Directors' duties owed to creditors—clarity from the Singapore Court of Appeal in Foo Kian Beng v OP3 International Pte Ltd (in liquidation) [2024] SGCA 10

When does a director first come under a duty to consider the interests of creditors (Creditor Duty)? How should the Creditor Duty be weighed up in a director’s decision on whether to authorise the repayment of shareholder loans and to declare dividends?

In the very recent decision of Foo Kian Beng v OP3 International Pte Ltd (in liquidation) [2024] SGCA 10 (Foo Kian Beng), the Singapore Court of Appeal (CA) sheds light on this important issue and gives practical guidance to directors. Prior to Foo Kian Beng, Singapore, English and Commonwealth courts had not been uniform in describing when the Creditor Duty is first engaged. Potentially confusing and ambiguous terms such as “financially parlous” and “on the verge of insolvency” were used, which resulted in uncertainty as to when the Creditor Duty first arises.

In Foo Kian Beng, Mr Foo Kian Beng (Mr Foo), the sole director and shareholder of the company, OP3 International Pte Ltd (OP3), authorised the payment of a dividend and the repayment of a shareholder loan to himself (Disputed Transactions) despite the company facing a suit arising from the defective design and construction of certain facilities at a clients’ premises. The crux of the dispute centred on whether the Creditor Duty was engaged at the time Mr Foo authorised the Disputed Transactions.

At first instance, the Singapore High Court found that OP3 was in a financially parlous state at the time of the payments to Mr Foo. In these circumstances, Mr Foo had an obligation to consider the interests of OP3’s creditors as part of his fiduciary duty to act in the best interests of the company at the time he authorised those payments to himself. The High Court held that Mr Foo had breached that duty because there was no legitimate reason to prefer repaying himself in preference to the other creditors.

On appeal, the timing of when the Creditor Duty first arises was disputed. The CA clarified that the Creditor Duty is invoked when a company is financially parlous and not when a company is on the verge of insolvency. Thus, a director’s duty to consider the interests of creditors can arise even before a company faces inevitable insolvency, so to prevent the company’s assets from being wrongfully dispersed and to ensure that the company retains the ability to repay its creditors.

The CA made clear that the courts will take a practical and broad assessment of the financial health of the company to decide when the Creditor Duty should arise, and assess the company's solvency in a flexible manner, including a consideration of all claims, debts, liability, and obligations of the company. The courts will not apply a strict and technical application of the “going concern” test or “balance sheet” test. 

In this regard, the CA also clarified the three stages of a company’s prevailing state and the corresponding directors’ duties at each stage, which we summarise below:

On the facts of Foo Kian Beng, the CA upheld the High Court’s finding that the Creditor Duty was already engaged when the Disputed Transactions were authorised. In reaching this conclusion, the following facts were considered:

1. OP3’s financial statements reflected that the company was in poor financial health. The company had a negative asset value far larger than the value of its assets at the material times immediately preceding and at the time which the Disputed Transactions were paid out to Mr Foo.
2. Mr Foo argued that he believed OP3’s contingent liability under the lawsuit would not arise as he sought legal advice from a law firm who advised that the company had a “strong defence”. However, this argument was rejected by the court as the correspondence between Mr Foo and the law firm was sparse and did not contain sufficient evidence. The CA reiterated that the mere fact that legal advice was taken does not inevitably mean that a defendant-director acted bona fide in taking a certain course of action. Mr Foo did not adduce cogent evidence to show that he honestly believed OP3 would face no liability. Thus, the CA held that OP3 had contingent liability under the lawsuit that was reasonably likely to materialise. This had to be considered in assessing the solvency of the company when the Disputed Transactions were paid out to Mr Foo.

In light of the above, because the company was evidently in a financially precarious position and there was a reasonable likelihood of the liability under the lawsuit materialising which would further strain the company financially, the CA determined that Mr Foo had breached the Creditor Duty by prioritising payments to himself over the claims of the other creditors. In the circumstances, Mr Foo failed to consider the interests of OP3’s creditors and acted in breach of the Creditor duty by authorising the payment of the Disputed Transactions to himself.

A point which carried significant weight was the nature of the payments that Mr Foo approved. OP3’s creditors gained nothing from these payments and the payments were not part of a strategic commercial decision to revitalise the fortunes of the company. Instead, the payments singularly enriched Mr Foo at the expense of OP3’s creditors. It was also emphasised that Mr Foo did not draw any dividends in the years preceding the commencement of the suit but paid himself $2,800,000 in dividends and $820,746 in loan repayments after the suit was commenced against OP3.

Conclusion

The CA’s clarifications represent a practical and welcome development for directors, who ought to take careful note of this decision in discharging their duties to act the best interests of the company at each stage of the company’s life cycle.

Directors should also be cognisant that the CA’s underlying rationale in reaching this decision is to prevent directors from dissipating the assets of financially distressed companies and preserve the company’s assets to repay its creditors. However, directors acting in the best interest of the company, with a view to achieve preferential financial outcomes for the company should not be unduly concerned that the ambit of this judgement is so wide that it would handicap directors, stopping them from making sound commercial decisions when a company is facing financial distress.

Additionally, as highlighted by the CA in Foo Kian Beng, when a company seeks legal advice on its potential liability under a lawsuit, directors must ensure that they keep detailed records and information about the circumstances under which such advice was provided. Detailed information about the advice and the surrounding circumstances must be provided before the Courts can evaluate the extent to which an individual can fairly rely on the fact of legal advice.

For more detail on Singapore law principles governing directors’ duties and risks in financially troubled businesses, please see our Practical Law article on “Risks for Transactions and Directors in Financially Distressed Businesses (Singapore)” (published prior to the judgment in Foo Kian Beng).