementioned article L. 653-5 of the Commerce code. This article similarly prohibits directors from paying creditors in a manner that prejudices other the creditors when the company is in financial difficulties. 

Conclusion

Where a company is in financial difficulties and the directors are concerned about the position of the company, they should seek advice as soon as possible in order to avoid any potential personal liability and to identify the options available for the company. As acknowledged in the Sequana judgment, this is “an area of law which is in the course of development, and many aspects of which remain controversial …”  and the specific actions to be taken by directors will depend on the facts and circumstances of each case and company.

As a general rule, whether under French or English law, directors should always keep the best interests of the company at the forefront of their minds (with creditors’ interests becoming relevant and increasingly more important as the financial situation deteriorates, under English law), but they should also be aware that their decisions may expose them to personal liability if they are made in breach of their duties.  Those duties and decisions are likely to come under increased scrutiny for certain companies facing challenging economic headwinds.