Supreme Court confirms directors' duty to creditors in limited circumstances

Key takeaways

In BTI 2014 LLC v Sequana SA and others,¹ the UK Supreme Court considered for the first time the existence, content and triggers of the obligation on directors to have regard to the interests of creditors when a company becomes insolvent or is bordering on insolvency (the Creditor Duty).

This decision addresses important issues for directors, stakeholders, and advisors of UK companies.

Background

Arjo Wiggins Appleton Limited (AWA) was wholly owned by Sequana SA (Sequana). In December 2008, AWA ceased trading. At the time, it had one pollution-related contingent liability in a material but uncertain amount. Its assets were an investment contract capped at a maximum of USD250 million, historic insurance policies with expected recoveries of an uncertain amount, and an inter-company debt of some EUR585 million owed by Sequana to AWA.

In May 2009, the directors of AWA caused it to distribute a dividend of EUR135 million to Sequana in accordance with Part 23 of the Companies Act 2006 (the 2006 Act). The effect of the dividend payment was to extinguish by set off almost all of the slightly larger debt then owed by Sequana to AWA.

The dividend was made at a time when AWA was balance sheet and cash flow solvent. However, as the Supreme Court noted, at the time of the dividend, there was "a real risk, although not a probability, that AWA might become insolvent at an uncertain but not imminent date in the future." In fact, AWA went into insolvent administration over 9 years later, in October 2018.

In the High Court, BTI 2014 LLC (BTI), an assignee of AWA's claims, sought to recover the amount of the dividend from AWA's directors. This was on the basis that, at time of the dividend, the directors' duty to act in the interests of AWA's shareholders had been superseded by their duty to act in the interests of creditors (i.e their decision to pay the dividend was a breach of the Creditor Duty). BTI's claim failed at first instance on the basis that the risk of insolvency at the time of the dividend did not trigger the Creditor Duty.

Dismissing BTI's appeal, the Court of Appeal held that, in May 2009, the risk of AWA's insolvency (although real) was not likely (meaning not "probable") and was therefore insufficient to trigger the Creditor Duty.

The Supreme Court's decision

The Supreme Court upheld the Court of Appeal's decision that the Creditor Duty had not been engaged at the time the dividend was paid. The Court's key findings are summarised below.

1. Under section 172(1) of the 2006 Act, directors have a duty to act in a way that would be most likely to promote the success of the company for the benefit of members as a whole.
2. The Creditor Duty modifies the duty under section 172(1). Where the Creditor Duty applies, directors are required to give appropriate weight to the interests of creditors when acting to promote the success of the company. The Creditor Duty is not a self-standing duty owed by directors to creditors; it forms part of the directors' duty to the company. Shareholders cannot ratify a breach of the Creditor Duty.
3. The existence of the Creditor Duty is justified on the following grounds:
   

   a) prior to the enactment of the 2006 Act, the rule was established by a long line of authority in the lower courts and in other common law jurisdictions, in particular West Mercia Safetywear Ltd (in liq) v Dodd;² and

   b) the majority agreed that section 172(3) of the 2006 Act recognised and preserved the existence of the Creditor Duty (although the content of this rule was left to the courts to further consider and develop).³
   
   

4. The Creditor Duty can operate to prevent payment of a dividend which is otherwise lawful, although it did not do so in this case.
5. The Creditor Duty is triggered when there is either: (i) an imminent insolvency (i.e. an insolvency which directors know or ought to know is just around the corner and going to happen); or (ii) a probable insolvent liquidation or administration (about which the directors know or ought to know). The majority held that, in each case, the assessment of whether the Creditor Duty has been triggered should be based on what the directors know or ought to know – however, the minority left this question open.
6. The practical result of this finding is that the Creditor Duty is engaged closer to the point of insolvency than was the case following the Court of Appeal's decision (where the Creditor Duty was engaged if insolvency was "probable").
7. As to how directors should balance the interests of members and creditors when considering the application of the Creditor Duty, Lord Reed stated "the effect of the rule is to require the directors to consider the interests of creditors along with those of members. The weight to be given to their interests, insofar as they may conflict with those of the members, will increase as the company's financial problems become increasingly serious. Where insolvent liquidation or administration is inevitable, the interests of the members cease to bear any weight, and the rule consequently requires the company's interests to be treated as equivalent to the interests of its creditors as a whole."
8. The Supreme Court noted that directors are under a duty to inform themselves about the company's affairs; and emphasised the importance of proactively keeping themselves informed as to company's financial position (including up to date and accurate accounting information) to help them assess whether the Creditor Duty has been engaged.

Comment

For directors, companies and their stakeholders, the judgment provides welcome clarity regarding the existence, content and triggers for the Creditor Duty.

The decision recognises that the threat of insolvency may be temporary and means that the Creditor Duty is engaged at a later stage (closer to insolvency). In this respect, directors may be comforted by Lord Briggs' comment that "practical common-sense points strongly against a duty to treat creditors interests as paramount on the onset of what may be only a temporary insolvency."

In practice, determining when the Creditor Duty applies remains a complex and fact sensitive issue; and directors continue to be at risk of personal liability if they fail to consider and apply the Creditor Duty correctly. If directors accord too much weight to creditors' interests before the Creditor Duty has been engaged, they may be exposed to claims from shareholders whose interests have been prejudiced by that decision. Directors should therefore continue to proceed with caution on these issues, keep regular and deliberate records of decisions (including, where appropriate, an explanation of the extent to which creditors' interest have been considered), and take appropriate professional advice.