B P Collins LLP’s insolvency and dispute resolution specialists considers the main issues in the recent Supreme Court decision in BTI 2014 LLC v Sequana SA and others  UKSC 25.
2016 – The High Court
In December 2008, Arjo Wiggins Appleton Limited (“AWA”) paid a dividend of €443 million to its sole shareholder, Sequana S.A. (“Sequana”) (the “December Dividend”). In May 2009, AWA paid Sequana a further dividend of €135 million (the “May Dividend”). The effect was to offset debt. AWA was solvent when the May Dividend was paid, but it had substantial pollution-related contingent liabilities of uncertain amount and there was a real risk that AWA might become insolvent in the future.
Ten years later, AWA went into administration. AWA, and later BTI 2014 LLC (a corporate vehicle of BAT Industries plc), sought to recover the May and December Dividends from the directors. After a 32-day High Court trial in 2016, Rose J had to determine whether the dividends paid by AWA to Sequana were lawful in line with Part 23, Companies Act 2006 (the “could not pay” claim), or were in breach of duties owed by directors (the “should not pay” claim), or, in any event, fell within section 423, Insolvency Act 1986.
Rose J dismissed all claims relating to the December Dividend. As to the May Dividend, she dismissed the ‘could not pay’ and ‘should not pay’ claims, finding that the directors’ decisions were properly made and accounts properly prepared, but upheld the section 423 claim against Sequana. At paragraph 527 Rose J concluded that the May Dividend, “…had the intention, in paying that dividend, of putting the dividend monies beyond the reach of BAT or of otherwise prejudicing BAT’s interests, BAT being a victim of the transaction within the meaning of section 423(5)”.
2019 – Court of Appeal
As to the May Dividend, Sequana was granted permission to appeal against the judgment under section 423, and BTI against the dismissal of the “should not pay” claim, namely that payment was not a breach of director’s duties to consider the interests of its creditors.
The key question was when, and in what circumstances, the duty to take into account the interest of creditors (often known as the rule in West Mercia) arises. Under section 172(1), Companies Act 2006, directors have a duty to act in a way that promotes the success of the company and, therefore, benefits its shareholders. However, per section 172(3), this duty is subject to any “enactment or rule of law” that would require a director to consider the interests of the company’s creditors.
BTI argued that directors should owe a duty to consider the interests of creditors where the risk of insolvency is “..real, as opposed to a remote”; and that such a “real” risk would arise – as here, when the May Dividend left AWA – when it could be said that creditors had a sufficiently strong stake in the conduct of the company’s business and activities such as when there was a risk that a business decision could lead to insolvency.
The Court concluded that the duty to consider a creditor’s interest could be triggered when a company’s circumstances fall short of actual, established insolvency, but concluded that the duty will arise where directors know or should know that the company is or is likely to become insolvent. In the Court’s view, the creditor duty did not arise until a company was either actually insolvent, on the brink of insolvency, or probably headed for insolvency; and since AWA was neither insolvent nor on the brink in May 2009, BTI’s creditor duty claim was dismissed.
2022 – Supreme Court
In relation to the creditor duty, the Supreme Court considered whether there was a common law creditor duty, its content, whether it could apply to a decision by directors to pay an otherwise lawful dividend, and whether and when it was engaged. As the Supreme Court’s first opportunity to consider the so-called “creditor duty”, the judgment was anticipated to be of key importance for company and insolvency law.
It was unanimously agreed that there was a “creditor duty”, although some labelled it “the rule in West Mercia”, and was affirmed by case law, as section 172(3), Companies Act 2006 indicated the duty’s existence, and because it was said to be justified by the fact that creditors have always had an economic interest in a company’s assets, albeit one which increases on insolvency.
It was held that the “creditor duty” could apply to a decision by directors to pay an otherwise lawful dividend, both via the common law and as expressly identified in section 172(3), and that the trigger for the duty was later in time than viewed by the Court of Appeal.
As to the duty’s content, it was held to apply to creditors as a general body; and it was held that where a company was insolvent, or bordering on insolvency, but not faced with an inevitable insolvent liquidation or administration, directors should consider creditor’s interests, balancing them against shareholder interests where they may conflict.
The Court unanimously agreed that where an insolvent liquidation or administration was inevitable, the creditors’ interests become paramount because the shareholders ceased to retain any valuable interest in the company. A majority of the Court held that the creditor duty was engaged when directors knew, or ought to have known, that the company was insolvent or bordering on insolvency, or that an insolvent liquidation or administration was probable.
All members of the Court agreed that the May Dividend did not engage the creditors duty, because at the time AWA was neither “actually or imminently insolvent, nor was insolvency even probable”.
Comment from B P Collins LLP’s insolvency and dispute resolutions teams
The Supreme Court’s comments arguably give rise to the possibility of a new sliding scale approach involving a balancing exercise to be undertaken as a company approaches insolvency where the interests of creditors will take increasing importance.
This could mean that a company bordering on insolvency may need to take account of the interest of creditors alongside those of shareholders to an increasing amount, where there are conflicting interests, the nearer they come to insolvency. It’s unclear how this might be tested in practice.
Additionally, the emphasis on creditors as a body may mean that directors also need to take more care so as to not pay one creditor ahead of another, whilst waiting for the company’s fortunes to turn around.
On one sense this decision adds useful clarity to the risk faced by directors when declaring dividends, however, questions over whether directors did or should have known as to the company’s particular point on the sliding scale toward insolvency risk seem bound to be heavily fat-dependent, and vulnerable to argument.