In this Article, José-Antonio Maurellet SC (a member of DVC and an Associate Member of 3 Verulam Buildings) and Michael Lok discuss the landmark decision just handed down by the Supreme Court of the United Kingdom in BTI 2014 LLC v Sequana SA and others [2022] UKSC 25. The central issue is the existence, triggering conditions, and the content of the directors’ duty to consider or act in the interest of the company’s creditors (labelled by Lord Briggs as the “creditor duty”).
The Facts – Briefly Stated
In gist, AWA’s directors caused the company to distribute a dividend of €135m to its only shareholder. At the time AWA made the dividends, whilst the company was solvent, there was a real risk, although not a probability, that it might become insolvent at an uncertain but not imminent date in the future. Nine years later, AWA went into insolvency. The Appellant, an assignee of AWA’s claims, sought to recover an amount equivalent to the dividend from AWA’s directors on the basis that their decision to distribute the dividend was a breach of their duty to consider the interests of the creditors.
As the Appellant could only show that there was a real risk of insolvency when the dividends were made, the creditor duty was not engaged in this case. Other issues surrounding the creditor duty, such as the pre-insolvency trigger and the remedies available for the breach of creditor duty, await another decision.
Key Takeaway 1: There is a common law creditor duty.
The Supreme Court unanimously held that there is indeed a creditor duty, being part of the directors’ fiduciary duty to act in the interests of the company in good faith ([11]). When the creditor duty arises, the concept of the “interests of the company” expands to include the interests of the general body of creditors as well as the interests of the general body of shareholders ([11], [77], [205]).
The starting point of the majority’s analysis is that the company has a separate personality and also independent responsibilities from its shareholders ([151]), and a director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole (i.e. a common law fiduciary duty which is codified in s. 172(2) of the Companies Act 2006). As a result, since the company itself owes responsibilities to its creditors once it is insolvent, the directors as the “custodians of the conscience of the company” are also obliged to see that the company performs those obligations to its creditors ([129], [142], [146]).
Key Takeaway 2: The creditor duty could apply to a directors’ decision to pay a lawful dividend.
The Court unanimously held that the creditor duty may apply to a decision to pay a lawful dividend. First, s. 851(1) of the Companies Act 2006 provides that the power to pay dividends is subject to any rule of law to the contrary, which includes the common law rule of creditor duty ([160]). Second, a company may well be balance sheet solvent (i.e. the value of the company’s assets is larger than the value of its liabilities) while being commercially insolvent (i.e. where the company is unable to pay its debts as they fall due). It cannot be right for directors of a company who has already been unable to pay its debts as they fall due to distribute a dividend, or do so if the consequence of the payment was to bring about cash flow insolvency ([161]).
Key Takeaway 3: The creditor duty involves a balancing exercise.
Prior to the time when liquidation becomes inevitable, “the creditor duty is a duty to consider creditors’ interests, to give them appropriate weight, and to balance them against shareholders’ interests where they may conflict” ([176]). In essence, the director must balance those interests and make a “commercial judgment about the benefits and risks of a transaction or course of action which may not readily be impugned” ([238]). It is noteworthy that creditors here refer to the class of creditors as a whole, instead of any individual creditors ([48]; [247(iv)]; [256]).
The precise content of the creditor duty is a fact-sensitive inquiry, covering issues such as the likelihood that the company may return to solvency, the relative stakes in the company of the creditors and the shareholders, and the risks involved in the proposed transactions ([81], [176], [238]). Even where a company is insolvent, the creditor duty does not compel a director to treat the creditors’ interest as paramount ([169]-[175]). It is only where an insolvent liquidation or administration is inevitable, the creditors’ interests become paramount as the shareholders cease to retain any valuable interest in the company ([81]; [176]-[177]; [247(iv)]; [291]; [306]).
Key Takeaway 4: The creditor duty is engaged when the company is insolvent (and arguably when insolvency is imminent or probable about which the directors know or ought to know)
The creditor duty is engaged when the company is insolvent ([199], [207]) The rationale is that the creditors only become the main stakeholders in the company when it goes into insolvent liquidation (in contrast with mere insolvency). It is that prospective entitlement which entitles the creditors to have their interests considered ([192]). Therefore, for the purpose of triggering the creditor duty, it is not enough to simply show that there is a real risk of insolvency because it is simply too remote to infer that a company will go into insolvent liquidation by showing that there is a real risk of insolvency ([193]).
As to the pre-insolvency trigger of the creditor duty, the Court has left the issue open ([199]). However, the majority, in obiter dictum, suggested that the creditor duty may also be engaged where there is “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” ([203], [231]). Lord Reed and Lady Arden had reservations about whether it is essential that the directors must know or ought to know that the company is insolvent or bordering on insolvency ([90], [281]).
