Directors’ duties in the zone of insolvency: has the law changed?

The European Union (Preventive Restructuring) Regulations 2021 (the Regulations) were signed into law in Ireland on 27 July 2022. The Regulations provide for the transposition of the mandatory articles of Directive (EU) 2019/1023 on preventive restructuring frameworks, on discharge of debt and disqualifications, and on measures to increase the efficiency of procedures concerning restructuring, insolvency and discharge of debt (the Directive). For an overview of the key features of the Regulations, see this recent publication from our Restructuring and Insolvency team.

The Directive sets down minimum rules for Member State preventative restructuring frameworks, in order to remove barriers to effective preventive restructuring of viable debtors in financial difficulties across the EU. The Directive ensures that across the EU viable enterprises that are in financial difficulties have access to effective national preventive restructuring frameworks that will enable them to continue to operate. The aim of the Directive is not to interfere with what already works well in a Member State, but to establish an EU-wide framework to ensure effective restructuring processes that are efficient both at national and cross border level.

Implementation into Irish law

In the words of then-Minister Troy, "Ireland's examinership framework is widely viewed as an example of best practice on preventive restructuring and already complies in numerous respects with the Directive requirements".

This is why, instead of introducing a separate restructuring regime, Ireland has chosen to implement the Directive by modifying the existing examinership process. The Regulations amend Parts 5, 10 and 11 of the Companies Act, 2014 (the 2014 Act) and insert a new Part 5A to transpose the requirements of the Directive not already provided for in Irish examinership law.

New directors' duty

One change introduced by the Regulations which has attracted the attention of commentators is effected by Regulation 4, which amends the 2014 Act by introducing a new section 224A into Part 5, with immediate effect. This reads as follows:

"(1) A director of a company who believes, or who has reasonable cause to believe, that the company is, or is likely to be, unable to pay its debts (within the meaning of section 509(3)), shall have regard to –

(a) the interests of the creditors,

(b) the need to take steps to avoid insolvency, and

(c) the need to avoid deliberate or grossly negligent conduct that threatens the viability of the business of the company.

(2) The duty imposed by this section on a director shall be owed by them to the company (and the company alone) and shall be enforceable in the same way as any other fiduciary duty owed to a company by its directors."

Additionally and also with immediate effect, Regulation 5 introduces a new duty into section 228 of the 2014 Act (section 228(1)(i)): "in addition to the duties under section 224A (directors to have regard to certain matters where company is, or is likely to be, unable to pay its debts), have regard to the interests of its creditors where the directors become aware of the company’s insolvency”.

Taken together, it is now clear that directors of a company who believe, or have reasonable cause to believe that the company is, or is likely to be, unable to pay its debts have a fiduciary duty to have regard to the interests of creditors (as well as the need to take steps to avoid insolvency and to avoid deliberate or grossly negligent conduct that threatens the viability of the business as a going concern), and that this fiduciary duty in common with the other fiduciary duties in section 228 is owed to the company alone, meaning that creditors will not have a direct course of action against directors for the breach of this statutory duty.

This duty is analogous to the existing duty at section 228(h) for directors to have regard to the interests of a company's shareholders and employees, which again is owed to the company alone and does not create a direct right of action against directors for employees or shareholders for breach of this fiduciary duty.

Section 224A(1)(a) clarifies and puts on a statutory footing the existing common law duty to have regard to creditors' interests in the context of an insolvency (as opposed to the interests of shareholders). It is not immediately clear that the two further limbs at (b) and (c) provide guidance that goes further than the existing position at common law (we imagine that well-advised directors are always at pains to avoid insolvency or deliberate or grossly negligent conduct that threatens the viability of their companies) and await with interest the outcome of how these provisions will be dealt with by the courts in due course.

Directors' duties to creditors – before the Regulations

As the Department of Enterprise Trade and Employment commented in its Information Note published alongside the Regulations, "Prior to the Regulations, a directors’ duty to creditors in the period approaching insolvency, often referred to as ‘the twilight zone’, was a common law duty only and was not provided for in the Companies Act 2014 or in any statute."

It is evident that the codification of this duty echoes a line of cases going back to the Supreme Court decision in Re Frederick Inns Ltd [1994] ILRM 387 that had seen the Irish courts impose a duty on directors to be mindful of creditors' interests upon a company becoming insolvent. There is one aspect in which the position under Irish law before this development was perhaps unclear: it had not been established beyond all doubt that this duty was owed by the directors to the company alone rather than to the creditors themselves particularly when the latter were considered as a group. The tendency, however, was for cases to support the view that this duty was owed to the company alone.

This echoed English case law on the point, recently confirmed in the UK Supreme Court's decision in BTI 2014 LLC v Sequana SA and others [2022] UKSC 25. In that case the Court considered that:

• there is a duty to consider creditors' interests in the zone of insolvency

• this duty is owed to the company alone

• this duty arises only when insolvency is probable or imminent

• this duty is more onerous as the situation worsens

In short, directors of English companies, similarly to their Irish counterparts acting in compliance with the Regulations, must closely monitor the financial health of their companies to ascertain to what extent they are required to prioritise the interests of creditors.

Early warning tools

To assist with this monitoring, Regulation 7 introduces a new section 271A into the 2014 Act, which provides that a director may have regard to “early warning tools” to allow them to prevent insolvencies. The aim of the Directive is for companies to have access to "one or more clear and transparent early warning tools which can detect circumstances that could give rise to a likelihood of insolvency and can signal to them the need to act without delay" and for directors to 'make use' of these tools "where applicable" when a company finds itself in financial distress.

In Ireland, the Corporate Enforcement Authority (CEA) has been charged with introducing an early warning system. On 14 October, the CEA announced that it is seeking views on a draft Information Note, which provides "(i) a non-exhaustive list of potential early warning indicators that might serve to assist company directors in identifying that a company may be approaching financial difficulties; and (ii) information on the restructuring options available to companies facing financial difficulties, but which may otherwise have a reasonable prospect of survival". The Information Note is essentially a guide to the key concepts and provisions of company law, relevant to companies in distress, and a list of possible early warning indicators, such as declining sales and unsustainable increases in expenses.

The Directive does not prescribe what early warning tools should look like and leaves it open for such tools to be developed either by Member States or by private entities, but it offers a few suggestions, such as "alert mechanisms when the debtor has not made certain types of payments" and incentives for reporting by third parties. At present, other Member States appear to have taken a similar approach to Ireland and focused on providing access to information and guidance for companies in financial difficulties. It remains to be seen if Ireland will take any further steps to develop such tools in the future, or if larger companies will look into developing their own tools in order to meet the requirements of the Regulations.

For further information in relation to this topic, please contact Paul White, partner, Michelle McLoughlin, Knowledge Lawyer,  Liam Murphy, Knowledge Lawyer, Anne O'Neill, Senior Knowledge Exectuive or any member of ALG's Corporate and M&A team.

Date published: 18 October 2022