Directors' Creditor-Regarding Duties in Respect of Trading Decisions Taken in the Vicinity of Insolvency

Abstract

This paper is concerned with the risks to creditors from strategic business decisions taken by directors. It seeks to explain both why the law should impose creditor-regarding duties when the shareholders no longer have any substantial equity in the company and why such duties should not be imposed when the shareholders still have a substantial economic interest in the company. It goes on to argue that duties on directors to put the company into a formal insolvency procedure once the company has reached a state of insolvency do not adequately meet the interventionist criterion. The incidence of such duties depends in part on whether a balance sheet or a cash flow test is used for insolvency, but in any event duties to open formal insolvency procedures are too rigid unless they operate only when all hope of rescue has disappeared. However, the paper also argues that the need to promote a 'rescue culture' for companies in financial distress may lead the legislature to limit the creditor-regarding duty arising before, but in the vicinity of, insolvency to cases of liquidation and not to extend it to companies being handled through procedures whose main aim is to save the company or (parts of) its business as a going concern.

Keywords: directors' duties, creditors, trading in the vicinity of insolvency, company rescue

JEL Classification: K20