UK: Supreme Court confirms existence of directors' "creditor duty"

Date

In brief

The UK Supreme Court has handed down its long-awaited judgment in relation to the case of BTI 2014 LLC (Appellant) v. Sequana SA and others (Respondents) [2022] UKSC 25, concerning the duty of directors of a company registered under the Companies Act 2006 to consider (and act in accordance with) the interests of the company's creditors.

Contents

  1. Directors' duties: existing framework
  2. Background
  3. Supreme Court's findings
  4. What does this mean for directors of UK companies?

Directors' duties: existing framework

Before this judgment was handed down, the general consensus was as follows:

  • Where a company is insolvent, the duty of its directors to act in the way they consider, in good faith, would be most likely to promote the success of the company in the interests of its members as a whole (as codified in Section 172(1) of the Companies Act 2006) is immediately and automatically altered such that directors should treat creditors' interests as paramount (that is, in priority to shareholders' interests). Directors must consider the interests of creditors as a whole, and not just the interests of any individual creditor or class of creditors.
  • The duty to consider or act in the interests of creditors arises when the directors knew, or should have known, that the company was (or was likely to become) insolvent.

It is not always clear whether a company is solvent or when it becomes insolvent (as that concept is defined in applicable legislation). The period in which a company's solvency is uncertain is commonly referred to as the "zone of insolvency", during which time directors may find it difficult to know whether to prioritise the interests of the company's members or whether their focus must shift to acting in the best interests of its creditors.

The Supreme Court's judgment in this case has confirmed and developed that understanding, as set out below.

Background

In 2009, the directors of AWA ("Directors") lawfully (that is, within the requirements of Part 23 of the Companies Act 2006) declared, and caused AWA to distribute, a dividend to its sole shareholder, Sequana SA, in an amount of EUR 135 million ("Dividend"). At the time the Dividend was declared and paid, AWA was solvent both in balance sheet and cash flow terms.

However, AWA also had existing contingent liabilities and an insurance portfolio that were of uncertain value. Those "gave rise to a real risk, although not a probability, that AWA might become insolvent at an uncertain but not imminent date in the future".1 That probability of AWA becoming insolvent in the future became a reality in 2018, when AWA went into insolvent administration.

BTI 2014 LLC ("BTI") sought, as the assignee of AWA's claims, to recover an amount equal in value to the Dividend. BTI's argument was that the Directors' decision to declare and distribute the Dividend was in breach of their duty to consider (and act in accordance with) the interests of AWA's creditors.

In the high court, in the first instance, and later in the court of appeal, BTI's argument failed. The case was appealed further to the Supreme Court, the members of which considered the so-called "creditor duty" in detail.

Supreme Court's findings

First, the court considered whether there is a common law creditor duty at all. Reference was made to the statutory duty of directors (as set out in Section 172(1) of the Companies Act 2006) to act in such a way as to promote the success of the company for the benefit of its members (that is, its shareholders). It was held that directors' duties are owed to the company itself, rather than directly to its shareholders. In certain circumstances — namely, when the company is insolvent or bordering on insolvency — the duty to promote the success of the company is extended as a matter of common law, such that the interests of the company are understood "so as to include the interests of the company's creditors as a whole as well as those of its shareholders" and it is "a breach of the directors' duty to the company for them to act in disregard of the creditors' interests".2

Secondly, the court held that the creditor duty was applicable to the Dividend, on the basis that (1) the lawfulness of the Dividend was subject to any rule of law to the contrary, pursuant to part 23 of the Companies Act 2006, and the common law creditor duty falls within that scope, and (2) a company could not lawfully distribute a dividend if it was unable to pay its debts as they fell due.

Thirdly, the court addressed the content of the creditor duty, holding that (1) where the company is insolvent or bordering on insolvency, but it is not an inevitability that it will be subject to an insolvent liquidation or an administration, the directors will need to balance the interests of the company's creditors with the interests of its shareholders (a "real risk of insolvency" at some point in the future is not sufficient to trigger this duty), (2) the duty is to consider the interests of the company's creditors as a general body (that is, there is no requirement to consider the interests of particular creditors), and (3) where an insolvent liquidation or an administration is inevitable, the creditors' interests become paramount.

Fourthly, and finally, the court held that whilst the creditor duty can arise when directors are considering the declaration or payment of an otherwise lawful distribution or dividend, on the facts, the creditor duty was not engaged in relation to the Dividend because, at the time that it was declared and subsequently paid, AWA was not insolvent (whether actually or imminently) and it could not be said that AWA's insolvency was even probable. There was a slight difference in interpretation amongst the judges; the view of the majority was that the creditor duty becomes engaged when the directors knew or ought to know that the company was insolvent or bordering on insolvency, or that insolvent liquidation or administration was probable. The minority did not take a firm stance on whether the directors' knowledge (or requisite knowledge) was crucial to the engagement of the creditor duty. To preserve the effectiveness of the creditor duty, the shareholders of a company "cannot authorise or ratify a transaction which would jeopardise the company's solvency or cause loss to its creditors".3

What does this mean for directors of UK companies?

Directors must be mindful of the company's solvency (or insolvency) at all times. Where the company is insolvent within the meaning of applicable legislation (for example, if it is deemed unable to pay its debts within the meaning of Section 123 of the Insolvency Act 1986) or bordering on insolvency, but it is not an inevitability that it will be subject to an insolvent liquidation or an administration, the directors will need to balance the interests of the company's creditors with the interests of its shareholders4 and have proper regard to the interests of the company's creditors.5 Where the company is irretrievably insolvent, the interests of its creditors must become a paramount consideration in the directors' decision-making.6

Practical considerations directors should draw from this judgment include the following:

  • Refrain from taking an overly cautious approach: By giving creditors' interests paramount consideration at a premature juncture, directors may act overly defensively and might in fact give rise to claims from shareholders in doing so.
  • Focus on the long-term interests of the company: Directors should balance the interests of creditors and shareholders.
  • Analyse and consider the company's trading and financial position on a regular basis: The frequency should increase if there are concerns as to the company's financial position and the directors should have access to all information necessary to give them a complete picture of the company's affairs.
  • Meet frequently, especially if concerns as to the company's solvency are mounting, and maintain a thorough, written record of their decision-making processes.
  • Follow professional advice from their legal and accounting advisers.

Generally, the more acute a company's financial distress, the greater the expectation will be for its directors to take steps in the interests of its creditors.

This judgment will no doubt be welcomed by practitioners and is highly relevant in today's challenging financial climate. Although we expect that the Supreme Court's findings will change little of the advice given to directors in practice, the judgment has helpfully articulated the creditor duty.

 

Location
Original Article