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Most company directors understand — at least in broad terms — that they owe duties to the company and its shareholders. Fewer appreciate that as a company slides toward insolvency, those duties can shift in a way that brings creditors into the picture. A recent decision from the South Australian Supreme Court, Ex NF Pty Ltd v Munneke, has brought this issue back into focus for Australian directors — and the trend is not moving in their favour.
The Traditional Position: Duties Run to the Company
Under Australian law, the primary duties imposed on directors — including the duty to act in good faith in the best interests of the company (section 181 of the Corporations Act 2001 (Cth)) and the duty to exercise reasonable care and diligence (section 180) — are owed to the company, not to individual shareholders, creditors, or other stakeholders.
This is a foundational principle of corporate law. Creditors have their contractual and statutory remedies. Shareholders have their rights as members. But the directors’ core duties run upward to the corporate entity itself.
The difficulty arises when that company is in financial distress. At that point, the interests of the company and the interests of its creditors begin to converge — and sometimes conflict with the interests of shareholders. A decision that benefits shareholders (say, paying a dividend or declaring a bonus) might devastate creditors if the company cannot actually afford it. Who do directors serve then?
The UK Position: Sequana and the Creditor Duty
The United Kingdom resolved this question definitively in BTI 2014 LLC v Sequana SA [2022] UKSC 25, a landmark decision of the UK Supreme Court.
The Court confirmed that directors of UK companies do owe duties to creditors — but that the nature, timing, and content of that duty is nuanced. It does not spring into existence at the first sign of financial difficulty. The duty crystallises when the company is insolvent, or when insolvency is probable. And even then, it does not mean directors must act solely for creditors — rather, they must give appropriate weight to creditor interests alongside those of the company as a whole.
Sequana also confirmed the “sliding scale” concept: the closer a company gets to insolvency, the more the balance tips from shareholder interests toward creditor interests. At the point of actual insolvency, creditor interests dominate.
Ex NF Pty Ltd v Munneke: The Australian Position
In Ex NF Pty Ltd v Munneke, the South Australian Supreme Court considered the question in the Australian context, taking careful account of Sequana.
The Court acknowledged the persuasive force of the UK Supreme Court’s reasoning. However, the Court also noted that the Australian position on when and how the creditor-regarding duty is triggered — and how it interacts with the specific language of section 181 of the Corporations Act — remains open. Australian courts have not definitively settled these questions.
That does not mean Australian directors can ignore the trend. It means the law is developing, the direction is clear, and directors who continue to act as if creditors are irrelevant when their company is in financial distress are taking an increasing legal risk.
The core proposition — that directors must give increasing weight to creditor interests as insolvency approaches — has been acknowledged in Australian authorities for some time, even if the precise doctrinal framework remains unsettled. Munneke confirms that the Australian courts are watching Sequana closely.
The Sliding Scale in Practice
The “sliding scale” concept is the most practically useful way to think about this area of law. It works like this:
- Company is solvent and trading well: Directors focus on the interests of the company and its shareholders. Creditors have contractual protections only.
- Company is in financial difficulty but not yet insolvent: Directors must start giving weight to creditor interests. Decisions that benefit shareholders at the expense of creditors attract increasing scrutiny.
- Company is insolvent or insolvency is probable: Creditor interests move to the foreground. Directors who continue to favour shareholders — or themselves — risk personal liability.
- Company is hopelessly insolvent: Creditor interests dominate. The duty to prevent insolvent trading (section 588G) is in play, along with potential personal liability for debts incurred.
The challenge for directors is identifying where they are on that scale — and adjusting their decision-making accordingly.
What This Means for Australian Directors
The practical implications of Munneke and the broader trend are significant for any director whose company is facing financial difficulty.
1. Don’t Favour Shareholders at the Expense of Creditors
As insolvency approaches, decisions that strip value from the company — paying dividends, making related-party payments, entering transactions at undervalue, paying out shareholder loans — carry real personal liability risk. These are exactly the kinds of transactions that liquidators will scrutinise if the company ultimately fails.
2. Get Proper Advice Early
The safe harbour provision in section 588GA of the Corporations Act provides protection from insolvent trading liability for directors who are genuinely pursuing a course of action that is reasonably likely to lead to a better outcome for creditors than immediate administration or liquidation. But the safe harbour has conditions. Directors must be obtaining proper advice, the restructuring must be genuine, and employee entitlements must be being paid.
The safe harbour is not a magic shield. It rewards directors who engage early and act in good faith — not those who hope the problem will go away.
3. Document Your Decision-Making
In the event of later insolvency, the decisions made during the twilight period will be examined closely. Board minutes, financial advice, restructuring plans, and records of what directors knew and when they knew it all become relevant. Directors who cannot demonstrate that they were giving appropriate weight to creditor interests — and obtaining proper advice — are exposed.
4. Consider Independent Legal Advice
Where there is genuine tension between shareholder and creditor interests, independent legal advice protects directors and demonstrates good faith. This is particularly important where the director is also a shareholder — the conflict of interest is obvious and the need for independent guidance is real.
Boss Lawyers regularly acts for directors facing personal liability claims arising from insolvent trading and breach of duty — and for creditors and liquidators pursuing those claims. Understanding where your duties lie as financial distress increases is not optional. It is foundational.
For more on directors’ duties and personal liability, visit our director disputes page. For insolvency options including safe harbour, see our insolvency services page.
Frequently Asked Questions
When do directors owe duties to creditors in Australia?
Under Australian law, the precise point at which directors must give weight to creditor interests is unsettled — but the trend is clear. Drawing on the UK Supreme Court’s decision in Sequana, Australian courts have acknowledged that as a company approaches insolvency, directors must increasingly take creditor interests into account. At the point of actual insolvency, creditor interests become the primary consideration. Directors who continue to favour shareholders or themselves when the company is insolvent risk personal liability under both the general law and the insolvent trading provisions of the Corporations Act.
What is the sliding scale of duties as a company approaches insolvency?
The sliding scale concept holds that directors’ duties shift progressively as financial distress increases. When a company is solvent, duties run primarily to shareholders. As the company approaches insolvency, those duties begin to incorporate creditor interests — the balance shifts. At actual insolvency, creditor interests dominate. The closer the company is to insolvency, the more weight directors must give to creditor interests in their decision-making.
What should directors do when their company is in financial difficulty?
Act early. Obtain independent legal and financial advice. Consider whether the safe harbour provisions under section 588GA of the Corporations Act are available and appropriate. Document all major decisions, including the advice received and the rationale applied. Avoid transactions that benefit shareholders or related parties at the expense of creditors. If insolvency is probable, seek specialist insolvency advice immediately — do not wait for the company to become hopelessly insolvent before taking action.
This is general information only and is not legal advice. You should obtain professional advice specific to your circumstances.
Article by Mark Harley | Principal Solicitor | Boss Lawyers | 17+ years experience in commercial litigation and insolvency law.
