Contributors
The long, long awaited Supreme Court Judgment in the Sequana case is finally here. Firstly, for those who may have forgotten what the Supreme Court was grappling with, the issue was 'whether the trigger for the directors’ duty to consider creditors is merely a real risk of, as opposed to a probability of or close proximity to, insolvency'.
The rather unique facts that gave rise to this issue were, in simple terms, that Sequana's subsidiary was liable to indemnify BTI for costs arising from the clean-up of a polluted river. The directors of the subsidiary resolved that it should pay a substantial divided to Sequana, without – as asserted by BTI – leaving enough money in the subsidiary to pay for the clean-up costs.
BTI brought a breach of duty claim against the directors of the subsidiary who authorised the dividend payment, arguing that it had been paid in breach of their duty to have regard to the interests of its creditors.
This 'creditors' interest duty', as it has come to be known, stems from the long-established fiduciary duty of a director to act in a way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its shareholders as a whole (as codified by section 172(1) of the Companies Act 2006). However, there is a common law rule (as recognised by section 172(3)) that this duty is modified in certain circumstances, namely the company's insolvency, such that the company's interests are said to equate to those of its creditors, which a director must therefore have regard to.
At what point this duty is engaged – in particular how short of/close to actual insolvency – is the issue that has gone all the way to the Supreme Court. This has wide-ranging implications, including at what point company directors should take various actions, including resolving to place a company into liquidation of administration or whether they can be criticised and sued further down the track for decisions taken, including by an administrator for breach of duty or liquidator under section 212 of the Insolvency Act 1986.
The Judge at first instance found that the subsidiary's risk of insolvency at the time the dividend was paid was not such so as to trigger the duty. BTI appealed, and one of the questions for the Court of Appeal was when and in what circumstances the duty arises. This involved the Court of Appeal considering the authorities and various expressions of the appropriate test and relevant threshold.
The Court of Appeal ultimately dismissed the appeal, similarly finding that the creditors' interest duty was not triggered on the particular facts and concluding that there were four possible answers to the question of when it is: Firstly, when a company is actually insolvent; Secondly, when it is on the verge of or nearing or approaching insolvency; Thirdly, when the company is or is likely to become insolvent; and Fourthly, where there is a real, as opposed to a remote, risk of insolvency. BTI appealed to the Supreme Court.
The Supreme Court has today unanimously dismissed the appeal. Whilst this short article cannot do justice to the 159-page Judgment and the lengthy reasonings of Lords Reed, Hodge, Briggs, Lady Arden and Lord Kitchin, all agreed that the duty (referred to as the 'creditor duty') was not engaged in the particular case. On the wider issues – questions of considerable importance for company law – the Supreme Court dealt with a number of these as follows:
Is there a creditor duty at all?
In short, yes. The Supreme Court agreed that a director's duty to act in good faith in the company's interests is modified in certain circumstances such that the company’s interests are taken to include the interests of its creditors as a whole. Directors, under certain circumstances, must have regard to and consider the interests of a company's creditors and prospective creditors.
However, it was stressed that this is a 'modifying rule', not a 'free-standing duty', which remains owed by a director to the company, not its creditors.
The duty was affirmed for a number of reasons, including that creditors have an obvious economic interest in the company and its assets, distinct from the interests of the company's shareholders, which increases in relative importance when the company is bordering on insolvency.
What is the content of the duty?
The duty to act in the company's interests has to reflect the above fact that both its shareholders and creditors have an interest in its affairs, which may not align. Once engaged, the creditor duty requires a director to have regard to the interests of the company's general body of creditors (not the interests of particular creditors in a special position), as well as the general body of shareholders, and act accordingly, with a balancing exercise necessary where they conflict. The more 'parlous' a company's financial state, the more the creditors' interests will 'predominate', eventually becoming 'paramount' when a company is irretrievably insolvent, at which point the shareholders no longer have any valuable interest in the company.
When is the creditor duty engaged?
The particular triggers referred to by the Supreme Court include 'imminent insolvency' or the 'probability of an insolvent liquidation or administration', which the directors 'know or ought to know about' and when the company is 'insolvent or bordering on insolvency', but a potentially earlier trigger of 'a real and not remote risk of insolvency' was rejected.
The Court was, however, less certain on and left open the question of whether it is essential that the directors know or ought to know.
Commentary
Clarification that the creditor duty indeed exists along with the reasons why is welcome; however, the fact-sensitive nature of when precisely a company is insolvent inevitably means that those hoping for a one size fits all test may be disappointed. Just as company directors have been proceeding carefully in the midst of the events of the last few years, the Supreme Court's decision may result in them continuing to take a cautious approach as to when the duty is engaged.
