What duties do directors have to creditors?
The Supreme Court has recently handed down what is considered a landmark judgement in BTI 2014 LLC v Sequana SA, which concerns the circumstances and extent to which company directors must consider the interests of creditors.
The Supreme Court were considering when and how company directors are required to exercise their fiduciary duties laid out in section 172 Companies Act 2006, with a particular focus on the interests of creditors. The highest UK court upheld the decision made by the Court of Appeal.
The Courts were asked to decide whether the point at which a company director has a duty to consider the company’s creditors; is it where there is merely a real risk of insolvency or is it if there is a probability or close proximity to the company becoming insolvent?
The Appellant (BTI 2014 LLC) was the assignee of a third party company’s claims and sued the directors of the assignor company. The subject of this original dispute was a transaction which took place in 2009. At that time, there was neither a real risk nor a real probability that the company would become insolvent.
Arjo Wiggins Appleton Limited (‘AWA’) subsequently paid two dividends worth €443 million in December 2008 and €135 million in May 2009 respectively to parent company ‘Sequana SA.’
When the €135 million dividend was paid, AWA ceased its trading activity and had one main liability, the size of which was not clear at the time. It turned out that AWA was liable to indemnify BAT Industries Plc (‘BAT’) for the costs associated with cleaning up a polluted river. BAT submitted that the payments of the dividends meant that AWA had no funds left to pay these costs. The claim was assigned to BAT’s corporate vehicle, BTI 2014 LLC (‘BTI).
At first, BTI sought to challenge the lawfulness of both dividends under Part 23 Companies Act 2006 on compliance issues. This was unsuccessful and the High Court dismissed all claims in relation to the larger December dividend, meaning there was no appeal on this element of the decision.
However, BTI then appealed against the decision that the May 2009 dividend was paid in breach of the director’s duty to have regard to the interests of company creditors. As a result, Sequana appealed the decision which held that the payment of a dividend is capable of defrauding creditors as a transaction.
Court of Appeal
The Court of Appeal decided that in general, a dividend can be challenged legally. Under s.423 Insolvency Act 1986, a transaction defrauding creditors is:
1) A transaction at an undervalue and;
(2) the purpose of which is to place assets beyond the reach of creditors.
Therefore, transactions entered into at an undervalue for no consideration can be found to be a transaction defrauding creditors.
Thus, the Court of Appeal held that the payment of a dividend can amount to a transaction because it does not have to involve any bilateral activity and can therefore include activity with only one party.
This meant that the High Court decision that the purpose of the dividend was to ensure company assets were out of the reach of any creditors was upheld.
The Court of Appeal concluded that directors can still be in breach of their fiduciary duties detailed in s. 172 (3) of the Companies Act 2006, which holds that the duty of a company director to promote the success of a company is subject to any rules requiring them to act in “the interest of creditors.” BTI therefore submitted that “the directors owe a duty to consider the interest of creditors in any case where a proposal involves a real, as opposed to a remote, risk to creditors.”
In response, the Court of Appeal noted that there was no authority in English law covering this precise area involving a company which is not insolvent or very close to that state to suggest that anything other than the actual insolvency would invoke this duty of company directors. As a result, the duty would only be present where the directors know, or ought to have known that the company was or was likely to be insolvent. In this context, “likely” was taken to mean “probable” or with a likelihood of greater than 50% in other words.
The Supreme Court broadly upheld the decision of the Court of Appeal. In its reading, the Supreme Court outlined four main issues:
i) What exactly is meant by the creditor duty?
The Supreme Court held that when a company is verging on insolvency or has become insolvent but is not yet faced with an active insolvency liquidation or administration, company directors have a fiduciary duty to act in the interests of the company whilst applying concern and acting in the interests of shareholders and creditors also. Where there is a conflict in these interests, ‘a balancing exercise will be necessary.’
ii) Does a common law creditor duty exist at all?
The Court held that that a common law duty towards creditors exists by virtue of s.172 (3) of the Companies Act 2006 and relevant case law. Interestingly, the Court expanded the scope of the duty in holding that the economic interests of creditors increase when a company reaches insolvency or gets close to insolvency.
iii) At what point is the creditor duty invoked?
Following the Court of Appeal decision, it was held that the duty arises when the company directors know or ought to know that the company is insolvent, becoming insolvent, or that insolvency administration is “probable.” A probability that the company may become insolvent and may not recover is not enough in itself to invoke the creditor duty.
iv) What duties do directors owe to creditors when an insolvent liquidation or administration becomes inevitable?
It was held that in this situation, the company directors should focus on the interests of the creditors which become paramount. Therefore, they should give priority to those interests over shareholders and any others. In practice, this means they must take all reasonable steps to minimise the losses of creditors, especially to avoid wrongful trading under the Insolvency Act which can lead to directors being personally liable, under section 214 of the Insolvency Act 1986.
This recent decision clarifies the question faced by all UK company directors which is whether a director must exercise their duties with regard to the interests of their creditors, to what degree and how exactly this should be done. The judgement means that all company directors should consider the impact of company decisions on creditors, especially in a financially distressed company. The facts of the case demonstrate that decisions can have long lasting effects and should be taken with this duty in mind at all stages.
However, following the case, there is still no definitive point at which the directors must consider their duty towards the interests of creditors. However, it clarifies that there is a duty to consider the impact(s) on creditors and in some circumstances, balancing the impacts of company decisions on other stakeholders with those of creditors.
Therefore, in business, company directors should take advice early from legal professionals to ensure that they are compliant and acting in accordance with their duties, especially throughout turbulent economic periods or at times when a company becomes distressed or considers making significant changes.
If you are a company director and making important company decisions where the interests of creditors may be a concern or factor in your business, speak to Martin de Ridder or Alex Medford at Ansons Solicitors by emailing email@example.com or firstname.lastname@example.org or call 01543 263456.
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