Directors’ duty to creditors
Steven Wood looks at the recent Supreme Court Judgment BTI 2014 LLC (Appellant) v Sequana SA and others, a significant case for company law and the duties of directors.
This case provided the first opportunity for the Supreme Court to consider the duty of company directors to consider, or to act in accordance with, the interests of the company’s creditors when the company becomes insolvent, or when it approaches, or is at real risk of, insolvency.
In May 2009, the directors of a company called AWA (“the company”) caused it to distribute a dividend of €135 million to its only shareholder, Sequana SA (“Sequana”). This extinguished almost the whole of a larger debt which Sequana owed to the company. The dividend complied with the legal requirements concerning the payment of dividends in Part 23 of the Companies Act 2006 and with the common law rules on the maintenance of capital.
At the time the dividend was paid, the company was solvent on both a balance sheet and a commercial (or cash flow) basis. However, it had long-term pollution-related contingent liabilities of an uncertain amount and an insurance portfolio of an uncertain value. There was a real risk that the company might become insolvent in the future, though insolvency was not imminent, or even probable.
The company ultimately went into insolvent administration almost ten years later, in October 2018. The appellant in the case was the assignee of the company’s claims, who sought to recover the amount of the dividend from the company’s directors.
It was argued that the directors’ decision to distribute the dividend was taken in breach of the duties owed to the company’s creditors because the directors had not considered or acted in their interests. Both the High Court and the Court of Appeal rejected these claims, with the Court of Appeal finding that the directors’ duty to creditors did not arise until a company was either actually insolvent, on the brink of insolvency or probably headed for insolvency. It’s provisional view was that the duty became paramount as soon as the company became insolvent. Since the company was not insolvent or on the brink of insolvency in May 2009, the appellant’s claim failed and was subsequently appealed to the Supreme Court.
The Supreme Court unanimously dismissed the appeal with all members of the Court agreeing that the company’s directors were not at the relevant time under a duty to consider, or to act in accordance with, the interests of creditors in the circumstances of the appeal.
Reasons for the Judgment
In summary, the Supreme Court found that:
- Directors owe their duties to the company, rather than directly to shareholders or to creditors. All members of the Court agree that the duty owed to creditors is not free-standing.
- The duty owed to creditors can apply to the directors’ decision to pay a dividend which is otherwise lawful.
- Where a company is insolvent, or bordering on insolvency, but is not faced with an inevitable insolvent liquidation or administration, the directors must balance the interests of both creditors and shareholders where they may conflict. The greater the company’s financial difficulties, the more the directors should prioritise the interests of creditors.
- The duty owed to creditors is engaged when the directors know, or ought to know, the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable. Where an insolvent liquidation or administration is inevitable, the creditors’ interests become paramount, as the shareholders cease to retain any valuable interest in the company.
- The interests of creditors are the interests of creditors as a general body. The directors are not required to consider the interests of particular creditors in a special position.
- All of the members of the Court agreed that the creditor duty was not engaged on the facts of this case. This is because, at the time of the dividend, the company was not actually or imminently insolvent, nor was insolvency even probable. The duty does not apply merely because the company was at a real and not remote risk of insolvency.
The Judgment is helpful in setting out that a duty is owed to creditors and provides clarity on the content of that duty and when it is engaged. The table below summarises the position:
Where the company:
is insolvent (which refers to cash flow or balance sheet insolvency based on s123 Insolvency Act 1986); or
is bordering on insolvency; or
where an insolvent liquidation or administration is probable, but not inevitable.
Directors should consider the interests of creditors, balancing them against the interests of shareholders where they may conflict.
The greater the company's financial difficulties, the more the directors should prioritise the interests of creditors.
|The directors know or ought to know that an insolvent liquidation or administration is inevitable (i.e. the same trigger as section 214 Insolvency Act 1986).||Directors must treat the creditors' interests as paramount.|
Notwithstanding the above, a number of the facts are case-specific, and this remains something to be considered by directors and their advisors on a case-by-case basis, particularly where the company’s financial arrangements are complex.