Fiduciary Duties in Distressed Companies: Balancing Creditor and Shareholder Interests

An analysis of directors' duties when companies approach insolvency, examining recent Kenyan case law and comparative Commonwealth jurisprudence.

By Reuben Mburu

Abstract

This article examines the evolution of directors' fiduciary duties in the zone of insolvency, analyzing recent Kenyan judgments and their alignment with Commonwealth authorities. It addresses the practical question: when do directors' duties shift from shareholders to creditors?

Introduction

The traditional formulation holds that directors owe fiduciary duties to the company, not to shareholders or creditors directly. However, when a company approaches insolvency, the content of those duties evolves to account for creditors' interests as residual economic owners.

Recent Kenyan case law has begun to clarify when this shift occurs and what practical obligations it imposes on directors, drawing on English, Australian, and South African precedents.

The Zone of Insolvency Doctrine

Commonwealth courts have developed the "zone of insolvency" concept: when a company's financial position deteriorates such that insolvency becomes reasonably foreseeable, directors must consider creditor interests in their decision-making.

This does not eliminate duties to shareholders or transform directors into creditor representatives. Rather, it requires directors to balance competing interests and avoid decisions that benefit shareholders at creditors' expense when the company cannot meet its obligations.

Recent Kenyan Developments

In XYZ Ltd v. ABC Bank (2025), the High Court held that directors who approved dividends when the company had negative net assets and unpaid creditors breached their duties. The court emphasized that directors cannot treat the company as a shareholder vehicle when creditors face loss.

The judgment adopts the English approach in BTI 2014 LLC v. Sequana SA, requiring directors to consider creditor interests when insolvency is probable or inevitable, while retaining discretion to balance interests when insolvency is merely possible.

Practical Implications

Directors of financially distressed companies should:

  • Obtain regular financial reports and cashflow projections
  • Document consideration of creditor interests in board minutes
  • Seek professional advice on solvency and restructuring options
  • Avoid transactions benefiting shareholders to creditors' detriment
  • Consider formal insolvency proceedings when prospects are poor

Conclusion

Kenyan courts are developing a sophisticated framework for directors' duties in financial distress, providing greater certainty while maintaining flexibility for genuine restructuring efforts. Directors who actively engage with these issues, seek advice, and document their reasoning will be better positioned to demonstrate compliance with their evolving duties.

Published in East African Law Review, Vol. 45, Issue 1 (2026)