Singapore Court of Appeal adds clarity to directors’ duties

On 27 March 2024, the Singapore Court of Appeal handed down a decision in Foo Kian Beng v OP3 International Pte Ltd (in liquidation)¹, which provides guidance on when directors’ duties are owed to a company’s creditors. In summary, it was held that such duties may arise even when a company is solvent.

In this landmark judgment, the Court of Appeal reasoned that directors’ duties owed to creditors - the so-called “Creditor Duty” - is first engaged when a company is in a “financially parlous” state, a position which is less dire than being “on the verge of insolvency”. The decision moves the dial in favour of creditors and puts additional pressure on directors of distressed companies to ensure that they are fully apprised of the financial state of the company before transacting and/or making decisions to the detriment of company creditors.

The Facts

The case related to dividends and loan repayments in the sum of USD2.8 million made by OP3 International Pte Ltd (OP3) to its sole director and shareholder, Mr Foo Kian Beng (Foo) between 2015 and 2017. These payments were made at a time when OP3 was technically solvent but was at risk of becoming insolvent following a lawsuit brought against it by Smile Inc in 2015.

In October 2017, as a result of the lawsuit, OP3 was ordered to pay USD534,000 in compensation for defective work OP3 had carried out for Smile Inc. In April 2020, OP3 went into liquidation after it had failed to pay Smile Inc.

The liquidators of OP3 brought a claim against Foo, alleging that Foo had breached his fiduciary duties as a director in authorising the dividends and loan repayments to himself during a time when OP3 appeared to be in financial difficulty.

At first instance, the Singapore High Court found in favour of OP3 noting that a duty is owed to creditors when the company is “financially parlous” as opposed to when the company is “on the verge of insolvency”. The duty imposed on directors is there to ensure that the company’s assets are not dispersed unjustly, regardless of whether the company is insolvent or not.

The salient facts of this case are not too dissimilar to those in the Sequana²  case that came before the UK’s Supreme Court in 2022 and afforded an opportunity for the English court to clarify the position regarding the same “Creditor Duty”³  under English law. Those similar facts were essentially: (i) a technically solvent company, faced with a contingent liability, allowing its assets to be reduced by its directors by declaring dividends; (ii) the contingent liability materialises; (iii) the company subsequently goes into a formal insolvency process; and (iv) the officeholders bring actions against the directors for breach of duty for their failure to take into account the interests of creditors at the relevant time they paid the dividends.

The practical import of these cases for directors goes beyond ensuring contingent liabilities are properly assessed at the time when declaring dividends. The Creditor Duty is engaged when undertaking any transactions, making any decisions or carrying out any acts at a time when the directors may be in a financially distressed situation or where storm clouds are on the horizon for their business despite the company not being cashflow or balance sheet insolvent at the time. Directors will need to properly consider the interests of their creditors and how they may be affected by such actions.

A wake-up call to directors of distressed companies

The Court of Appeal has now upheld the High Court’s decision giving greater clarity on when the duties of directors of distressed companies are engaged. Following this judgment, directors of distressed companies need to be cognisant that their acts will be closely scrutinised in the future by subsequently appointed liquidators in any claims they may bring before the courts.

This decision undoubtedly protects the rights and interests of creditors when a company is in distress, albeit not yet insolvent. It also serves as a reminder to directors that the court will shift the weight given to creditors’ interests in their favour when the financial state of a company and its prospects are in the balance.

What to consider moving forward

The Court of Appeal noted that the Singapore authorities to date had not adopted a consistent approach in describing when the duty was first engaged, which had caused some confusion. A review of existing case law showed some cases suggesting that the company must be insolvent or close to being insolvent before the creditor duty is engaged, whereas other cases suggested that the company only needs to be doubtful of its solvency.⁴

Notwithstanding this, the Court of Appeal agreed that the authorities have “spoken with one voice” on the underlying rationale for the duty and that there is a need to constrain directors from conveying the risks of continued trading of financially distressed companies onto its creditors – a conclusion which is consistent with the decision in Sequana.

The Court of Appeal agreed that a two-pronged approach should be adopted by the Singapore courts when determining whether a duty to creditors has been engaged and whether a director has breached such a duty. In determining whether a director has acted in breach of his creditor duty, the court will consider the following:

1. Objectively determine which of the three financial stages the company was in at the time the transaction was entered into or that was likely to arise as a result of the company entering into such a transaction; and
2. Examine the subjective intentions of the director and determine whether he had acted in what he considered to be the best interests of the company.

It was also noted that if a court has found that a director has acted in breach of the duty, it should finally consider whether it is appropriate to relieve him of that liability⁵ . The burden lies on the director to prove he acted honestly and reasonably (i.e. the director misjudged the financial state of the company and failed to adequately consider the interests of creditors in undertaking certain acts on behalf of the company). However, the Court of Appeal stressed that these types of situations are “likely to be few and far between”.

Conclusion

This decision should be carefully considered when directors are contemplating whether or not to proceed with a specific transaction in circumstances where the company is in a financially precarious position or where the transaction could jeopardise the company’s solvency. It is crucial that directors have a handle on the financial health and prospects of their companies as well as the broader macro-economy. As well as understanding and assessing the quantum and likelihood of any contingent liabilities materialising and how those liabilities may affect the cashflow and balance sheet of the company.

When facing financial difficulties, directors should seek professional advice sooner rather than later; to ensure that they keep a record of their decisions and the basis for making them; and to ensure that they keep themselves informed with up-to-date financial reporting so as to avoid being found personally liable for breach of duties where the company subsequently ends up in an insolvent liquidation or judicial management. Clear evidence in the form of board minutes will help directors justify a particular course of action when viewed with hindsight.

This decision and its helpful practical guidance will no doubt be welcomed by creditors and liquidators alike for bringing clarity to this area of law. It offers greater certainty in formal insolvency processes where claims against directors for a clear breach of duties may be the company (in liquidation)’s only route to recoveries for the insolvent estate.

DLA Piper is restricted for regulatory reasons from practicing local law in Singapore. This article is not intended to constitute the general dispensation of advice on Singapore law.