Across the globe, the fiduciary duties of executive and supervisory (or non-executive) directors dictate that they act in the company's best interests. The vibrant economy of the last few years permitted many companies to focus nearly exclusively on growth and the creation of shareholder value. When a financial outlook dwindles, however, the content and focus of these duties shift. This may be of particular relevance in today's challenging financial climate.
In this article, we discuss how the fiduciary duty for directors of Dutch companies shifts when the outside world is changing, with a particular focus on the weighing of creditor interests when the financial outlook becomes a concern. This shift is especially relevant for directors of companies in a group, where parent and broader group interests will lose weight relative to creditor ones. We also discuss the fiduciary duty for directors of companies in the UK – traditionally a jurisdiction with a strong shareholder focus – where the UK Supreme Court recently confirmed the existence of creditor duty in its landmark ruling Sequana. We conclude with some practical guidance that may help directors navigate turbulent times and address possible financial distress.
Fiduciary duties towards creditors in the Netherlands
The corporate governance regime in the Netherlands is characterised by a stakeholder-oriented approach. In the general course of business, directors of Dutch companies must be guided by the interests of the company and its business, and in doing that consider the interests of all the company's stakeholders, including shareholders, employees and creditors. This means that these directors should consider the interests of creditors at all times, even when the company is not facing financial difficulties, although they have wide discretion in weighing the various interests involved. If a company is part of a larger group, its interests may be considered in the group context.
When the outlook of a company becomes less stable, or the going-concern assumption is even being challenged, the own interests of the relevant group company will prevail over those of the group as a whole, and creditor interests will become more important relative to equity ones. In other words: when the company is profitable and the cash flow is positive, the company should be able to pay its debts and focus largely on creating shareholder value – but if the ability to pay creditors, also in the medium term, becomes a bit uncertain, the senior ranking of those creditors over shareholders means that their interests should also outweigh the shareholders' interests in board decisions. In that situation, directors should – among other things – be especially attentive to legal limitations aimed at protecting the interests of one or more creditors, including:
- selective payment limitations: while directors of a company in financial difficulties are under no general duty to treat creditors equally, they should be aware that selective payments are only allowed under certain conditions;
- undue preference rules: once the company is in distress, it should not enter into voluntary – or, subject to certain conditions, even mandatory – legal acts that may be considered prejudicial to its creditors;
- dividend distribution limitations: before allowing dividend distributions or proposing a dividend to its shareholders meeting, the board should be satisfied that, following dividend distribution, the company will remain able to pay its debts as they fall due.
Creditor duty in the UK following Sequana
The corporate governance structure in the UK generally supports shareholder primacy. In the UK, directors' fiduciary duty to act in the company's best interests generally requires them to act for the benefit of the company's shareholders, and to have regard for matters such as the company's business relationships and employees' interests in doing so.
Over the past few decades, lower courts in the UK have supported the view that this duty to act in the company's best interests should in times of financial difficulties be understood to include the interests of the company's creditors as a whole. Only recently has the UK Supreme Court also had the opportunity to address this "creditor duty", and this led to the Sequana landmark ruling, which held that:
- when a company is insolvent or bordering on insolvency, or an insolvent liquidation or administration is probable, directors should consider the interests of creditors, balancing them against the interests of shareholders where they may conflict. A "real risk" of insolvency at some point in the future is not sufficient to engage the creditor duty;
- the greater the company's financial difficulties, the more directors should prioritise the interests of creditors; and
- if an insolvent liquidation or administration is inevitable, the creditors' interests become paramount, as the shareholders at that point no longer have any valuable interest in the company.
This ruling gives directors and stakeholders of UK companies valuable guidance on the content and engagement of the creditor duty that exists when a company is facing financial difficulties. This is particularly relevant now, when more companies may face financial difficulties. Dutch companies with subsidiaries in the UK – often structured so that the sole director of the UK company is its direct shareholder, thereby putting the creditor duty onus directly onto the (Dutch) parent company – should also take note.
While the comparison with the UK law position is an easy one, the relative weight attributed to the various interests at hand is still likely to differ between jurisdictions, and between group members. A case-by-case review will therefore continue to be necessary.
Practical considerations for turbulent times
As ever, directors should keep the company's financial position under careful review at all times and consider obtaining professional advice when concerns arise. This may help directors to manage – or even prevent – financial distress, engage with stakeholders in a timely and effective manner, and navigate their director duties in what are to them unprecedented times. Practically speaking, outside counsel will also be able to help the board to duly consider creditor interests where required under applicable law and properly document such considerations for future benefit.
Without prejudice to this general approach, directors should be particularly prudent when deciding on transactions or dividend payments that may conflict with creditor interests, as these could lead to claw-back or liability risks and, when in doubt, they should obtain advice on the issue.