It is becoming increasingly common in out of court restructurings for directors to award themselves substantial bonuses for seeing a restructuring through successfully. This often seems counter-intuitive. Surely directors who have led their company into trouble do not deserve what they are being paid, let alone more?

The director's point of view

Naturally, the directors do not see it like this. From their point of view, there are many reasons why an additional bonus is not just fair, but actually a jolly good thing – even for creditors. They know the business better than anyone and they are crucial to its survival. They are indispensable and, without a retention bonus, they might be tempted to accept one of the many offers of alternative employment they are bound to receive once the market hears of their company's plight.

Restructurings are highly complex and require levels of performance and commitment way beyond those for which they were originally employed and are currently remunerated. During the restructuring process, their company will pay out millions of pounds in fees to the company's lawyers, financial advisers and restructuring advisers… and to the members of the senior lenders' steering group and their lawyers, financial advisers and 'plan B' insolvency practitioners… and to the junior lenders' lawyers and financial advisers… and to the pension trustees' lawyers and… you get the picture. Surely a modest sum for the key players is in order?

The creditors' point of view

When creditors are being asked to take a significant cut in the value of their investment, they tend to see things differently. If the directors knew anything about their business, they would never have let it get into the mess it is in. Noone is indispensable. If anyone is crazy enough to offer the directors another job, hopefully they will take it and save the company the cost of sacking them. Even if they do resign, the directors are obliged to work out their notice period.

On the other hand, if they are any good, the directors should recognise that they are already employed and remunerated to see the company through thick and thin and not just to deal with easy issues. Millions of pounds of the creditors' money is already being used to pay the hoards of advisers flocking to the carcass, and now management want more for fixing a problem they created and which they are already being paid once to fix. Clearly, if the directors award themselves a bonus or walk away from the mess, then they are in breach of their duty to act in the best interest of creditors.

The creditors' argument is very powerful and often feels intuitively correct. It is their money the directors are taking. The directors are employed to run the business. Their service contracts do stop directors simply walking away. In a substantial restructuring, it is common for senior and junior lenders who object to a proposed bonus scheme to put these arguments in a forceful way. That is, the arguments are often combined with a warning that if the directors do implement a bonus scheme against the lenders' wishes, or walk away because they do not have a bonus scheme to rely on, then the lenders will sue them for breach of fiduciary duty.

The courts' point of view

Creditors could also reach for the assistance of Mr Justice Lloyd. This is because, in The Secretary of State for Trade and Industry v Cleland and Wildman [1997] (in which two directors had paid themselves a handsome bonus when they ought to have known that their company was in trouble) Lloyd said: "The payment of remuneration at a level beyond contractual entitlement was something that had to be very carefully considered and properly justified as appropriate in the company's interests at a time when the company's financial circumstances were somewhat precarious… it may be possible to justify [the bonuses] but… the [company] was in difficulty, and on the face of it, these payments… raise questions as to whether they were proper payments in the interests of the company."

It is a brave board which chooses to press ahead with a bonus scheme in these circumstances.

If they do so wrongly, board members risk personal liability and disqualifi-cation. But a board will not always be wrong to press ahead against the senior and junior creditor's wishes. In some cases, a bonus will be appropriate, and it is the job of the company's lawyer to work out whether or not that is the case in the particular circumstances he or she is dealing with.

As Wildman confirms, (assuming there are no prohibitions in constitutional documents or financing agreements) the question boils down to one of directors' fiduciary duties. Despite what a surprising number of serious (and legally advised) creditors would have you believe, in a restructuring, even when their company is insolvent, directors do not owe a fiduciary duty to their creditors and they are not obliged to act at their creditors' direction. Instead, directors are required to act in what they honestly believe to be the best interest of their company and to avoid being negligent.

The next steps

So, what the directors need to do is consider carefully all the relevant circumstances and decide what they honestly believe is best for their company. In doing this, the directors do need to put the interest of creditors above those of shareholders, but that is not the same as doing what some or other creditor constituent requires. Directors would be wise to seek the views of creditors but if they do not – or will not – provide helpful guidance, then the matter of a bonus is one the directors can and must deal with themselves.

In practice, when it comes down to it, the properly advised board will have to stand up to pressure from some or other creditors and make a decision. Often, quite properly, a board will conclude that a director is important to a successful outcome, is relatively under-paid for the task he or she now has to perform, is in danger of being tempted away by the competition and is not constrained from leaving.

In these cases, where the board is considering a bonus scheme which is appropriately tailored to reward directors only for a successful outcome, has carefully considered all relevant factors and honestly believes that paying a bonus will keep the directors in office and focused and achieve a more positive outcome for creditors than would otherwise be the case, then it can, and should, go ahead and approve a bonus, whatever the creditors say, and however counter-intuitive it may seem.

Nick Angel is a partner and Rita Tetere an assistant at Ashurst.