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In this post, Alex Tubbs, an Associate in the CMS Disputes team, comments on the UK Supreme Court’s decision in BTI 2014 LLC v Sequana SA & Ors [2022] UKSC 25, handed down by the Supreme Court on 5 October 2022. This case concerns the issue of 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.

Background

On 18 May 2009, the directors of a UK limited company, Arjo Wiggins Appleton Limited (“AWA”) resolved to distribute a dividend of €135m (“the Dividend”) to its parent company and sole shareholder, Sequana SA (“Sequana”). At the time, AWA’s assets consisted of an investment contract, insurance policies and a debt owed to the company by Sequana. These assets far exceeded the provision made for the company’s contingent liabilities on its balance sheet, and the company was consequently deemed solvent on both a cash flow and balance sheet basis at the date of distribution of the Dividend. Pursuant to their obligations under the Companies Act 2006, s 643(1), the directors signed a solvency statement confirming the same. It was common ground that the Dividend also complied with the rules regarding maintenance of capital.

AWA’s sole liability was its long-term contingent liabilities relating to environmental clean-up costs of the Fox River in Wisconsin (“the Liabilities”). However, the Liabilities were of an uncertain amount, and this gave rise to a ‘real risk’ that AWA might become insolvent at an uncertain future date. Several years following distribution of the Dividend, it became apparent that the Liabilities had a significantly higher value than the directors of AWA had estimated. AWA subsequently entered into administration in October 2018.

BTI 2014 LLC (“BTI”) was the assignee of AWA’s claims. Following AWA’s insolvency, BTI commenced proceedings in which it sought to recover the value of the Dividend on the basis that (i) the distribution constituted an unlawful reduction of capital; and (ii) the decision to pay the Dividends was a breach of the directors’ fiduciary duties to consider the creditors’ interests.

Additionally, AWA’s principal creditor sought to have the Dividend set aside as a transaction at an undervalue which was intended to defraud creditors, contrary to the Insolvency Act 1986, s 423.

Decisions of the lower courts

The High Court dismissed BTI’s claim.

The High Court determined that there were circumstances in which company directors were bound to consider the interests of creditors in addition to those of its members (“the Creditor Duty”). However, Rose J explained that the Creditor Duty would not apply in situations where there is a mere ‘real risk’ that a company will have insufficient assets to meet a liability, which included temporary circumstances where a company was balance-sheet insolvent. This would place an unfair burden on directors, who would be incorrectly forced to prioritise creditors’ interests over shareholders’ interests over a prolonged period of business activity. The High Court was particularly concerned about such a duty causing “significant inroad to the normal application of directors’ duties”. Instead, the High Court held that the Creditor Duty should only become engaged in circumstances “where the company is insolvent, or where it is more likely than not to become insolvent”.

The High Court also determined that since AWA was solvent on a balance sheet basis at the date of distribution of the Dividend (“the Date of Distribution”), there was no justification for holding that the Dividend constituted an unlawful reduction of capital. Furthermore, the High Court determined that AWA was not insolvent or likely to become insolvent at the Date of Distribution. The Creditor Duty was therefore held not to have been engaged when the Dividend was paid. It was consequently irrelevant that, in distributing the Dividend, the directors of AWA had not considered the creditors’ interests.

BTI sought to appeal the High Court’s findings on the basis that Rose J had misinterpreted the circumstances in which the Creditor Duty would engage.

Rose J did, however, find in favour of AWA’s principal creditor on its claim that the Dividend should be set aside on the grounds that there was a transaction at an undervalue intended to defraud creditors under the Insolvency Act 1986 s 423. Sequana also cross-appealed the High Court’s decision that the Dividend should be set aside as a transaction at an undervalue intended to defraud creditors. However, the Court of Appeal upheld the first instance decision on this discrete matter.

The principal task for the Court of Appeal was therefore to determine whether a Creditor Duty existed, and if so, when the duty arose, and specifically whether it had engaged by the Date of Distribution. BTI’s submission was that the Creditor Duty should arise in circumstances where there is a “real, as opposed to remote, risk of insolvency”; a significantly lower bar than the test set by Rose J in the first instance decision. In the leading judgment, Richards LJ affirmed that there were circumstances in which directors were obliged to consider the interests of creditors, noting that the court was bound by this rule following the decision in Liquidator of West Mercia Safetywear Ltd v Dodd [1987] 11 WLUK 231. However, although the Court of Appeal accepted the existence of a Creditor Duty, it adopted a near-identical test to the High Court as to when the duty was triggered. The court expressly rejected any assertion that the duty should be imposed as early as when there is a real, but not remote, risk of insolvency at an unidentified future date. The Court of Appeal accepted that such a test would unfairly hinder legitimate business activities and risk taking by company directors.

In adopting this test, the Court of Appeal subsequently dismissed BTI’s submission that the Dividend was paid in breach of the fiduciary duties of AWA’s directors. It held that AWA was not insolvent, or likely to become imminently insolvent, at the Date of Distribution, even though there was a real risk of the future insolvency of the company. Accordingly, the Dividend had not been distributed in breach of the Creditor Duty.

The Court of Appeal went on to opine on a fundamental point. Although the duty had not arisen on the facts, once the Creditor Duty had been engaged, Richards LJ explained that it was “hard to see that creditors’ interests could be anything but paramount”. In doing so, the Court of Appeal implied that in these circumstances, directors would be bound to treat the creditors’ interests as primary when making decisions on behalf of the company.

Summary of the Supreme Court’s findings

The Court of Appeal’s determination that the Dividend should be set aside as a transaction at an undervalue intended to defraud creditors was not appealed to the Supreme Court. However, BTI successfully obtained permission to appeal the Court of Appeal’s findings on the Creditor Duty.

The principal argument brought by BTI was that the High Court and Court of Appeal had incorrectly applied the test for when the Creditor Duty should be engaged. BTI contended that the duty should be engaged as soon as the directors know, or ought to know, that there is a ‘real risk’ the company will become insolvent. The Supreme Court concluded that although there were circumstances in which directors owed a Creditor Duty, this duty would not be triggered by a mere ‘real risk’ of insolvency. It therefore unanimously dismissed the appeal, in which Lord Briggs gave the leading judgment. The judgment focussed on determining four issues:

Is there a separate duty which obliges directors to have regard to the interests of creditors?

The court was unanimous in determining that, in certain circumstances, directors do owe a duty to creditors to have regard to their interests when making decisions on behalf of the company. This duty was founded in common law. However, crucially, it had been preserved by Parliament through the Companies Act, s 172(3), which requires directors “in certain circumstances, to consider or act in the interests of creditors of the company” pursuant to any enactment or rule of law.

Although the Creditor Duty was recognised by the Supreme Court, BTI’s submission that the duty was a “free-standing duty” enforceable by creditors was rejected. Lord Reed and Lord Briggs concluded that the Creditor Duty could not exist as a separate duty; it merely amended the content of the existing duty for directors to act in good faith in the interests of the company. Therefore, in circumstances where the Creditor Duty was engaged, the ‘interests of the company’ would be held to also include the interests of creditors; in addition to those of the members and it was not conceivable that the directors would be required to have regard to the interests of specific categories or classes of creditors.

When is the Creditor Duty triggered?

Although it affirmed the existence of the duty, the Supreme Court emphasised that the critical question for determination in the appeal was when the Creditor Duty was triggered. Lord Reed and Lord Briggs dismissed BTI’s argument that the Creditor Duty should be engaged in circumstances where there was a “real and not remote risk of insolvency”, holding that this was not a sufficient trigger for the duty. The court preferred different, but near-identical, formulations of the test, consistent with the Court of Appeal’s findings. Lord Reed and Lord Hodge adopted a formulation that the Creditor Duty would only be engaged when the company was “insolvent or bordering on insolvency“, in harmony with the position adopted in Bilta (UK) Ltd (No 2) v Nazir [2015] UKSC 23. Lord Briggs’ preference was for the duty to only be engaged where the directors knew, or ought to have known, of the company’s “imminent insolvency”.

The Supreme Court was moreover unanimous in affirming that the test for determining a company’s solvency should be the definition in the Insolvency Act 1986, s 123; namely whether the company is unable to pay its debts as they fall due (the cash flow basis) or whether the company’s assets exceed its liabilities (the balance sheet basis).

What are directors required to do when the Creditor Duty has been engaged?

It was held that the Court of Appeal was incorrect to conclude that when the Creditor Duty was engaged, creditors’ interests then became ‘paramount’ to directors. The Supreme Court found that during the period between the Creditor Duty being triggered, but prior to the company entering into formal insolvency, the correct interpretation is that directors are required to give the interests of creditors “appropriate weight”, and balance these against the interests of shareholders when making decisions on behalf of the company. The appropriate weight was fact-specific, but greater weight should be given to creditors’ interests as the likelihood of the company avoiding insolvency reduces.

The court emphasised that directors were not required to treat creditors’ interests as ‘paramount’ once the Creditor Duty was engaged. The court noted that its conclusion was based on (i) its interpretation of the discrete duties owed by company directors under the Companies Act 2006, s 172; and (ii) practical common sense, principally to avoid situations where directors would be forced to give effect to creditors’ interests in situations where the company is only temporarily insolvent on a cash-flow or balance sheet basis.

What duties do directors owe to creditors when an insolvent liquidation or administration becomes inevitable?

The Supreme Court held that in circumstances where the liquidation or administration of a company has become inevitable, directors must treat the interests of creditors as paramount. At this time, directors must give priority to the creditors’ interests – not those of the shareholders – and take all reasonable steps to minimise losses to creditors, to avoid personal liability for wrongful trading under the Insolvency Act 1986, s 214.

Comment

To quote Lady Arden, the Supreme Court’s judgment constitutes a “momentous decision” in the sphere of company law. The highest court has affirmed for the first time that directors of a company are required to take into consideration the interests of creditors, and balance these with the shareholders’ interests, when making decisions in the best interests of the company. However, in doing so, the Supreme Court has offered welcome relief to directors that a high bar must be reached before such a ‘Creditor Duty’ is engaged, namely only when directors know, or ought to know, that the company is insolvent or bordering on insolvency. In rejecting BTI’s submission that the duty should apply as soon as there is a ‘real risk of insolvency’, the Supreme Court appears to have been attempting to remedy concerns that an unfair burden may be placed on company directors if an earlier and less precise test was adopted.

The Supreme Court’s decision has also helpfully emphasised the long-held view that when creditors lend funds to businesses, they do so at their own risk, and as large commercial entities they are expected to take adequate steps to protect their own commercial interests through means other than a Creditor Duty.

However, although the decision delivers some clarity on the circumstances when the Creditor Duty arises, the test for when a company is insolvent or bordering on insolvency remains, by its nature, fact-sensitive. This decision is unlikely to change the fact that directors will still face ambiguity and difficult deliberations when concluding whether the test has been met in their specific circumstances, a concern expressly raised in Lord Reed’s judgment. Furthermore, since this is the first occasion in which the Supreme Court considered the question of whether a Creditor Duty can arise prior to insolvency, it is anticipated that any certainty afforded by the judgment could be extinguished by future decisions by the lower courts which attempt to refine the scope of the duty.

Given the inherent vagueness of the test for the imposition of the Creditor Duty, it is critical that directors continue to seek regular input from their advisors on their company’s financial position, and separately keep themselves informed of any liquidity concerns. Directors will need to continue to give adequate consideration to the interests of creditors, particularly where boards become aware of consistent financial difficulties.