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Directors Duties to creditors

Directors Duties to creditors

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Published by Farhan Khan

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Published by: Farhan Khan on Jan 17, 2011
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01/17/2011

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The director's duty to take intoaccount the interests of companycreditors
PRESENTED BY :FARHAN RIYAZ KHAN
 
The director's duty to take into account the interests of company creditors: when is it triggered?
Since the comments of Mason J in
W
alker v
W
imborne
,
a strong line of judicial opinion hasdeveloped whereby in certain circumstances it is mandatory for directors
,
in discharging theirduties to their companies
,
to take into account the interests of their companies' creditors. But thereis uncertainty as to what the actual circumstances are that will lead to directors being required todo this.It is a well-established principle in company law that directors owe duties to theircompanies as a whole but not to any individual members or other persons
,
such as creditors; in factdirectors would be acting beyond the scope of their powers if they acted for the benefit of creditors. Yet
,
by way of exception to this principle
,
and to the principle established in
Salomon vSalomon,
it has been held in a significant number of cases that in certain circumstances it ismandatory for directors
,
in discharging their duties to their companies
,
to take into account theinterests of their companies' creditors. However
,
this exception is ill-defined for there is a distinctlack of judicial unanimity as to the actual circumstances which will cause directors to have toconsider creditors' interests. The lack of precision in delineating the point at which directors are tohave regard for creditor interests
,
and may potentially become liable
,
is highly unsatisfactory. Whileacknowledging the fact that establishing guidelines in this area of the law is not easy
,
it is submittedthat directors in undertaking their decision-making need to be guided by consistent and clearprinciples so that they know the ground rules and at what point in time
,
if at all
,
they are subject tothis duty. As a matter of legal certainty and fairness
,
lines have to be drawn so that directors can beconfident that when they act they are taking into account the appropriate interests and that theiraction is safe from attack. If directors are unable to ascertain
,
with a fair degree of certainty
,
whatthey can do and when they are potentially liable
,
then
,
from an academic viewpoint
,
the law isunjust
,
and
,
from a practical perspective
,
directors will nearly always take the safest option in orderto prevent any possible lawsuits. In doing this
,
directors are likely to act defensively and makedecisions not on the basis of what is best for the company
,
but of what will avoid liability.
 
THE RATIONALE FOR THE DUTY
the predominant amount of case law in many jurisdictions has taken the view that if a company isin various states of financial difficulty the creditors warrant some special consideration. Certainly if the company is insolvent
,
in the vicinity of solvency or embarking on a venture which it cannotsustain without relying totally on creditor funds
,
`the interests of the company are in reality theinterests of existing creditors alone.' At this time
,
because the company is effectively trading withthe creditors' money
,
the creditors may be seen as the major stakeholders in the company. Thecreditors are protected only by contractual rights
,
but when companies are financially stressedperhaps it is only fair that their position warrants some form of fiduciary protection
,
whereby thedirectors become accountable principally to the creditors. Unless this occurs
,
then the directorshave every reason
,
at this time
,
to engage in risky ventures that could bring in substantial benefits
,
 but could
,
if they fail
,
imperil the company. The shareholders have little or nothing to lose by such agamble as they have already lost the money that they invested in the company and they cannot bepursued by creditors because of the concept of limited liability. A venture
,
however risky
,
couldconceivably turn the company around and provide the shareholders with some return
,
but suchaction
,
if it failed
,
would see the creditors suffer an even greater loss as they would be the ones tolose out if the company collapsed. So
,
while the doctrine of limited liability shifts the risk of failurefrom the shareholders to the creditors
,
the duty to take account of creditors' interests seeks tomitigate the shift. Breach of the duty is usually claimed when the company is in liquidation and theduty is a way of compensating unsecured creditors for whom liquidation is frequently perceived asan empty formality. While most jurisprudence sees debtors as the weaker party in the lendingsituation
,
the fact of the matter is that when a company is in financial distress it is the creditorswho often occupy a position of weakness.

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