The Supreme Court has unanimously dismissed the appeal of the decision in BTI –v- Sequana.
At a time when many companies are facing financial difficulties and directors are considering their legal duties, this long-awaited judgment has confirmed that directors have a 'creditor interest duty' when a company is insolvent or bordering on insolvency or an insolvent liquidation or administration is probable.
The judgment concerns a dividend paid by AWA, an English company, in May 2009. The dividend was lawful (under the Companies Act) and was paid when AWA was solvent, but AWA had an uncertain contingent liability for pollution clean-up costs. This gave rise to a real risk, but not considered probable at the time, that AWA might become insolvent at an uncertain but not imminent date in the future. In fact, AWA entered insolvent administration ten years after the dividend was paid. AWA’s assignee (BTI) then brought a claim against the former directors for return of the dividend on the basis that the decision to pay it was in breach of the creditor duty because insolvency was a real risk at the time. Both the High Court and the Court of Appeal rejected the claim because the risk of insolvency fell short of being probable.
BTI appealed to the Supreme Court, claiming that the duty arises where there is a real (but not remote) risk of a company becoming insolvent at some point in the future.
The creditor duty exists
The Supreme Court held that a 'creditor interest duty' exists,
- it is not a free-standing duty, it is part of the director's duty owed to the company requiring consideration of both creditor and member interests,
- it is a recognition of the creditors' stake-holding in the company when it is bordering on insolvency or is insolvent, and
- it is owed to the creditor body as a whole.
- Stage 1 Where a company is insolvent, or bordering on insolvency, or where insolvent liquidation or administration is probable but not inevitable, or where a transaction in question would place the company in one of those situations, the directors must balance the interests of both creditors and shareholders where they may conflict.
- Stage 2 Where an insolvent liquidation or administration is inevitable, the directors must treat the creditors’ interests as paramount as the shareholders cease to retain any valuable interest in the company (this is also the point at which the wrongful trading duty is triggered).
The appeal was unanimously dismissed because the creditor duty was not engaged on the facts of this case. This is because, at the time of the dividend, AWA's insolvency was not even probable.
Key takeaways for directors
- The judgment gives some welcome clarity on the 'trigger date' for when creditors' interests must be considered but this will still be difficult to accurately assess eg when is a company 'bordering on' insolvency?
- When the duty is first triggered, the directors must balance the shareholder and creditor interests by applying a 'sliding scale'. Many start-up companies are by their nature insolvent and directors must balance the risk to creditors from the outset, giving greater priority to their interests if the financial difficulties increase.
- Shareholder ratification cannot protect the directors from breach of duty once the creditor duty is engaged.
- There were points left open or not fully examined by the Supreme Court such as the state of knowledge required to fix directors with liability and whether in some situations the interests of an individual or class of creditor has to be taken into account separate from the creditor body.
- Directors are under a general duty to keep themselves informed about the company's affairs and this judgment emphasises the need for that to include the company's solvency and to continue taking a cautious approach as to when the duty is engaged. Directors should ensure they keep up to date with company financial information, seek legal and financial advice and record decisions.