Directors’ duties to creditors

The Supreme Court has given judgment in BTI 2014 LLC v Sequana SA [2022] UKSC 25, 17 months after the hearing.

The decision concerns the fiduciary duty of directors to act in good faith in the company’s interest. The Supreme Court had to consider for the first time the point at which, if at all, company directors owe a duty to consider or act in accordance with the interests of the company’s creditors (the creditors’ interest duty). The Court had to decide whether, if at all, this duty was triggered when the company is actually insolvent, or when it approaches, or is at real risk, of insolvency.

There were four separate judgments from the five Justices and the majority agreed on the key issues raised in this appeal. From a practical perspective, there is much that remains to be decided on another day.

The facts and issues before the Supreme Court

Lord Briggs summarised the facts succinctly:

The facts concern an English company called Arjo Wiggins Appleton Limited (AWA). In May 2009 AWA’s directors (second and third respondents) caused it to pay a dividend of €135m (the May Dividend) to its only shareholder, Sequana SA (the first respondent). This was used to set-off almost all of a slightly larger debt which Sequana owed to AWA.

Both sides accepted the May Dividend was lawful, in the sense that it complied with the statutory scheme regulating payment of dividends in Part 23 of the Companies Act 2006 and with the common law rules about maintenance of capital. Further, when AWA paid the May Dividend, AWA was solvent, on both a balance sheet and a commercial (or cash flow) basis. Its assets exceeded its liabilities and it could pay its debts as they fell due. However, AWA had long-term pollution-related contingent liabilities of a very uncertain amount. These liabilities, taken with an uncertainty about the value of rights under certain insurance policies, resulted in a real risk, although not a probability, that AWA might become insolvent at an uncertain but not imminent date in the future. AWA went into insolvent administration almost ten years later in October 2018.

The Appellant, BTI (2014) LLC (BTI), sought, as assignee of AWA’s claims, to recover an amount equivalent to the May Dividend from AWA’s directors on the basis that their decision that AWA should pay the May Dividend was a breach of the creditors’ interest duty. Meanwhile, AWA’s main creditor applied to have the May Dividend set aside as a transaction at an undervalue intended to prejudice creditors, under section 423 of the Insolvency Act 1986.

The two claims were heard together in the High Court before Rose J (as she then was). She held the May Dividend fell foul of section 423, although Sequana then went into insolvent liquidation and did not repay any part of it. But BTI failed against the directors both before the judge and in the Court of Appeal. This was because, although they had not taken into account the interests of AWA’s creditors, the creditors’ interest duty had not become engaged by May 2009. AWA had not then been insolvent, nor was a future insolvency either imminent or probable in the sense of being more likely than not, even though there was a real risk of it. In the judgment of the Court of Appeal, the creditor duty did not arise until a company was either actually insolvent, on the brink of insolvency or probably headed for insolvency. A risk of insolvency in the future, however real, was insufficient unless it amounted to a probability. Although the dividend was lawful, this did not of itself prevent its payment amounting to a breach of creditor duty, had it arisen in May 2009.

Before the Supreme Court, BTI argued that a real risk of insolvency was enough to engage the creditors’ interest duty.

In response the directors argued the Court of Appeal was wrong to decide:

1. the creditor duty existed at all;
2. that, if it did, it could apply to paying a dividend which was lawful (in the sense described above); and
3. alternatively, that it could be engaged short of actual, or possibly imminent, insolvency.

In the final alternative, the directors argued the Court of Appeal was right to hold that a real risk of insolvency (being less likely than a probability of insolvency) was not enough to engage the creditors’ interest duty.

The decision

The Supreme Court unanimously held that a creditors’ interest duty existed. They held that no separate duty is owed to creditors, but instead it forms part of the directors’ fiduciary duty to the company to act in good faith in the interests of the company. The decision makes it clear there are circumstances in which the interests of the company, which is usually taken to be the equivalent of the interests of its members as a whole, should be understood as including the interests of its creditors as a whole. In other words, there were circumstances where creditors, who have no legal relationship with directors, could look to them to restore some or all of what the company owed them.

The creditors’ interest duty can apply to the payment of an otherwise lawful dividend (i.e. a dividend that complies with Part 23 of the 2006 Act and the common law rules about maintenance of capital).

The Justices unanimously held that a company facing a real risk of insolvency is not sufficient to give rise to the duty. That alone was fatal to BTI’s appeal.

So when is the creditors’ interest duty triggered?

• Lords Briggs, Kitchin and Hodge agreed the triggers of: (a) imminent insolvency (i.e. an insolvency which directors know or ought to know is just round the corner and going to happen); or (b) the probability of an insolvent liquidation (or administration) about which the directors know or ought to know, are sufficient triggers to engage the duty.
• Lord Reed provisionally agreed with Lord Briggs but was less certain that it was essential the directors “know or ought to know” the company was insolvent or bordering on insolvency, or that an insolvent liquidation or administration was probable. He stated it was unnecessary and inappropriate to express a settled view on the necessary knowledge of directors given the parties had not fully argued this issue.
• Lady Arden felt the task for directors was to manage all the interests in the company (not just creditors and shareholders, but for example, employees as well) until the point is reached whereby they must treat creditors’ interests as predominant. This is where the insolvency becomes irreversible.

What does the duty entail?

• Lords Briggs, Kitchin and Hodge held that before liquidation becomes inevitable and the duties under section 214 Insolvency Act 1986 (wrongful trading) are engaged, the creditors’ interest duty is a duty to: (a) consider creditors’ interests; (b) give them appropriate weight; and (c) balance them against shareholders’ interests where they may conflict. 

“Much will depend on the brightness or otherwise of the light at the end of the tunnel; i.e. what the directors reasonably regard as the degree of likelihood that a proposed course of action will lead the company away from threatened insolvency, or back out of actual insolvency. It may well depend on a realistic appreciation of who, as between creditors and shareholders, then have [SIC] the most skin in the game: i.e. who risks the greatest damage if the proposed course of action does not succeed”.

This is a departure from the Court of Appeal’s decision that creditors’ interests are triggered when there is a probability (in the sense of more likely than not) of insolvency.

• Although expressed in different terms, the Justices all agreed that where insolvent liquidation or administration is inevitable, the interests of the members cease to bear any weight. In this case, the rule requires the company’s interests to be treated as equivalent to the interests of its creditors as a whole; creditors’ interests become paramount.
• 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.

The judgment is 160 pages long. It’s helpful for directors in that it pushes back the trigger when the creditors’ interests become paramount to when the company is facing unavoidable insolvency. In practical terms, not much will change. When a company is facing financial difficulty, a well-advised board will review continually the company’s financial position and the justification for continuing to trade and entering transactions, particularly those that are not in the ordinary course of business. Professional advice is essential. What is left for the Supreme Court on another day (which is unlikely to be too far in the future) is:

• A final decision on whether it is essential that directors know or ought to know the company is facing unavoidable insolvency for liability to be triggered.
• The scope of liability where the creditors’ interest duty is breached before irretrievable insolvency.
• The remedies available when a director causes a payment to be made that is both a preference under section 239 Insolvency Act 1986 and a breach of their fiduciary duties. This payment will not usually cause the company any loss; one creditor is paid at the expense of another and the company’s liabilities remain the same.
• Given the duty is to “creditors as a whole”, is “robbing Peter to pay Paul” (paying one creditor ahead of another) a breach of the creditors’ interest duty? The New Zealand Supreme Court recently held that it was, in Madsen-Ries v Cooper [2020] NZSC 100.
• Whether directors who have breached the creditors’ interest duty can be relieved of their liability.