The Supreme Court has handed down a significant judgment in BTI 2014 LLC v Sequana SA. It addresses the existence, substance and circumstances of the ‘creditor duty’ – the duty of company directors to consider or act in accordance with the interests of companies’ creditors in the context of prospective insolvency.
The judgment has important ramifications in both corporate and insolvency law, particularly in the context of the ‘twilight zone’ prior to a company’s insolvency. In particular, it offers guidance to directors as to the circumstances when duties to creditors (as distinct from shareholders) are engaged and when they may become paramount. In its own words, the Supreme Court described its judgment as going to ‘the heart of our understanding of company law’.
The court found that a creditor duty is not triggered when insolvency is neither probable nor imminent, but once it is triggered, in certain circumstances the duties of a director are modified. The judgment gives guidance on how the creditor-related part of those duties develops the balancing act for directors with regard to shareholders’ interests, and the extent of the creditor duty in various circumstances. That guidance will offer important practical assistance to directors of companies in this jurisdiction, and the judgment will be of interest to investors, auditors, shareholders and insolvency practitioners.
The judgment relates to a dividend paid in May 2009 by an English company named AWA. AWA was solvent at that time, and the dividend was lawful under part 23 of the Companies Act 2006 (as well as the common law rules governing maintenance of capital).
However, AWA had a contingent liability relating to pollution-related litigation in the US. That contingent liability gave rise to a ‘real risk, although not a probability, that AWA might become insolvent at an uncertain but not imminent date in the future’. AWA did in fact go into insolvent administration, but nearly 10 years after the dividend was paid, in October 2018.
BTI (the assignee of AWA’s claims) brought proceedings to recover the dividend amount from AWA’s directors. BTI argued that the directors’ decision to distribute the dividend breached the creditor duty. The High Court and the Court of Appeal rejected BTI’s claim. The appeal court held that the creditor duty does not arise until a company is insolvent, on the brink of insolvency, or probably headed for insolvency. None of those circumstances applied to AWA in May 2009. BTI appealed to the Supreme Court.
The court dismissed BTI’s appeal. It found that AWA’s directors were not under a duty to consider or act in accordance with creditors’ interests in AWA’s circumstances at the relevant time (when the dividend was distributed).
Insolvency trigger
The court found that the creditor duty does exist, but, crucially, it is not triggered ‘merely because the company is at a real and not remote risk of insolvency at some point in the future’. The relevant trigger is when one of the following three circumstances applies:
(1) Insolvency, ‘imminent insolvency’ or the company ‘bordering on’ insolvency. (A real risk of insolvency is insufficient.)
(2) Insolvent liquidation or administration being probable.
(3) A transaction under consideration that would put the company in one of these two positions.
The court also framed the creditor duty as an aspect of, or adjustment to, the well-established duty for directors to act in good faith in the interests of the company. It is not a separate duty owed directly to the creditors; the creditor duty arises under common law, is preserved by statute, and is owed to the company. In specific circumstances, addressed in the judgment, the company’s interests should be taken to include the interests of its creditors.
Once the creditor duty is triggered, the directors should balance creditors’ interests against those of shareholders where they conflict: the greater the company’s financial problems, the greater priority should be given to creditors’ interests. The Supreme Court confirmed that the creditor duty, when triggered, applies to directors’ decisions including the declaration and payment of a dividend. Where insolvent liquidation is inevitable, the creditors’ interests will predominate (since shareholders cease to retain any valuable interest in the company). In those circumstances, the duty to act in the company’s interests ‘requires the company’s interests to be treated as equivalent to the interests of its creditors as a whole’. At this stage, the shareholders’ right to ratify directors’ decisions ceases.
In obiter comments, the Supreme Court provided guidance about the circumstances in which the creditor duty might apply prior to insolvency, and the extent of the duty if it does apply. The creditor duty would be engaged if a company’s directors know, or ought to know, that it is insolvent or bordering on insolvency, or that insolvent liquidation or administration is probable. Where the interests of shareholders and creditors conflict, a balance must be struck between them, ‘reflecting their respective weight in the light of the gravity of the company’s financial difficulties’.
In AWA’s circumstances, it was ‘much too early to consider the creditor duty engaged merely because the company faced a real risk of insolvency’; as the judgment put it, ‘that is a common factor among many companies’.
Directors of companies in financial difficulties will wish to consider where their circumstances sit within the framework established by this decision. Further developments in this area of law may follow. The courts may provide further clarity as to precisely when the creditor duty is triggered, given that the judgment contains several formulations of the threshold.
Paul Brehony is a partner and Olivier Swain senior associate at Signature Litigation LLP
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