In a series of articles, we explore issues and some practical matters that directors should be considering at this time.
The COVID-19 pandemic presents many issues for company directors. One question that arises is the extent to which directors owe a duty to consider the interests of creditors of the company and, if so, what such a duty requires. Further, the COVID-19 pandemic will shape the standard expected of directors in relation to their deliberations and decision-making, and directors should take steps to understand the risks and opportunities the COVID-19 pandemic presents to the company.
In a recent article,1 ASIC Commissioner John Price refers to the evolving circumstances surrounding COVID-19 and notes that at this time directors and officers:
“will need to carefully reflect on their fundamental duties to act with due care, skill and diligence and to act in the best interests of the company. This will include reflection on which stakeholders’ interests need to be factored into decisions – including employees, investors and creditors.”
In his article, Commissioner Price refers to the new section 588GAAA of the Corporations Act 2001 (Cth), which provides relief for directors from potential personal liability for insolvent trading, where certain criteria are met. However, Commissioner Price observes, correctly, that whilst temporary relief is provided from the insolvent trading provisions, that relief does not extend to relief from statutory and common law directors duties. According to Commissioner Price:
“These include the duty to act in the best interests of the company as a whole (which can involve directors taking into account the interests of stakeholders beyond shareholders including creditors when the company is in financial distress).”
The issue of whether, and when, directors owe a duty to consider the interests of creditors of the company is not straightforward.
The High Court has made clear that directors do not owe a duty directly to the company’s creditors.2 However, current Australian authority suggests that directors, in discharging their duty to act in the best interests of the company, must “take account of” or “consider” the interests of its creditors, in some situations.3
This duty to “consider” the interests of creditors raises a number of difficult questions, including:
- what financial state the company must be in for the duty to arise. It seems to be accepted that the duty is not triggered if the company is clearly solvent, but beyond that there is a lack of certainty as to the degree of financial distress or instability that must exist. Some judges have used the expression “insolvency or near insolvency”, which just raises the question of what “near insolvency” means. Others have suggested that directors may owe a duty to creditors when they are aware of a “real and not remote risk of insolvency”;
- do the interests of future, or prospective, creditors need to be considered, or is it just existing creditors?
But more fundamental issues arise as well. In particular, there is an absence of guidance regarding the weight to be given to creditors’ interests, beyond them needing to be ‘considered’.
As Kenneth Hayne AC QC has observed,4 the suggested duty to “consider” or “take into account”, is expressed as only an obligation about the process of decision-making, not an obligation regarding the kinds of decision that may or may not be made:
“It says that, in some circumstances, directors must consider the interests of the company and that those interests include the interests of some creditors. But no explanation is proffered for why acting in the best interests of the company requires a particular process of decision-making in which the interests of a particular group are ‘considered’ …The supposed duty, in its terms, is not directed to limiting the way in which directors may exercise their powers. Rather, it is expressed as no more than a counsel of prudence.”
Hayne goes on to note that if something more is meant, then the statement that:
“creditors’ interests should be ‘considered’ is masking an obligation radically different from those conventionally understood to attach to the office of director.”
To the extent that the duty does bear upon the kinds of decisions that may or may not be made, it is also unclear how creditor and other stakeholder interests should be reconciled in order to determine if a decision is or is not in the best interests of the company.
It may be that the High Court will get the opportunity, at some stage, to clarify this difficult area of law.
For present purposes, during this time of significant financial instability, directors should approach their duty to act in the best interests of the company on the basis that the best interests of the company will depend on various factors including the solvency of the company.5 As a company gets closer to insolvency, this can require more careful consideration of other stakeholders’ interests, including creditors.
In a subsequent article, we will address other key considerations for directors that arise from the COVID-19 pandemic.
- Spies v R (2000) 201 CLR 603 at .
- See, eg: Walker v Wimborne (1976) 137 CLR 1 at 7; Geneva Finance Ltd v Resource & Industry Ltd (2002) 169 FLR 152; Kinsela v Russell Kinsela Pty Ltd (in liq) (1986) 4 NSWLR 722 at 732; Kalls Enterprises Pty Ltd (in liq) v Baloglow (2007) 63 ACSR 557 at 
- Hayne, K M --- "Directors' Duties and a Company's Creditors"  MelbULawRw 28; (2014) 38(2) Melbourne University Law Review 795.
- Angas Law Services Pty Ltd (in liq) v Carabelas (2005) 226 CLR 507, 532 .
The contents of this publication, current at the date of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2020