The European Union (Preventive Restructuring) Regulations 2022 have amended the Companies Act 2014 so as to require for the first time in statute that directors of companies unable, or likely to be unable, to pay their debts, must have regard to the interests of creditors.
The European Union (Preventive Restructuring) Regulations 2022 (S.I. No. 380/2022) (the “2022 Regulations”), introduced on 27 July 2022 for the purpose of giving effect to Directive (EU) 2019/1023 of the European Parliament and of the Council of 20 June 2019 (the “Directive”) 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, and amending Directive (EU) 2017/1132 (Directive on restructuring and insolvency), have amended the Companies Act 2014 (the “Act”) so as to require for the first time in statute that directors of companies unable, or likely to be unable, to pay their debts, must have regard to the interests of creditors.
Under Irish law, a director’s primary duties are owed to the company. This principle had been well established by common law and is codified under s 227(1) of the Act which states that “a director of a company shall owe the duties set out in section 228 to the company (and the company alone)”. These fiduciary duties included a duty to act in good faith, to act honestly and responsibly, to avoid conflicts of interest and to exercise care, skill and diligence in conducting the affairs of the company.
The courts had however additionally held in a number of instances that when the directors of a company become aware that it is, or is likely to be, unable to pay its debts, those directors also owe a duty of care to the company’s creditors. Notably, in Re Frederick Inns Ltd [1] , the Supreme Court acknowledged the existence of a duty to have regard to the interests of creditors where a company was insolvent. Subsequent case law has held that the directors of an insolvent company have a duty to put the company into creditors’ voluntary liquidation [2] and preserve the company’s assets so that they can be applied in discharging its liabilities [3] .
There has been no express authority in Irish case law as to whether these duties are owed directly to creditors or are merely part of the duties that the director owes to the company on insolvency. The better view is that any such duties are owed to – and enforceable by – the company and this has generally been preferred, and is in line with recent case law in England & Wales. Until now, however, there has been no express confirmation of this in Irish statute or case law.
Regulation 4 of the 2022 Regulations amends the Act with immediate effect by inserting a new s 224A into Part 5 of the Act, 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.”
Regulation 5 additionally introduces a new duty into s 228, as a new s 228(1)(i), whereby “[A director of a company shall …] 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”.
These provisions are significant. They expressly impose an obligation on directors, for the first time in statute in Ireland, to have regard to the interests of creditors, where a director believes, or has reasonable cause to believe, that a company is, or is likely to be, unable to pay its debts, or becomes aware of its insolvency.
The duty in s 224A(1) arises where a director believes, or 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)” of the Act. The definition in s 509(3) is significantly broader than the ordinary meaning of the words “unable to pay its debts”, and provides such to be the case where:
(a) it is unable to pay its debts as they fall due,
(b) the value of its assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities, or
(c) the circumstances set out in section 570(a), (b) or (c) are applicable to the company.
Whereas the common law duty to have regard to creditors’ interests was generally accepted as only arising where a company was unable, or likely to be unable, to pay its debts as they fall due (within the ordinary meaning of those words), the statutory duty is considerable broader.
The statutory duty also arises where a company is balance sheet insolvent (even if it is able to pay its debts as they fall due).
In addition, by reason of the reference to sections 570(a), (b) or (c), the duty arises where any of the following situations pertain:
(a) if, other than during the interim period—
(i) a creditor, by assignment or otherwise, to whom the company is indebted in a sum exceeding €10,000 then due, has served on the company (by leaving it at the registered office of the company) a demand in writing requiring the company to pay the sum so due, and
(ii) the company has, for 21 days after the date of the service of that demand, neglected to pay the sum or to secure or compound for it to the reasonable satisfaction of the creditor,
(b) if, other than during the interim period—
(i) 2 or more creditors, by assignment or otherwise, to whom, in aggregate, the company is indebted in a sum exceeding €20,000 then due, have served on the company (by leaving it at the registered office of the company) a demand in writing requiring the company to pay the sum so due, and
(ii) the company has, for 21 days after the date of the service of that demand, neglected to pay the sum or to secure or compound for it to the reasonable satisfaction of each of the creditors, or
(c) if execution or other process issued on a judgment, decree or order of any court in favour of a creditor of the company is returned unsatisfied in whole or in part.
Notably, the “interim period” continues to pertain and is not due to end until 31 December 2022.
Where s 224A applies, the new statutory duty on a director is to have regard to three matters, namely, 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.
The first point, having regard to the interests of creditors is not novel and was the previous position at common law.
The second matter to have regard to (i.e. to have regard to the need to take steps to avoid insolvency) is somewhat peculiar, since if a company is unable to pay its debts as they fall due (as that expression is broadly defined, see above) then it is already insolvent. Perhaps it is only intended that this point would be relevant in cases where a director believes that the company is likely to be unable to pay its debts as they fall due.
The third matter to which a director must have regard is nothing if not bizarre, since one might reasonably have thought that a director will in all circumstances have a duty to avoid deliberate or grossly negligent conduct that threatens the viability of the business of the company!
It is particularly important to note that the new statutory duty is owed to the company alone (and not to the creditors themselves). In the context of the duty in s 224A(1), this is set out in s 224A(2), while for the duty in s 228(1)(i), this is made clear by s 227(1) (as cited above).
The statutory position in respect of this new duty is consistent with the duty of a director to have regard to the interests of the company’s shareholders and employees under s 228(1)(h) of the Act, which again is a duty owed to the company, and the company alone.
Therefore creditors will have no direct right of action against a director for a breach by that director of the new statutory duties above.
The 2022 Regulations introduce a new s 271A into the Act, which provides that a director may have regard to “early warning tools” – a mechanism to alert the directors to circumstances that could give rise to a likelihood that the company will be unable to pay its debts (within the meaning of s 509(3)) and can identify the restructuring frameworks available to the company and signal to such directors the need to act without delay. It is important to note that this is not a prescriptive provision which requires action to be taken by directors; it merely acknowledges that directors may have regard to early warning tools, without prescribing adverse consequences should directors fail to do so.
While it remains to be seen what early warning tools involve, over and above preparing regular management accounts and having access to legal and accounting advice on the options open to ailing companies, an early warning system will be made available by the Corporate Enforcement Authority on its website setting out useful information and corrective steps that viable businesses need to take in order to respond and recover.
The importance of this amendment should not be understated. While numerous decisions of the courts had imposed duties on directors to be cognizant of the interests of creditors in the event of the company being insolvent, the Irish courts had not expressly established whether these duties were owed to the company or to the creditors themselves. It is now crystal clear that this duty is owed to the company, and only to the company.
It remains to be seen how the second two aspects of the threefold duty “to have regard” will be interpreted.
Of greatest concern is the expanded definition in the 2022 Regulations of the meaning of “unable to pay its debts as they fall due”. It is notable that this appears to go further than was required by the Directive and certainly goes further than the Company Law Review Group had recommended in the Report on the Protection of Employees and Unsecured Creditors dated June 2017.
For further information contact: Dr Thomas B Courtney, Partner & Head of Company Compliance & Governance; Suzanne Kearney, Of Counsel and Dáibhí O’Leary, Senior Associate, Company Compliance & Governance or your usual contact in Arthur Cox
[1] Re Frederick Inns Ltd [1994] 1 I.L.R.M. 387
[2] Re Shannonside Holdings Ltd [1993] unreported, High Court decision of 20 May 1993
[3] Hughes v Hitachi Koki Imaging Solutions Europe [2006] IEHC 223
