The Supreme Court’s recent judgment in BTI 2014 LLC v Sequana SA  UKSC 25 is a significant decision for the law of directors’ duties. It is the only decision in which the Supreme Court has addressed (1) whether a director owes a duty to creditors, separate and free standing from the fiduciary duty owed to a company (“Creditor Interest Duty”), and (2) whether a company director owes a duty to consider or act in accordance with the interests of the company’s creditors over its shareholders when a company becomes insolvent, or when insolvency approaches, or there is a real risk of insolvency.
In summary, the decision rejects the existence of a separate and free standing duty to creditors. It confirms that the trigger point at which directors must consider the interests of creditors is when a director knows or ought to know a company is insolvent or bordering on insolvency. The reality is trading through challenging economic conditions means the timing of the trigger is often not clear cut. Directors will need to keep the financial position of their company under close review, as was the case before Sequana, and to seek professional advice to support them in making financial assessments and determining when the trigger has been pulled.
In May 2009, the directors of AWA Limited (“AWA”), a wholly owned subsidiary of Sequana SA (“Sequana”), declared substantial dividends, totalling €135m, to Sequana, its only shareholder. This had the effect of reducing or extinguishing by way of set off, a debt owed by Sequana to AWA. At the time the dividend was declared, the payment was legal and AWA was solvent, with its assets exceeding its liabilities. No insolvency was imminent and it was able to pay debts as they fell due. However, AWA faced long term pollution-related contingent liabilities of uncertain amounts.
In 2018, AWA went into administration and BTI obtained an assignment of AWA’s claims. BTI brought proceedings against AWA’s directors to recover an amount equal to the dividend, on the basis that the directors’ decision to pay the dividend was taken in breach of their fiduciary duties to consider or act in the interests of AWA’s creditors. That was because AWA had left itself without sufficient funds to satisfy the contingent liabilities and pay for clean-up costs resulting from the pollution.
There was a further claim brought in relation to the dividend. AWA’s main creditor applied to have the May dividend set aside pursuant to S423 of the Insolvency Act 1986 (“IA 1986”) as a transaction at an undervalue on the basis that AWA had intended to prejudice its creditors.
At first instance, the two claims were heard together. Liability was found at first instance under S423 of the IA 1986 but Sequana went into insolvent liquidation and no part of the dividend was repaid. The attempt by BTI to rely on the Creditors’ Interest Duty was rejected.
The decision was upheld by the Court of Appeal which concluded that the creditor duty could be engaged short of actual insolvency but was only triggered when the directors knew or should have known that the company was or was likely to become insolvent. A risk of insolvency in the future was insufficient to engage the duty unless it amounted to a probability.
The Supreme Court rejected the contention that there was a “Creditor Interest Duty” distinct from a directors fiduciary duty to act in the interest of the company and in good faith. It unanimously decided that the weight to be given to the interests of a company’s creditors would depend on the gravity (or not) of the company’s financial position. The greater the company’s liabilities, the more weight should be given to the interests of the company’s creditors - essentially a “sliding scale”.
In its judgment, the court concludes that directors owe duties to the company rather than its shareholders or creditors, although these often competing interests should be balanced if the financial position of the company deteriorates, it is bordering on insolvency and an insolvent administration or liquidation is inevitable. This can be either balance sheet or cashflow insolvency. In those circumstances, the directors must treat the interests of creditors as paramount. There is, however, no duty to consider the interests of creditors when there is merely a real risk of insolvency.
The decision in Sequana should not ultimately alter the way in which directors and their advisers approach financial distress. Now as always, time is of the essence. Directors must stay informed about the company’s financial position and have access to reliable current financial and operational information, including knowledge of the various classes of creditors and the time for which their debts have been outstanding in order to respond effectively to a changing situation and protect themselves from personal liability. The entire board has a responsibility to be aware of the company’s financial position and the scope of their duties. The board should take legal and financial advice from lawyers and accountants recognised in the management of restructuring and insolvency situations. That advice should include timely, continuous and regular monitoring of the company’s financial position, along with the formulation and, if necessary, implementation of an appropriate contingency plan.
In addition, directors should hold, and minute, regular and if necessary frequent board meetings and “ad hoc” discussions as the company’s situation evolves. Those minutes should set out clearly the basis for and likely outcomes of any proposed courses of action. Directors should be seen to review the results of their actions in real time. Where necessary they should be prepared and seen to be willing to modify and adopt proposed solutions to reflect changes in their company’s situation.
Implications of Creditor Interest Duty
The existence of a Creditor Interest Duty will inevitably give rise to wide ranging consequences including at what point directors should take various actions, and, if appropriate, resolve to place a company into liquidation or administration. In practice, this means that the trigger for and the content of the Creditor Interest Duty will be matters on which directors will, now as before, require specialist financial and legal advice.
The decision recognises that the basis for the operation of a limited liability company is “to encourage risk taking as an essential part of commercial enterprise”. Lady Arden, in her judgment, considered that the court should clearly approve a restriction on directors’ obligations to promote the success of their company so as to provide a measure of protection to creditors. In her view, the issue was really what that restriction involved and how far it went and the “sliding scale” analogy should not be taken too literally as events leading to financial stress could occur very quickly and without warning. She stressed the need for directors to keep themselves informed about their company’s financial position as the transition from trading as a going concern to trading with the risk of actual or prospective insolvency was often and invariably rapid.
The Sequana decision is reassuring both for company boards and their advisers in that the Supreme Court confirms there is no Creditor Interest Duty when there is merely a real risk of insolvency, and only when a company is bordering on insolvency and an insolvent administration or liquidation is inevitable. When a company encounters financial difficulty, its directors must therefore be vigilant but they should not panic. Directors should instead and, in short order, take and act upon advice from lawyers and financial advisers and be prepared to change course should their company’s position either worsen or improve.
Demonstrating the degree of knowledge of any director at any specific time will inevitably be fact specific but we do not believe that this decision will lead to any significant increase in claims against directors. Insolvency practitioners or other stakeholders, such as claim funders, wishing to bring a claim will still need to continue to consider the factual position carefully to decide whether they have sufficient evidence first to demonstrate that the Creditor Interest Duty has been engaged and secondly that it has been breached.