“Momentous” Supreme Court decision on directors’ duties in respect of creditors’ interests

5 October, 2022

The Supreme Court has given judgment in BTI 2014 LLC v Sequana SA [2022] UKSC 25.

Lord Reed observed that the issues on the appeal “go to the heart of our understanding of company law, and a of considerable practical importance to the management of companies”.

Lady Arden described the Supreme Court’s decision as being “as momentous a decision for company law as this Court’s recent decision in Patel v Mirza [2017] AC 467 was for the law of illegality”.

The decision concerns the fiduciary duty of directors to act in good faith in the interests of the company. It is the first occasion on which the Supreme Court (or the House of Lords) has addressed whether company directors owe a duty to consider or act in accordance with the interests of the company’s creditors when the company becomes insolvent, or when it approaches, or is at real risk, of insolvency (“the creditor duty”).

Separate judgments were delivered by Lord Reed, Lords Briggs (with whom Lord Kitchin agreed), Lord Hodge and Lady Arden.

The facts and issues before the Supreme Court

In a nutshell, the facts concern a company called AWA. In May 2009 AWA’s directors caused it to distribute a dividend of €135m (“the May dividend”) to its only shareholder, Sequana SA, which extinguished by way of set-off almost the whole of a slightly larger debt which Sequana owed to AWA.

It was common ground before the Supreme Court that the May dividend was lawful, in the sense that it complied with the statutory scheme regulating payment of dividends in Part 23 of the Companies Act 2006 (“the 2006 Act”) and with the common law rules about maintenance of capital. Further, the May dividend was distributed at a time when AWA was solvent, on both a balance sheet and a commercial (or cash flow) basis. Its assets exceeded its liabilities and it was able to pay its debts as they fell due. However, AWA had long-term pollution-related contingent liabilities of a very uncertain amount, which 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. AWA went into insolvent administration in October 2018.

The Appellant, BTI (2014) LLC (“BTI”), sought, as assignee of AWA’s claims, to recover an amount equivalent to the May dividend from AWA’s directors on the basis that their decision that AWA should distribute the May dividend was a breach of the creditor duty. Meanwhile, AWA’s main creditor applied to have the May dividend set aside as a transaction at an undervalue intended to prejudice creditors, under section 423 of the Insolvency Act 1986.

The two claims were heard together in the High Court before Rose J (as she then was). The May dividend was held to have fallen foul of section 423, although Sequana then went into insolvent liquidation and no part of it was repaid. But BTI failed against the directors both before the judge and in the Court of Appeal. This was because, although they had not taken into account the interests of AWA’s creditors, the creditor duty had not become engaged by May 2009. AWA had not then been insolvent, nor was a future insolvency either imminent or probable even though there was a real risk of it. In the judgment of the Court of Appeal, the creditor duty did not arise until a company was either actually insolvent, on the brink of insolvency or probably headed for insolvency. A risk of insolvency in the future, however real, was insufficient unless it amounted to a probability.

Before the Supreme Court, BTI argued that a real risk of insolvency was sufficient to engage the creditor duty.

In response the directors argued that the Court of Appeal was wrong to conclude:

  1. That the creditor duty existed at all;
  2. That, if it did, it could apply to the payment of a dividend which was lawful (in the sense that it complied with Part 23 of the 2006 Act and the common law rules about maintenance of capital); and
  3. In any event, that it could be engaged short of actual, or possibly imminent, insolvency.

The Supreme Court’s decision

The Supreme Court held that a creditor duty existed, although it is not a duty owed to creditors, or any duty separate from the directors’ fiduciary duty to the company. It is a modification of the ordinary rule whereby, for the purposes of the director’s fiduciary duty to at in good faith in the interests of the company, the company’s interests are taken to be equivalent to the interests of its member as a whole. There are circumstances in which the interests of the company should be understood as including the interests of its creditors as a whole.

The creditor duty is a recognition of the economic interests or stakeholding in the company of its creditors when the company is bordering on insolvency or is insolvent.

The creditor duty can apply to the payment of a lawful dividend (i.e. a dividend that complies with Part 23 of the 2006 Act and the common law rules about maintenance of capital).

However, the fact that a company faces a real risk of insolvency is not sufficient to give rise to the duty. That was sufficient to dismiss BTI’s appeal.

In relation to the trigger for the engagement of the duty:

  1. Lords Briggs, Kitchin and Hodge held that the trigger 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, are sufficient triggers for the engagement of the duty.
  2. Lord Reed noted that this was an area of the law which was in the course of development, and many aspects of which remain controversial, and that it was not appropriate to attempt to answer all the questions that might arise in respect of the creditor duty in the present case, but that it was nevertheless necessary to express a provisional view about some issues which did not call for a final decision. In relation to the trigger test, he provisionally agreed with Lord Briggs, save that he was less certain that it was essential that the directors “know or ought to know” that the company was insolvent or bordering on insolvency, or that an insolvent liquidation or administration was probable. Directors are under a duty to inform themselves about the company’s affairs and the creditor duty will itself incentivise directors to keep the solvency of the company under careful review. However, it was unnecessary and inappropriate to express a concluded view.
  3. Lady Arden also noted that directors should always have access to reasonably reliable information about the company’s financial position, emphasising that “[t]he message which this judgment sends out is that directors should stay informed. The company must maintain up to date accounting information itself though it may instruct others to do so on its behalf. Directors can and should require the communication to them of warnings if the cash reserves or asset base of the company have been eroded so that creditors may or will not get paid when due. It will not help to resign if they remain shadow directors. In addition, directors can these days without much difficulty undertake appropriate training about their responsibilities, and about the penalties if they disregard them”. Lady Arden also considered that the Supreme Court should not consider itself absolutely bound by its obiter views on the precise trigger until the issue actually arose.

In relation to the content of the duty:

  1. Lords Briggs, Kitchin and Hodge held that where a company is insolvent or bordering on insolvency the duty requires the directors to take into account and give appropriate weight to the interests of the company’s creditors as a body, and to balance them against shareholders’ interests where they may conflict. In that regard, much may depend upon what the directors reasonably regard as the degree of likelihood that a proposed course of action will lead the company away from threatened insolvency, or back out of actual insolvency (i.e. the brightness or otherwise of the light at the end of the tunnel) and a realistic appreciation of who, as between creditors and shareholders risks the greatest damage if the proposed course of action does not succeed (i.e. who has “the most skin in the game). However, where the company is irretrievably insolvent, the interests creditors become a paramount consideration in the directors’ decision-making.
  2. Lord Reed stated that the effect of the rule is to require the directors to consider the interests of creditors along with those of members. The weight to be given to their interests, insofar as they may conflict with those of the members, will increase as the company’s financial problems become increasingly serious. Where insolvent liquidation or administration is inevitable, the interests of the members cease to bear any weight, and the rule consequently requires the company’s interests to be treated as equivalent to the interests of its creditors as a whole. Prior to that point, he agreed with Lord Briggs that there was much to be said for an approach to these issues which is sufficiently fact-specific to “take account of differences, according to particular circumstances, in what it may be reasonable and responsible for directors to do when they find that the company is in a sufficiently weak financial situation that a conflict of interest between its creditors and its shareholders appears to arise”.
  3. Lady Arden stated the interests of creditors could only supplant the interests of shareholders altogether when the company becomes irreversibly insolvent, making insolvent liquidation or an administration unavoidable. She said that she did not did not believe that there was any great difference between her view and that of Lord Briggs, but she did not consider that the paramountcy of creditors could depend simply on the directors’ assessment of what was in the best interests of the company, if that was being suggested.

A number of other questions were expressly left open, including in relation to the scope of liability and relief.

The judgment is available here.

Ciaran Keller appeared for BTI, led by Andrew Thompson KC of Erskine Chambers, instructed by Kevin Lloyd and Richard Lawton of Hogan Lovells International LLP