When is a director allowed to pay certain creditors and not other creditors - such as the IRS?

In principle, a director of a company is not privately liable for the debts of his or her company. A business owner must be able to do business and that involves (certain) risks. The basic principle that only the company is liable for debts suffers an exception if the director can be seriously blamed personally. Is this the case if a company in danger of bankruptcy decides to pay its financier, suppliers and staff, but not an outstanding tax debt?

The Supreme Court recently ruled on this issue, after the Arnhem-Leeuwarden Court of Appeal previously ruled that the director is liable (in addition to the company). The Supreme Court is of a different opinion.

So, good news for the driver in question, but what exactly did the Supreme Court say?

Starting point: director determines which creditors are paid

The Supreme Court stated first that there is no general rule under which a company, unable to pay all its creditors in full, acts unlawfully when it satisfies a creditor before other creditors. This principle applies even if a preferential (higher ranked) creditor is not paid as in this case the tax authorities.

Thus, in principle, a director is free to decide which creditors of the company he will and will not pay based on his own consideration. Thus, in principle, he may choose not to pay the tax authorities and to pay another creditor.

When is this different and should a driver beware?

Exceptions: the director is still liable

Only if no reasonable thinking director under the same circumstances would have made the same consideration of not paying the tax authorities does the director act unlawfully toward the tax authorities under Section 36 of the Collection Act 1990, the Supreme Court ruled.

The question arises as to exactly when this is the case. In general, that cannot be said in one, two, three ways and depends on the circumstances of the case. What is certain is that this is an onerous requirement, one that will not easily be met.

The Supreme Court has ruled that this does exist in any case if the director of a company has caused tax debts of that company to remain unpaid, while he knew or reasonably should have understood that his actions would result in those tax debts remaining unpaid, and if he is personally at fault.

The Supreme Court has further said that under certain circumstances the director is at additional risk. This is the case, for example, if the company has decided to cease operations and does not have sufficient funds to satisfy all creditors. In such circumstances, the director of the company is (in principle) no longer free to satisfy creditors affiliated with the company in preference to other creditors - including the tax authorities.

This also applies when paying unaffiliated creditors of the company if the director of the company has a personal interest in that payment. Special circumstances justifying the payments may lead to a different judgment.

Conclusion

The director of a company has great freedom to decide which creditors to pay and which not. This also applies if the tax authorities have sums to claim.

Only if a director does not act as a reasonably thinking director would have done in the same circumstances does the director act unlawfully toward the tax authorities. When that is the case is impossible to say in general terms.

It is therefore wise to seek advice when in doubt, especially if the company has decided to cease operations and there is not enough money to pay all creditors.

It is especially careful if the little money that is still available is used to pay said intercompany receivables or if the director has a personal interest in the payment. In such cases - in order for a director not to be liable to the tax authorities - there must be special circumstances that justify payments.