Directors’ Duties in the Zone of Insolvency (Sequana)

In our experience acting for directors of distressed companies, decisions taken in the zone of insolvency carry the highest personal-liability risk in UK corporate law. The Supreme Court’s landmark ruling in BTI 2014 LLC v Sequana SA [2022] UKSC 25 confirmed that directors’ duties shift as a company approaches insolvency: the interests of creditors must be considered alongside, and eventually in place of, those of shareholders. This article explains when the so-called creditor duty is engaged, how the sliding scale operates, and what steps directors and their advisers should take. It draws on the record findings against BHS directors in Wright v Chappell [2024] EWHC 1417 (Ch) to show how the courts are now applying Sequana in practice.

Legal Framework: s.172 CA 2006 and the Creditor Duty

The general duty in s.172(1) Companies Act 2006 requires a director to act in the way they consider, in good faith, most likely to promote the success of the company for the benefit of its members. That primary duty is qualified by s.172(3), which preserves any enactment or rule of law requiring directors to consider or act in the interests of creditors. The common law rule preserved by s.172(3) traces to West Mercia Safetywear Ltd v Dodd [1988] BCLC 250, in which the Court of Appeal held that a director of an insolvent company owes duties to the company’s creditors.

In Sequana, the Supreme Court unanimously confirmed the continued existence of this creditor duty and clarified its trigger, content and scope. The duty is not a free-standing obligation owed directly to creditors. It is a modification of the fiduciary duty owed to the company. Once engaged, a breach cannot be ratified by shareholders.

Validation Orders and Board Decisions in the Creditor Duty Window

Directors of distressed companies routinely take decisions on dividends, remuneration and inter-company transfers at the precise moment the creditor duty is engaged. Our dual-qualified Companies Court team advises boards on Sequana compliance and, where a petition follows, obtains validation orders under s.127 Insolvency Act 1986 to authorise essential post-petition payments. We act for directors from statutory demand through to Court of Appeal.

When the Creditor Duty is Triggered?

The Sequana Trigger Test

The critical question was the point at which the creditor duty is engaged. The Supreme Court rejected the appellant’s argument that a mere real risk of insolvency was sufficient. The duty is triggered where the directors know, or ought to know, that:

• the company is insolvent (on the cash-flow or balance-sheet test under s.123 Insolvency Act 1986) or is bordering on insolvency;
• an insolvent liquidation or administration is probable; or
• the transaction in question would place the company into either of those situations.

The creditor duty in Sequana is triggered when directors know or ought to know that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable. A mere real but non-imminent risk of future insolvency is not enough to engage the duty.

The Sliding Scale

Once engaged, the duty operates on a sliding scale. Where insolvency is only probable, directors must balance creditor and shareholder interests, with the balance tilting progressively towards creditors as distress deepens. Where insolvent liquidation or administration is inevitable, creditors’ interests become paramount and shareholders’ interests cease to bear any weight.

The Facts of Sequana

The claim concerned a €135 million dividend paid by AWA to its parent Sequana SA in May 2009. AWA was then solvent on both cash-flow and balance-sheet tests, but held long-term contingent pollution liabilities of uncertain magnitude. AWA entered administration nearly a decade later. The Supreme Court held that a real but non-imminent risk of insolvency was not enough to engage the duty and dismissed the appeal.

Creditor Duty vs Wrongful Trading

The creditor duty and wrongful trading under s.214 Insolvency Act 1986 are distinct. Wrongful trading requires the director to know, or to have concluded, that there was no reasonable prospect of avoiding insolvent liquidation or administration. The Sequana duty arises earlier, when insolvency is merely probable. Directors can therefore face fiduciary liability well before wrongful trading is engaged, as illustrated by Wright v Chappell [2024] EWHC 1417 (Ch) and the quantum ruling at [2024] EWHC 2166 (Ch), which produced record awards against former BHS directors.

Practical Guidance: Directors in the Zone of Insolvency

Where a company shows signs of distress, the directors should:

1. Take specialist insolvency advice immediately. Sequana liability is fact-sensitive and reviewed with the benefit of hindsight. Early advice is a proportionate protective step and materially reduces exposure to later directors’ disqualification proceedings.
2. Review solvency on both cash-flow and balance-sheet bases. Section 123 Insolvency Act 1986 sets the statutory tests. Contingent and prospective liabilities must be brought into account. Document the review contemporaneously.
3. Minute every material decision. Board minutes should record the directors’ consideration of creditor interests, the alternatives weighed, and the reasons for the course taken. Contemporaneous minutes are the strongest evidence in later proceedings.
4. Do not pay dividends or make distributions without a formal solvency review. Sequana arose out of a dividend. Distributions in the zone of insolvency are prime clawback targets under ss.238 and 239 Insolvency Act 1986.
5. Engage with HMRC and other pressing creditors early. Ignoring HMRC increases the risk of a petition. Our specialist HMRC tax disputes team advises on enforcement, and we regularly defend and dismiss winding-up petitions at the Rolls Building.
6. Consider whether professional advisers have failed you. Negligent restructuring, insolvency or tax advice at the twilight zone can itself found a claim. Our professional negligence lawyers act for directors and companies against negligent accountants, IPs and advisers.

How LEXLAW Can Help?

Facing personal liability as a director of a distressed company is a high-pressure situation with severe commercial and reputational consequences. Our specialist insolvency litigation solicitors and barristers act for directors, shareholders and creditors in matters of every complexity: Sequana-based board advice, defending wrongful trading and misfeasance claims, and directors’ disqualification proceedings up to Court of Appeal level. Our work includes urgent applications to restrain advertisement of a winding-up petition, validation orders under s.127 Insolvency Act 1986, and defending post-liquidation claims brought by officeholders. Early specialist advice materially improves outcomes: documented decisions taken in the zone of insolvency are far harder to unpick than those taken without them.