The Supreme Court has, for the first time, considered and ruled on the duties owed by directors of companies on the brink of insolvency.
Its long-awaited judgment in the case of BTI 2014 LLC v. Sequana (handed down on 5 October 2022) brings some much-needed clarity for boards and those advising them, after many years of confused and divergent judgments from the lower courts, although there remain questions that will need to be resolved by future litigation. At 159 pages, and 451 paragraphs, the judgment is a hugely rich source of company and insolvency law.
The essential facts of BTI v. Sequana were as follows:
- In 2009, Arjo Wiggins Appleton Limited ("AWA") paid a dividend to its sole shareholder, Sequana SA (“Sequana”). That dividend was set off against a debt owed by Sequana to AWA.
- AWA had sufficient distributable reserves to declare and pay the dividend, and was solvent. However, it had long-term contingent liabilities of an uncertain amount, relating to an indemnity given to a related company ("BAT") in relation to liabilities arising from pollution of a river in the USA. As a result of those liabilities there was a risk that AWA might become insolvent in the future (although insolvency was not imminent, or even probable, in 2009).
- In 2014, AWA's claims against Sequana and its directors were assigned to BTI 2014 LLC ("BTI"), an SPV created by BAT. AWA eventually went into administration in 2018, on the basis of its inability to pay its liability to BAT.
- BTI issued proceedings to recover the value of the 2009 dividend from AWA’s directors, arguing that their decision to declare and pay was taken in breach of duty because the directors had not considered or acted in the interests of AWA’s creditors. Other bases of claim were advanced that were not the subject of the appeal to the Supreme Court.
- Both the High Court and the Court of Appeal rejected the breach of duty claim, and BTI appealed.
The Supreme Court unanimously rejected BTI's appeal, holding that the directors of AWA had not been subject to a duty to consider the interests of the company's creditors at the date when the dividend was declared. In doing so, the Court confirmed the existence, scope and nature of the duties owed by directors of companies of doubtful solvency (the "Creditor Duty"). The main points arising from the judgments may be summarised as follows.
- The Court confirmed that the Creditor Duty does exist. It is an aspect of the duties owed by directors to the company, and is not a free-standing duty owed to the creditors themselves. In contrast to other duties owed to the company, it is not open to the company's shareholders to authorise or ratify a breach of the Creditor Duty.
- The interests that the directors must consider are those of the body of creditors as a whole; there is no duty to consider the interests of particular creditors in a special position where those interests differ from the interests of the creditors as a class.
- The Creditor Duty can apply to a decision by directors to pay a dividend, notwithstanding that the payment of the dividend would otherwise be lawful. The directors of a company which is unable to pay its debts as they fall due will therefore breach their duties if they declare and pay a dividend to the company's shareholders.
- The Creditor Duty requires directors to consider the interests of the company's creditors in making their decisions. As regards the degree of weight to be given to creditors' interests:
- If the circumstances of the company are such that an insolvent liquidation or administration is inevitable, the creditors’ interests become paramount.
- In any other case where the duty is engaged the position is more nuanced. Directors must "consider creditors’ interests, […] give them appropriate weight, and […] balance them against shareholders’ interests where they may conflict." ( per Lord Briggs). The greater the company’s financial difficulties, the more the directors should prioritise the interests of creditors.
- The Creditor Duty is engaged when the directors know, or ought to know, that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable. As Lord Briggs stated at paragraph  (giving the judgment of the majority):
"I would prefer a formulation in which either imminent insolvency (ie 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 ought to know, are sufficient triggers for the engagement of the creditor duty. It will not be in every or even most cases when directors know or ought to know of a probability of an insolvent liquidation, earlier than when the company is already insolvent. But that additional probability-based trigger may be needed in cases where the probabilities about what lies at the end of the tunnel are there for directors to see even before the tunnel of insolvency is entered."
The Supreme Court's decision will be welcome to directors and their advisors, but questions remain. The effect of the judgment may that the Creditor Duty is engaged at a slightly later point than was the case under the Court of Appeal's decision, and it thus provides some reassurance and certainty to boards of companies which (like AWA) have contingent or unquantified liabilities but are not at risk of imminent failure. There are, however, aspects of the Supreme Court's decision that will not be straightforward to apply in practice. For example:
- Assessing the probability of future insolvency (in a case where it is not clear and imminent) is often challenging. That remains an assessment that directors must make, and (as was the case following the Court of Appeal's decision) they are obliged to consider the interests of creditors where insolvency is probable rather than imminent. The Supreme Court's formulation of the test means that directors will not be at risk where, although insolvency is probable, the board did not know and ought not have known that that was the case. However, that is likely to offer directors only limited comfort in practice.
- The duty to balance the interests of creditors and shareholders (in a case where insolvency is not imminent) is subjective and will create challenges for boards and advisors. Given that the Creditor Duty is only engaged when insolvency is probable, it is not clear when (in such a case) it will ever be appropriate for directors to favour the interests of shareholders.
- The court has stated that the Creditor Duty requires the directors to consider the interests of the body of creditors as a whole. However, the interests of the creditors as a whole are made up of numerous divergent interests: both between different classes of creditors (e.g. secured, preferential and unsecured) and creditors within a class. Directors will need to decide upon the relative weight to be given to those interests in assessing the interests of the creditors as a whole, and the judgment gives them little assistance in doing so.
For insolvency office-holders, the judgment will be less welcome. However, it preserves the essential elements of the Creditor Duty and should provide office-holders with all they need to challenge the actions of directors of insolvent companies in most cases. In our view, however, there will inevitably need to be further litigation to resolve some of the points left open by the Supreme Court's judgment (and not least because a number of the points above are obiter).