Joel Wallace provides an overview of the recent Supreme Court decision in BTI 2014 LLC v Sequana SA and Ors [2022] UKSC 25. A copy of the judgment can be found here. Topics include: Directors duties, insolvency, acting in the interest of creditors and section 172 of the Companies Act 2006.
Introduction
The sacred duty of a company director is to act,
“[I]n the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole”.[1]
Common law has developed an apparent exception to this duty: where a company is insolvent or, perhaps, approaching insolvency the interests of creditors becomes a significant, if not paramount, concern of a director.[2] Indeed, room for this special duty – dubbed “creditors duty”[3] – is made by the Companies Act 2006, s 172(3), which provides that a director’s duty to act for the benefit of the company’s members is subject to “any enactment or rule of law” that requires a director “in certain circumstances” to consider or act in the creditors’ interests.
In BTI 2014 LLC v Sequana SA and Ors [2022] UKSC 25, the very existence of this creditors duty and when it is triggered was brought centre stage before the UK’s highest court for the first time. Four of the five Supreme Court Justices produced a written decision; only Lord Kitchin relented and chose to adopt Lord Briggs’ decision instead. Although all five judges broadly agreed to dismiss the appeal, the disparate obiter comments and divergent philosophies expressed are likely to prove troublesome to businesses, except (of course) those providing litigation services.
The Facts
The matter arose from a myriad of corporate transactions. Sequana SA (“Sequana”) had built up a considerable amount of debt as a result of a taking a loan from its daughter company, Arjo Wiggins Appleton Ltd (“AWA”), following the sale of an AWA subsidiary company in 2001. AWA became a non-trading company with substantial assets (including the Sequana debt).
On 18th May 2009, the AWA board resolved to pay an interim dividend (€135,181,358) by way of set-off against the Sequana debt. However, AWA had become laden with contingent liabilities due to various indemnities which it had given or adopted. Some of the indemnities were for liability flowing from the pollution of the Lower Fox River in Wisconsin, USA and there was a real risk that AWA would become insolvent at an uncertain date in the future should the indemnity be activated.[4] It was noted by Lord Briggs that the risk was real but “not a probability” and that a prospective insolvency date was uncertain but “not imminent”.[5]
Unfortunately for BAT Industries PLC (“BAT”), a beneficiary of the indemnities given by AWA and (therefore) a potential AWA creditor, AWA went into insolvent administration in October 2018. BAT sought to recover the €13M May dividend from the directors. through BT1 2014 LLC, which is a company that was set up for the very purpose of the claim.
The Issues
The issues that materialised before the Supreme Court were expressed in various ways by the Justices. The core questions with which this overview is concerned can be summarised as follows:
One category of issue missing from the above list is any issue as to the duty’s content eg “what is the extent and scope of the duty?” However, as was noted by Lord Reed and Lord Briggs, some analysis of the duty’s content could be expected (if not required) when addressing the above issues.
Does the Creditor Duty Exist?
Although deeply unsatisfying, the positivist analysis provides the quickest route to an answer: yes, the duty exists because it has been a long-established doctrine of common law and is plainly accepted by Parliament. Disappointingly, the court majority adopted this approach. Lord Briggs (with Lord Kitchin in agreement) and Lord Reed considered the Companies Act 2006, s 173(3) as plainly endorsing the common law development of the duty,[7] whilst Lord Hodge came to the conclusion following a deep dive into the statutes preparatory documents.[8]
Lord Briggs did, at least, address three alternative grounds on which the creditor duty doctrine might rest.[9] The first ground is ethical in nature and views the duties owed by directors as inextricably bound to the power that directors wield, particularly in times of insolvency; with great power comes great responsibility. However, Lord Briggs aligned himself with various legal critics and held that limited liability companies did not grant privilege; rather they encourage risk. The nub of Lord Briggs’ point is clear: the purpose of a limited company would be undermined or perhaps thwarted if their mere creation could give rise to quasi-tortious duties. Further, there is no basis for imposing a duty to care for creditors on directors.
Lord Briggs found the second and third grounds more attractive.[10] The second ground arises from an attempt to marry insolvency and company law. A core tenet of insolvency law is that insolvent persons are obligated to their creditors. Since insolvent companies are incorporeal, some duty must pass to the directors for the company to be properly obligated to its creditors. The third ground was developed through the lens of competing interests. Directors duties are, ordinarily, directed towards shareholders because of the shareholders’ proprietary interest in the company. However, in insolvency, creditors interests overtake and at the extreme (ie liquidation) the company’s assets belong (for all practical purposes) to the creditors.
Whilst Lady Arden agreed with the conclusion of her fellow judges on this issue, her analysis differed. For Lady Arden the timing or triggering of the duty was the split or shift in economic interests between the creditors and shareholders in times of financial difficulty.[11] This provided a sufficient basis for the creditor duty,
“Since the interests of creditors (in the absence of some special agreement) are economic rather than proprietary… it seems to me that the motivation for the rule of law is the need to redress the fact that, until formal insolvency procedures are initiated, creditors do not have control of the company’s affairs. The governance position is asymmetric… In my judgment… [T]he rationale of the Rule in West Mercia is the need to ensure, so far as practicable, that creditors are not harmed by the asymmetry in governance following on from the shift in the economic interest which Lord Reed describes.”[12]
Could the Duty be Breached if the Dividend had been Properly Administered?
The Companies Act 2006, pt 23 outlines how profits are calculated for the purpose of issuing a dividend. The argument made by Sequana and AWA directors was that the statutory regime already required AWA to account for potential liabilities when calculating the distributable profit. Accordingly, creditor protection is built into the dividend issuing process.
Lord Briggs and Lady Arden gave this argument short shrift.[13] Firstly, the Companies Act 2006, s 851(1) made part 23 subject to “any rule of law to the contrary”, which could include rules pertaining to directors’ duties. Secondly, part 23 provides a lower level of protection for creditors than the creditors duty since Part 23 profits are calculated on a balance sheet basis. However, insolvency can occur on either a balance sheet basis (ie a negative balance sheet) or a cash flow basis (ie inability to meet demand for payments as they fall due).
Did the Duty Arise When There was Actual Insolvency or Imminent Insolvency?
The Court was agreed that as a starting point the creditor duty was actually a modified duty to the company, in that,
“The interests of the company are no longer regarded as solely those of its shareholders but are understood as including those of its creditors as a whole.”[14]
It was also unanimous in its view that real risk of insolvency was too remote to trigger the duty. However, the precise content of the duty was explicated in nuanced and somewhat divergent ways.
Lord Briggs’s aligned his understanding of the duty with Westpac Banking Corpn v Bell Group Ltd (in liquidation) (No 3) [2012] WASCA 157, (2012) 270 FLR 1 and Carlyle Capital Corpn Ltd v Conway, Royal Court of Guernsey, Civil Action 1519 (Judgment 38/2017) (4th September 2017), and held that the creditor duty is,
“[A] duty to consider creditors’ interests, to give them appropriate weight, and to balance them against the shareholders’ interests where they may conflict”.[15]
The content of Lord Briggs’ articulation is, thus, context dependent in the extreme. However, it is not immediately clear as to whether Lord Briggs envisaged a universally applicable triggering event for the duty (eg insolvency) or whether he conceived of a duty which emerges at different times depending on the facts. Lord Briggs expressly declined to answer whether anything short of actual insolvency (eg probable or imminent insolvency) was sufficient to trigger the duty,[16] although he did express some leaning towards the view that probable or imminent insolvency “about which the directors know or ought to know” could give rise to the duty.[17]
Lord Reed’s version of the duty was similar but, arguably, broader than Lord Briggs’ pronouncement. For Lord Reed, the duty and its emergence were fact specific:
“Where the company is insolvent or bordering on insolvency but is not faced with an inevitable insolvent liquidation or administration, the directors’ fiduciary duty to act in the company’s interests has to reflect the fact that both the shareholders and the creditors have an interest in the company’s affairs. In those circumstances, the directors should have regard to the interests of the company’s general body of creditors, as well as to the interests of the general body of shareholders, and act accordingly. Where their interests are in conflict, a balancing exercise will be necessary… [T]he more parlous the state of the company, the more the interests of the creditors will predominate, and the greater the weight which should therefore be given to their interests as against those of the shareholders. That is most clearly the position where an insolvent liquidation or administration is inevitable, and the shareholders consequently cease to retain any valuable interest in the company.”[18]
Note that Lord Reed made no mention of the directors’ knowledge in articulating this duty or the time at which it is triggered. Whilst Lord Reed was reluctant to formulate a conclusive view on the point (after all, the content of the duty was not directly in issue), Lord Reed noted that the creditor duty would provide some incentive for directors to comply with another important duty: the duty to keep informed about company affairs.[19]
For Lady Arden, the potential conflict between the interests of creditors and the interests of shareholders is acute and irreconcilable; “Directors cannot have ‘two masters’.”[20] As such, Lady Arden developed a duty with had two requirements. The first was,
“[A] requirement on directors to consider creditors’ interests at all material times and not to harm their interests.”[21]
The second requirement was that directors should act predominantly in the creditors’ interests. [22] However, neither requirement meant that the company should be run for the benefit of the creditors. Rather creditors interests are considered and acted upon only in particular circumstances,[23] namely when the company was in financial distress (ie bordering on insolvency), in circumstances where insolvent liquidation or administration is probable, or where the directors plan to enter into a transaction that would place the company into such a circumstance.[24]
As to directors’ knowledge, Lady Arden suggested the criterion of knowledge would operate differently in respect of each requirement. In respect of requirement one, the director would be taken to know when the company is in financial distress because directors should have a knowledge of company affairs. Of course, it is possible for the director to show that they “reasonably ought to be excused” although the threshold for meeting this test is high (eg fraud prevented the director from knowing).[25] However, where the creditors’ interests become paramount, requirement two, the threshold lowers to something like “knows or ought to have known”. [26]
Whatever the duty, Lady Arden encouraged courts to be careful not to intrude unnecessarily on decisions which are properly within the gift of the director; directors must have some freedom to make commercial decisions about the company and its direction of travel. Further, Lady Arden warned against viewing the creditor duty as a “sliding scale”. In reality, a company’s descent into insolvency may not be a smooth transition and particular events may deal catastrophic blows to company finances. It is only when such catastrophe hits, when the company becomes “irreversibly insolvent”,[27] that the interests of creditors is able to supplant the interests of shareholders altogether.
Conclusion
Lady Arden outlined what she saw as a principal take-home from Sequana thus:
“The message which this judgment sends out is that directors should stay informed. The company must maintain up to date accounting information itself though it may instruct others to do so on its behalf.”[28]
True that Sequana confirms the existence of the creditors duty in common law and that directors should be alive to their potential obligations under the duty. Yet, precisely what the duty is, how it operates and what defences might be available in the event of a prima facie breach are all at large. Moreover, although the Supreme Court has confirmed that the duty is not triggered by a mere real risk of insolvency, no greater clarity has been given over what the triggering event will be (if such an event exists at all).
Until the requirements of the creditors duty and the circumstances in which the duty arises are clarified in law, Lord Hodge’s view that breach would probably arise in “more egregious circumstances” so that it is rare[29] will likely do little to assuage directors’ concerns.
Joel Wallace
14th October 2022
[1] Companies Act 2006, s 172(1).
[2] Eg West Mercia Safetywear v Dodd [1988] BCLC 250, 252-253; Nicholson v Permakraft (NZ) Ltd [1985] 1 NZLR 242; Re Joshua Shaw & Sons Ltd [1989] BCLC 362, 364; Berg & Sons & Co Ltd v Adams [1992] BCC 661, 679.
[3] As christened by Lord Briggs (Sequana [2022] UKSC 25 [112]). Lord Reed and Lady Arden referred to the doctrine as the rule in West Mercia (Sequana [2022] UKSC 25 [79] and [249]).
[4] See the Richards LJ’s judgment in Sequana [2019] EWCA Civ 112 [7]-[20].
[5] Sequana [2022] UKSC 25 [115].
[6] The parties agreed before the Supreme Court that the dividend was part 23 compliant and so, in that sense, the dividend was “lawful”.
[7] Sequana [2022] UKSC 25 [76]-[77], [154].
[8] Sequana [2022] UKSC 25 [210]-[224].
[9] Sequana [2022] UKSC 25 [126]-[157].
[10] Sequana [2022] UKSC 25 [146]-[148].
[11] As articulated by Lord Reed in Sequana [2022] UKSC 25 [83].
[12] Sequana [2022] UKSC 25 [256].
[13] Lord Reed and Lord Kitchen agreeing, Sequana [2022] UKSC 25 [110] and [339]-[342].
[14] Sequana [2022] UKSC 25 [79].
[15] Sequana [2022] UKSC 25 [176].
[16] Sequana [2022] UKSC 25 [199]
[17] Sequana [2022] UKSC 25 [203].
[18] Sequana [2022] UKSC 25 [81].
[19] Sequana [2022] UKSC 25 [90].
[20] Sequana [2022] UKSC 25 [250].
[21] Sequana [2022] UKSC 25 [288].
[22] Sequana [2022] UKSC 25 [279].
[23] Sequana [2022] UKSC 25 [264].
[24] Sequana [2022] UKSC 25 [279] and [288].
[25] Sequana [2022] UKSC 25 [280].
[26] Sequana [2022] UKSC 25 [280].
[27] Sequana [2022] UKSC 25 [306].
[28] Sequana [2022] UKSC 25 [304].
[29] Sequana [2022] UKSC 25 [238].
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