On 5 October 2022, the Supreme Court delivered its long awaited judgment in BTI 2014 LLC V Sequana SA [2022] UKSC 25 dismissing an appeal by BTI. Lord Reed and Lady Arden each gave their own judgments which concurred, largely applying the same reasoning, with the judgment of Lord Briggs with whom Lord Kitchen and Lord Hodge agreed.
The appeal concerns the fiduciary duty of directors to act in good faith in the interests of the company. It is the only decision on which the Supreme Court has addressed (1) whether a director owes a duty to creditors, separate and free standing from the fiduciary duty owed to a company, and (2) whether a company director owes a duty to consider or act in accordance with the interests of the company’s creditors when a company becomes insolvent, or when it approaches, or is at real risk of insolvency.
The Supreme Court judgments confirm, once and for all, that directors’ duties evolve as follows:
- Company solvent: The directors must act in what they honestly consider to be the best interests of the company’s shareholders and there is no “duty” to consider the interests of creditors.
- Company begins to encounter financial stress: The directors must begin to consider the interests of the company’s creditors and shareholders lose the ability to ratify the decisions and actions of the directors. The greater the financial stress faced by a company, the more weight that the directors should give to the position of its creditors. This is because the creditor duty arises at a point short of a company’s actual insolvency.
- However, that point is not simply when where is a “real risk” of insolvency. The creditor duty comes into play at an earlier point. Identifying that “earlier point” is therefore a question of fact, to be determined by reference to the company’s actual and prospective situation.
- Company irretrievably insolvent or subject to an insolvency process; creditors’ interest become paramount to those of the members.
Hence while the Sequana judgment will, in the short term, result in the spilling of much ink and launch many a seminar, it should not ultimately alter the way in which directors and their advisors approach financial distress. Now as always, company directors should take and act on legal and financial advice from lawyers and accountants with a proven track record in the management of restructuring and insolvency situations. That advice should include timely, continuous and regular monitoring of the company’s financial position, along with the formulation and, if necessary, implementation of an appropriate contingency plan.
Directors should hold, and minute, regular board meetings and “ad hoc” discussions. Those minutes should set out clearly the basis for and likely outcomes of any proposed courses of action. In addition, directors should be seen to review the results of their actions in real time. Where necessary they should be prepared and seen to be willing to modify and adopt proposed solutions to reflect changes in their company’s situation.
Background
In May 2009, the directors of AWA Limited (“AWA”), a wholly owned subsidiary of Sequana SA (“Sequana”), declared substantial dividends, totalling €135m, to Sequana. its only shareholder. This had the effect of reducing or extinguishing by way of set off, a debt owed by Sequana to AWA. It was accepted that at the time the dividend was declared, the dividend was legal and that AWA was solvent, its assets exceeded its liabilities and it was able to pay debts as they fell due. No insolvency was imminent. However, AWA faced long term pollution related contingent liabilities of uncertain amounts.
In 2018, AWA went into administration and BTI obtained an assignment of AWA’s claims. BTI brought proceedings against AWA’s directors to recover an amount equal to the dividend payment made in May 2009, on the basis that the directors’ decision to pay the dividend was taken in breach of their fiduciary duties to consider or act in the interests of AWA’s creditors. That was because AWA had left itself without sufficient funds to satisfy the contingent liability and pay for clean-up costs resulting from the pollution (“the Creditor Interest Duty”).
There was a further claim brought in relation to the dividend. AWA’s main creditor applied to have the May dividend set aside pursuant to S423 of the Insolvency Act 1986 (“IA 1986”) as a transaction at an undervalue on the basis that AWA had intended to prejudice its creditors.
At first instance, the two claims were heard together. Liability was found at first instance under S423 of the IA 1986 but Sequana went into insolvent liquidation and no part of the dividend was repaid. The attempt by BTI to rely on the creditors’ interest duty was rejected.
The decision was upheld by the Court of Appeal which concluded that the creditor duty could be engaged short of actual insolvency but was only triggered when the directors knew or should have known that the company was or was likely to become insolvent. A risk of insolvency in the future was insufficient to engage the duty unless it amounted to a probability.
The Decision
The Supreme Court rejected the contention that there was a “Creditor Interest” Duty distinct from a directors fiduciary duty to act in the interest of the company and in good faith. However, the court found that the “Creditor’ Interest Duty” should include the creditors as a whole (as provided for in West Mercia Safetywear Ltd (in liquidation) v Dodd [1988] BCLC 250).
S172(1) of the Companies Act 2006 (“CA 2006” ) requires directors to act in a way they consider would promote and achieve the success of the company for the benefit of its members as a whole. S172(3) of the CA 2006 recognises that this duty is modified in certain circumstances, such as the company’s insolvency with the result that that the company’s interests equate to those of its creditors. The Creditor Interest Duty therefore amounted to a recognition of the economic interests or stakeholding in a company of its creditors when the company was bordering in insolvency or was insolvent.
The Supreme Court unanimously decided that the Creditor Interest Duty will be engaged when directors knew or ought to have known that a company was insolvent or bordering on insolvency or that insolvent liquidation or administration was likely. The weight to be given to the interests of a company’s creditors would depend on the gravity (or not) of the company’s financial position. The greater the company’s liabilities the more weight should be given to the interests of the company’s creditors. If a company became irretrievably insolvent, the interests of the creditors would become paramount.
Implications of Creditor Interest Duty
Having concluded that Creditor Interest Duty does not arise merely because a company is at a real and not remote risk of insolvency, it is necessary to consider the extent of the knowledge of the directors at the relevant time. In their judgments, both Lord Reed and Lady Arden questioned the degree of knowledge the directors would need of an actual or impending insolvency. However, they considered it unnecessary to express a concluded view absent a specific case.
Demonstrating the degree of knowledge of any director at any specific time will inevitably be fact specific. To show a duty exists, a company’s directors must know that financial stress is imminent. In short, directors must have regard to the interests of creditors from the point at which the company begins to encounter financial stress and not merely because the company is or may be at risk of insolvency at some indeterminate point in the future. Again, this is a fact specific question, the answer to which will vary from one case to the next.
The existence of a Creditor Interest Duty will inevitably give rise to wide ranging consequences including at what point directors should take various actions, and, if appropriate, resolve to place a company into liquidation or administration. In practice, this means that the trigger for and the content of the Creditor Interest Duty will be matters on which directors will, now as before, need to take specialist financial and legal advice.
The decision recognises that the basis for the operation of a limited liability company is “to encourage risk taking as an essential part of commercial enterprise” but this is something which must be balanced. Thus, directors must, as was the case before Sequana, keep themselves informed about their company’s financial position and have access to reliable information in order to respond to a changing situation effectively and protect themselves from personal liability. The entire board has a responsibility to be aware of the company’s financial position and the scope of their duties. The board should have available to it, up to date financial and operational information and to know the position of the various classes of creditors including the time for which their debts are left outstanding.
Lady Arden, in her judgment, considered that the court should clearly approve a restriction on directors’ obligations to promote the success of their company so as to provide a measure of protection to creditors. She said that, in her view, the issue was really what that restriction involved and how far it went. Lady Arden considered that the “sliding scale” analogy should not be taken too literally as events leading to financial stress could occur very quickly and without warning. It was therefore vital for directors to keep themselves informed about their company’s financial position as the transition from trading as a going concern to trading with the risk of actual or prospective insolvency was often and invariably rapid.
Conclusions
As we said at the start of this note, Sequana is an important case because it is the first occasion on which the Supreme Court has undertaken a full analysis of the Creditor Interest Duty. In all other respects, however, its judgments are reassuring both for company boards and their advisors. The Supreme Court has confirmed that when a company encounters financial difficulty, its directors must be vigilant but they should not panic. Directors should instead and in short order take and act upon advice from lawyers and financial advisors with expertise in restructuring and insolvency. They should be prepared and able to change course, based on that advice as and if their company’s position either worsens or improves.
Provided that directors take these steps, their risk of incurring personal liability on account of a company’s financial difficulties will be low. As a corollary, insolvency practitioners or other stakeholders, such as claim funders, need thoroughly to consider whether they have sufficient evidence first to demonstrate that the Creditor Interest Duty has been engaged and secondly that it has been breached. Once again the safest way of achieving this will be to take and act upon advice from lawyers and financial advisors who are experts in restructuring and insolvency.
