In BTI v Sequana & Ors, the Supreme Court handed down a landmark judgment which, in the words of Lord Reed, addressed "questions of considerable importance for company law" concerning the development of the law on duties owed by company directors towards the company's creditors.
Supreme Court decision
The Supreme Court, in dismissing BTI's appeal, found, on the facts of the case, that the directors' duties to creditors had not been triggered. The Court decided that the "so-called" 'creditor duty' is not triggered where the risk of insolvency, although properly described as "real", was nevertheless neither imminent nor probable. In doing so, the Supreme Court promulgated important principles on the duties of directors in such instances. The respondents had questioned the very existence of the 'creditor duty' and specifically whether it could even apply to a lawful payment of a dividend.
The Supreme Court also clarified that there is no free-standing 'creditor duty' separate from the directors' wider duties to act in the interests of the company. Instead, Lord Reed relied on 'the rule in West Mercia' to show that the creditor duty was a subset of the directors' wider duties.
Impact of the judgment: more litigation and thoughtful directors
Although the Supreme Court decision has been clear that no new duty has been created, it has undeniably broadened the way directors' duties will be understood. Indeed, the Supreme Court was alive to the fact that it had not been able to answer many questions which arose in the case and that some of its answers that it was able to give were nevertheless provisional. The questions that remain unanswered and those that have been answered provisionally will result in further litigation on issues such as what the consequences of the breach of duty might be and the forms of relief that may be granted. The judgment will also widen the scope of action for future litigants in creditor and management disputes.
From the perspective of directors' decision-making, the judgment will impact on the consideration of risks that are excluded in the determination of solvency but may nevertheless impinge upon the interests of creditors. Although several questions remain unanswered, it is now clear that when a company is bordering on insolvency directors can no longer simply sign off on the payment of a dividend on the basis of balance-sheet solvency but have to consider the impact of that dividend on the interests of creditors.
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Facts and Background
An English company called AWA distributed a dividend of €135 million to its parent company (and sole shareholder), Sequana SA, in May 2009. Almost ten years later, in October 2018, AWA became insolvent and its rights and claims were assigned to BTI 2014 LLC ("BTI"). The payment of the dividend in May 2009 became a matter of controversy when BTI sued AWA's then directors for breach of their 'creditor duty' and sought to recover the amount of the dividend distribution. It was alleged that the directors failed to regard AWA's creditors' interests when paying the dividend at a time when AWA was at a real risk of insolvency.
Interestingly, in May 2009, AWA was unquestionably solvent and the payment of dividend was statutorily compliant and lawful. However, there was a real risk of insolvency as AWA had pollution-related contingent liabilities of an uncertain amount as well as an insurance portfolio with an uncertain value.
BTI's claim failed before both the court of first instance and the Court of Appeal on the ground that the 'creditor duty' was not engaged in May 2009. Those lower courts held that, whilst the risk of future insolvency was real, it was neither imminent nor probable. In particular, the Court of Appeal held that the creditor duty did not arise until a company was either actually insolvent, on the brink of insolvency or probably headed for insolvency.
BTI challenged the earlier dismissals before the Supreme Court on the ground that "a real risk of insolvency" alone was sufficient to engage the 'creditor duty'.
The rule in West Mercia
The directors' duty to consider the interests of creditors sees its genesis, at least in reported cases, in the case of West Mercia Safetywear Ltd v Dodd [1988] BCLC 250, which was the first English authority that expressly articulated the duty towards creditors.
Also referred to as the "modifying rule", the rule in West Mercia requires directors, in certain circumstances, to consider the interests of the company's general body of creditors along with the interests of the company's general body of shareholders when they are discharging their fiduciary duty. The weight given to the interests of both stakeholders must move along a sliding scale depending on the financial health of the company and a "balancing exercise" becomes necessary in case a conflict arises between their respective interests. At the point when insolvent liquidation or administration becomes inevitable, shareholders' interests in the company cease.
The Supreme Court in BTI v Sequana & Ors held that the creditor duty, as established in West Mercia, is engaged at the point when the directors know, or ought to know, that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable.
The rationale for the rule
The Supreme Court explained the rationale of this rule to be based on economic reality and on fundamental principles of insolvency law. The duty of the directors to manage the company ought to be directed towards the interests of the stakeholder that is primarily bearing the commercial risk. When the company is financially stable, the shareholders bear this risk. However, in times of insolvency, this risk shifts upon creditors whose recovery during winding up becomes of paramount importance, not least because the shareholders no longer have an economic interest in the shares which by reason of the insolvency are rendered valueless. If the focus of the directors' duty does not shift along with the shift in risk, there is a danger of externalisation of risk (losses resulting from risk-taking are borne wholly or mainly by creditors) and it is this risk that the rule in West Mercia seeks to avoid.
The preservation of the common law creditor duty
The Supreme Court noted that the common law fiduciary duty of a director to act in good faith in the interests of the company has been codified in Section 172 of the Companies Act 2006 (the "2006 Act") as meaning action for the benefit of its members as a whole. This duty was found to encompass the common law duty of directors towards creditors in certain circumstances (i.e. the rule in West Mercia or the creditor duty). The Supreme Court referred to Section 172(3) which states that the duty imposed under Section 172 "has effect subject to any…rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company" (emphasis added) and reiterated the view taken by the English courts that this had the effect of preserving the common law 'creditor duty' in the 2006 Act.
The content of the duty
Once the duty is engaged, it requires giving consideration and weight to creditors' interests proportionate to the particular financial and business circumstances of the company at the time. The creditors' interests as a whole (as opposed to an individual creditor's interest) have to be balanced against the interests of other stakeholders in the company including those of its shareholders.
The lawfulness of the dividend does not insulate the directors from the 'creditor duty'
The Supreme Court was disinclined to accept that the lawfulness of the payment of the dividend provided a 'silver bullet' in excusing the directors from abiding by their 'creditor duty'. The duty was engaged because it is a common law duty that cannot be avoided by the mere fact that the dividend was paid in compliance with Part 23 of the 2006 Act. It follows that a dividend that was paid lawfully may nevertheless be made in breach of a duty although, on the facts of this case, there was no such breach.
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