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BTI v Sequana: Can directors take comfort from the recent Supreme Court judgment?

On 5 October 2022, the Supreme Court handed down its long-awaited judgment on the scope of directors’ duties in circumstances where a company is in financial difficulty, often referred to as the “twilight zone” i.e. the company is not yet insolvent but the company’s financial position is precarious. The hope was that the Supreme Court would provide certainty for those directors faced with difficult decisions in such circumstances, however, it is arguable whether the judgment has gone far enough to provide precise guidance.

Summary

  • Directors have a number of duties that have been codified by the Companies Act 2006 (“CA 2006”)
  • Section 172(1) of the CA 2006 states that a director 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
  • Section 172(3) CA 2006 modifies this duty where any enactment or rule of law requires directors to consider or act in the interests of creditors of the company
  • A common law rule was established in West Mercia Safetywear Ltd v Dodd [1988] recognising a director’s duty to consider creditors’ interests in certain circumstances
  • The Supreme Court has been asked, for the first time, to consider the point at which that duty to consider creditors’ interests is engaged i.e. the “trigger” point
  • The Court of Appeal in Sequana held that the duty to consider creditors’ interests is engaged “when the directors know or should know that the company is or is likely to become insolvent”, with likely in this context meaning “probable”. A “real risk” of insolvency was not sufficient to trigger the duty
  • The Supreme Court judgment has pushed the trigger point back opting also for a “sliding scale” approach where the creditors’ interests are given a greater degree of weight as the company approaches insolvency

Facts

The case concerns a dividend issued by a company known as AWA in May 2009. The dividend of some €135m was paid to Sequana SA and was used to offset a larger debt owed by Sequana to AWA. Although the dividend was deemed lawful (pursuant to the rules around declaring dividends in the CA 2006), and made at a time when AWA was solvent, it was deemed open to challenge as a result of long-term pollution-related contingent liabilities which made insolvency a real risk at some point in the future although not probable or imminent.

BTI, as assignee of AWA’s claims, sought to recover the dividend from AWA’s director on the basis that they had breached the creditors’ interest duty. However, this argument failed at both first instance and in the Court of Appeal as it was held that the duty had not been engaged at the point at which the dividend was declared.

Supreme Court decision

Does the creditors’ interest duty actually exist?

The Supreme Court recognised the creditors’ interest duty (having been established in West Mercia) but held that it was not a separate duty in its own right, rather a modification of a director’s fiduciary duty to the company (now codified in s.172(1) CA 2006). The Supreme Court considered that the duty had been preserved by s.172(3) CA 2006.

When is the creditors’ interest duty triggered?

The Appellant argued before the Supreme Court that the creditors’ interest duty should be triggered even earlier than the Court of Appeal’s trigger point where there is a “real risk” of insolvency (i.e. where insolvency is neither imminent nor probable). The Supreme Court resisted that approach and concluded that the creditors’ interest duty is triggered only:

  • when the company is insolvent or bordering on insolvency;
  • where an insolvent liquidation or administration is probable; or
  • where the transaction in question would place the company in either of the foregoing two situations.

The judgment recognises that the economic interest of creditors does not arise until insolvency i.e. that it is not until the company is wound up that creditors have an interest in the proceeds of realisations. This was the justification for pushing the trigger point further towards the point of actual insolvency.

There is, of course, a benefit to directors to push back the trigger point, however the point at which the duty is engaged in practice remains difficult to determine, and directors will still be reliant on seeking professional advice in such circumstances.

What is the scope of the creditors’ interest duty?

The Supreme Court held that it is a balancing exercise between the interests of shareholders and creditors which works on the basis of a sliding scale the closer the insolvency of a company becomes. The creditors’ interests will become increasingly important the closer the company gets to the point of insolvency, until insolvency is inevitable, at which point their interest becomes paramount.

The Supreme Court recognised that this was still a developing area of law and held back from making decisions about the duty that were not required on the facts of the case before them. They were keen to stress that the decision making of directors in these circumstances would be heavily fact sensitive and must reflect the reality of what is happening on the ground. This has left a degree of uncertainty.

What does this all mean for directors?

Many had hoped that the Supreme Court judgment would provide all of the answers for directors faced with very difficult decisions when steering a company through financial difficulties. Unfortunately, despite the outward appearance of certainty regarding the trigger point, the decision still leaves directors floundering when interpreting what it actually means in practice.

On a practical level, during times of financial difficulty, directors should:

  • ensure they are kept abreast of the company’s financial position
  • have their legal duties at the forefront of their minds
  • be conscious of making factual statements to creditors about the solvency position of the company
  • ensure that Board meetings at which the company’s financial position is discussed are accurately recorded in writing
  • seek professional advice early

If you are a director or creditor concerned about these issues, please do not hesitate to get in touch at hello@tenetlaw.co.uk

Published on October 14, 2022

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