‘More case law to come’ after BTI v Sequana judgment
As Lord Reed recognised, the appeal before the Supreme Court on the case of BTI 2014 LLC v Sequana S.A. & Others raised questions of considerable importance for company law. The issue was whether the trigger for the directors’ duty to consider creditors is merely a real risk of – as opposed to a profitability of or close proximity to – insolvency.
AWA, a subsidiary of paper manufacturer Sequana S.A., was liable to indemnify BAT costs arising from the clean-up of a polluted river. AWA’s directors paid two dividends to its parent company, Sequana, namely €443 million in December 2008 and €135 million in May 2009. Lord Briggs explained in his judgment that, while the second dividend in May 2009 was distributed when AWA was solvent, the pollution related liabilities and uncertainty over the value of one of its asset classes created a risk of insolvency1.
As the assignee of the claims against AWA, BTI (a subsidiary of BAT) initially challenged the dividends on the grounds that (i) they were not lawfully paid in accordance with the provisions of Part 23 of the Companies Act 2006; (ii) alternatively, they were paid in breach of the duty of the directors of AWA to have regard to the interests of its credits (“should not pay claims”); and (iii) in any event, the payment of the dividends fell within section 423 of the Insolvency Act 1986.
Sequana appealed against the judgment under s.423 and BTI appealed against the dismissal of the “should not pay” claims. The Court of Appeal dismissed Sequana’s appeal under s.423 and dismissed BTI’s appeal about the should not pay claims. Lord Justice Richards gave BTI permission to appeal to the Supreme Court on the issue of the creditors’ interest duty.
The creditors’ interest duty
The unanimous judgments of Lord reed, Lord Hodge, Lady Arden, and Lord Briggs formally recognise and establish the creditors’ interest duty. This duty previously arose at common law but, since the relevant part of the Companies Act 2006 came into force, it arises under section 172(3) which states: “…the duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company”.
The duty for directors to consider the interests of creditors raises several significant questions.
When does the creditors’ interest duty arise?
Although the Supreme Court agreed the creditors’ interest duty exists, they disagreed as to when it arises. Lord Briggs held that it was not necessary “…to decide whether any other trigger earlier than insolvency itself would be sufficient…any trigger earlier than actual insolvency needs clear justification”. Lord Briggs, Kitchin and Hodge all agreed that the duty was engaged when either “imminent insolvency (i.e. an insolvency which directors know or ought to know is just round the corner and going to happen) or the probability of an insolvent liquidation (or administration) about which the directors know or out to know”2. Lady Arden held that the Supreme Court should not consider itself bound by its views on the precise trigger for the engagement of the creditors’ interest duty until the issue actually arose.
What is the content of the credits interest duty?
Again, the Supreme Court were not in agreement as to the content of the duty. Lady Arden held that the interests of the creditors could only supplant the interests of the shareholders when the company is irreversibly insolvent making liquidation or administration unavoidable. Lord Reed caveated that since the issue did not need to be determined in this appeal, his views on content were expressed provisionally. He held that the effect is to “…preserve the director’s duty to act in the interests of the company, but to modify the sense of the latter expressions so that, where the rule applies, the interests of the company are no longer regarded as solely those of its shareholders but are understood as including those of its creditors as a whole”3. Lords Briggs, Kitchin and Hodge all agreed that the creditors’ interest duty requires the directors to consider and give appropriate weight to the interests of the company’s creditors, balanced against any conflicting shareholders’ interests.
Is the creditors’ interest duty paramount? What are the consequences for breaching it? What is the available relief?
None of these questions were specifically addressed by the Supreme Court, but we can expect to see a great deal of further case law on these issues in the future.
S.214 of the Insolvency Act 1986 requires directors to take all reasonable steps to reduce the loss to creditors “where they ought to have recognised that the company had no reasonable prospect of avoiding insolvent liquidation”. Any breach of s.214, would then be a breach of the director’s fiduciary duty.
Lardy Arden emphasised the need for directors to remain informed about the status of the company, take careful notes and maintain up to date accounting information.
Directors will need to be able to discern when the creditors’ interest duty arises (imminent insolvency or the probability of an insolvent liquidation), which in practice will be difficult, especially as the change from a business which is a going concern to insolvent is typically abrupt. The judgments of directors will need to be balanced and entrepreneurial.
Directors should ensure that they take both legal and accountancy advice at the earliest opportunity and, if they have any doubts, avoid authorising payments until they have done so. This will provide the best opportunity to not only rescue the distressed company, but also for the directors to avoid liability for breaching the creditors’ interest duty.
Auditors’ financial statements will be very important to help ascertain the risk of imminent insolvency or the probability of an insolvent liquidation. Auditors must be satisfied that their accounts are both true and fair. They may have to provide advice about whether a contingent liability for any breach of the creditors’ interest duty will or will not crystallise. Given the increased risk of liability, auditors and accountants should also take legal advice.
Ultimately, the formal recognition of the creditors’ interest duty is a positive change for creditrs, because creditors’ interests will be considered earlier and before a company is insolvent, or at the onset of insolvency, making creditors more likely to make recoveries. Creditors may be able to bring causes of action against directors personally for breaching the duty.
However, on the flip side, if directors are more cautious due to the personal liability they owe to credits, the solvent company may choose not to take calculated risks due to the potential consequences.
The primacy of shareholders’ interests in a solvent company is well-established. However, when the creditors’ interest duty arises, the shareholders’ best interests will be considered alongside the company’s creditors, inevitably giving rise to conflicts. As the distressed company comes closer to insolvency, greater weight will be given to creditors’ interests.
Lawyers and others advising the solvent company and its directors will have to take creditors’ interests into account when providing advice. A potentially risky, albeit lucrative, deal may not be in the best interests of the company’s creditors, although it may be in the best interests of the shareholders. Providing advice to the company and dealing with the conflicting interests may prove to be challenging.
Insolvency practitioners are used to considering creditors’ interests after the company has reached the point of insolvency. Now, when advising a distressed company, shareholders or creditors, they will need to consider whether the creditors’ interests have been considered sufficiently and timeously.
This judgment has been heralded as the most significant ruling in relation to directors’ duties and company law for 30 years. This is still a developing area of law and, over the next few years, as more insolvency litigation proceeds through the courts, the law will develop and be refined further.
1 Paragraph 115
2 Paragraph 203
3 Paragraph 79
This article was first published in the Winter 2022 edition of RECOVERY.