In a previous article “Do directors owe any duty to creditors (and when does the duty arise)? Key takeaways from recent UK Supreme Court decision in BTI 2014 LLC v Sequana SA and others [2022] UKSC 2” , José-Antonio Maurellet SC and Michael Lok discussed the UK Supreme Court’s seminal decision in BTI 2014 LLC v Sequana SA and others [2022] UKSC 25.
In the recent decision of Foo Kian Beng v OP3 International Pte Ltd (in liquidation) [2024] SGCA 10 (dated 27 March 2024), the Singapore Court of Appeal upheld a director’s breach of duty by authorising the payment of a dividend and the repayment of a loan to himself. The decision, considering Sequana, sheds further important light on the directors’ duty to consider or act in the interest of the company’s creditors, coined as “creditor duty”.
The Facts – Briefly Stated
OP3 International Pte Ltd (“OP3”) was ordered to be liquidated on 3 April 2020 arising from its failure to satisfy a judgment sum by which it was ordered to pay in a lawsuit commenced in 2015 (“Lawsuit”). Mr Foo Kian Beng (“Mr Foo”), the sole director and shareholder of OP3, caused the company to pay him dividends and to repay loans that he had earlier extended to the company between 2015 and 2017, when the Lawsuit was ongoing. The liquidators of OP3 brought a claim against Mr Foo, alleging that he breached his duties as a director in authorising the payments to himself, and sought to recover the sums paid to Mr Foo during that period.
At first instance, the High Court found that OP3’s potential liability under the Lawsuit was reasonably likely to materialise when the Lawsuit was commenced in 2015. Mr Foo could not reasonably have believed that OP3 would not face any liability. OP3 was in a financially precarious state because of the contingent liability and the director was obligated to consider the interests of the company’s creditors. The first instance judge ruled that the director breached his duty by prioritising his own payments over the claims of other creditors. The decision was upheld in the Court of Appeal ([124], [148]). Mr Foo failed to consider the interests of creditors in breach of creditor duty since the payments “singularly enriched Mr Foo at the expense of OP3’s creditors” ([153]–[154]).
Key Takeaway 1: the rationale of the creditor duty is that creditors displaced shareholders as major stakeholders in insolvency
To discharge the duty to act in the best interests of the company, directors always need to have regard to the interests of different stakeholders, including creditors. The rationale underpinning the creditor duty is that whereas shareholders’ and creditors’ interests are generally aligned when the company is solvent, an insolvent company effectively trades and conducts its business with its creditors’ money such that the creditors become the main economic stakeholders (when the shareholders essentially have nothing to lose) while having no control over the company’s business. Therefore, the law seeks to respond to the “misalignment of incentives” by requiring directors to make corporate decisions with the interests of creditors in mind ([69]-[70], [72]).
Key Takeaway 2: the analysis is two-fold: (1) whether the creditor duty has arisen, and (2) whether the creditor duty has been breached
The real question for breach of creditor duty is “whether the director exercised his discretion in good faith in what he considered to be in the best interests of the company, as understood with reference to the financial state of the company” ([74]-[75]). The Court will approach the claim by asking two distinct questions i.e. (1) whether the creditor duty was engaged in the first place, and (2) whether the creditor duty has been breached. The former question will help determine the weight a director ought to attribute to the interests of creditors when making decisions for the company ([93]-[95]).
On the first question, the Court objectively determines what was the financial state of the company at the time of the impugned transaction taking into account all surrounding circumstances, including the impugned transaction. This is categorised into three stages: (1) the company was solvent, (2) the company was imminently likely to be unable to discharge its debts, or (3) where corporate insolvency proceedings were inevitable ([103]-[105]).
On the second question, the Court will examine the subjective bona fides of the director ([106]).
- Where the company is solvent, the creditor duty does not arise as a discrete consideration as a director typically does not need to do “anything more than act in the best interests of the shareholders” to comply with his fiduciary duty.
- Where in the intermediate zone the company is likely to be unable to discharge its debts, the Court will scrutinise the director’s intention “with reference to the potential benefits and risks that the relevant transaction might bring to the company”. The Court will be slow to second-guess the honest, good faith commercial decisions made by a director to revitalise the company. However, “the greater the extent to which the transaction is one which exclusively benefits shareholders or directors (and does not benefit the company as an entity), the more closely a court will scrutinise the decision of the director”.
- Where corporate insolvency proceedings are inevitable, the creditor duty prohibits directors from authorising corporate transactions that “have the exclusive effect of benefiting shareholders or themselves at the expense of the company’s creditors, such as the payment of dividends”.
Key Takeaway 3: the statutory regime does not affect the company’s ability to sue for breach of creditor duty
First, a claim for breach of the creditor duty predicated on the wrongful payment of dividends overlaps to some extent with a claim for statutory breach of s 403(1) of the Singapore Companies Act which provides that dividends are payable from profits of the company only (similar restrictions on distributions can be found in s 297 of Companies Ordinance (Cap.622) for Hong Kong and s 830 of Companies Act 2006 for the United Kingdom). However, the claims are distinct and the fact that the company is not entitled to sue under the Companies Act will not affect the company’s standing to pursue a claim for breach of creditor duty ([110]-[114]).
Secondly, the statutory unfair preference regime does not operate as a fetter on a company’s ability to bring a claim for breach of the creditor duty, even when the prevailing statutory clawback period has expired. The statutory clawback periods concern the interest of finality of transactions which is not engaged in an action for breach of creditor duty which is brought against a director personally ([116]-[118]).
Comparing with the approach of the UK Supreme Court in Sequana
The two apex Courts spoke in one voice on the nature and doctrinal basis of creditor duty ([60], [72], [89]). The objective assessment of the financial state of the company also echoes Lady Arden’s approach in Sequana of considering whether the directors plan to enter into a transaction which would place the company in a situation where the creditor duty is ordinarily engaged (Sequana [279]; Foo [103]). The Court of Appeal further agreed with the majority in Sequana on circumstances rendering the interests of creditors paramount i.e. “a clear shift in the economic interests in the company (from the shareholders to the creditors as the main economic stakeholders of the company) would occur where insolvent liquidation or administration…is inevitable”, ([105(c)]; Sequana [86] c.f. Lord Briggs opined that conversion took place only at the “onset of liquidation itself”[164]-[165]). Both Courts prefer a flexible assessment of the company’s financial state in light of the rationale and context of creditor duty, as opposed to adopting a stringent and technical test of solvency.
Conclusion
This case clarified the nature and content of the creditor duty, and how the Court will go about assessing the weight to be given to creditors’ interests, depending on the financial status of the company. This highlights the importance of directors fulfilling their fiduciary duty to act in the best interests of the company, especially in financially precarious situations, which extend to the interests of creditors.
