Call of Duty: Sequana and the state of directors’ duties

Alert
|
5 min read

Recently, the Supreme Court of the United Kingdom released its judgment in BTI 2014 LLC v Sequana SA1. This marks the first occasion on which the nature, scope and content of directors' duties to creditors when a company is nearing insolvency (the "Creditor Duty") has been considered by the Supreme Court.

While the decision essentially confirms what is generally considered the status quo, it nevertheless provides useful guidance for company directors in identifying which stakeholders need to be considered in the exercise of their common law and statutory duties and, (more relevantly), the point at which the Creditor Duty arises.

Background

AWA distributed a €135 million dividend to its sole shareholder (Sequana) in May 2009 (the "Dividend"). AWA was solvent at the time, and the distribution was lawful insofar as it complied with maintenance of capital rules and relevant statutory requirements. AWA was not a trading company, though it did have a number of contingent liabilities, and there was uncertainty both as to the amount of these liabilities and the value of certain of its assets. As a result, there was a risk that AWA would become insolvent at some point in the future – which in fact occurred in October 2018. 

BTI 2014 LLC (to whom AWA had assigned its claims) sought to recover the amount of the Dividend from AWA's directors on the basis that the distribution breached the Creditor Duty. Meanwhile, AWA's primary creditor sought to set aside the Dividend as a transaction at an undervalue. Previously, the Court of Appeal had found that the Creditor Duty was not sufficiently engaged at the time the Dividend was paid such that the directors ought not to have authorised the Dividend. This was because, while there was a risk that AWA might become insolvent in the future, the opinion of that Court was that a risk alone, even if it is a real risk, is not sufficient unless it amounted to a probability. It then fell to the Supreme Court to determine firstly whether there is indeed a duty to creditors in these circumstances, i.e., the Creditor Duty, and if so, whether it could be engaged short of actual (or possibly imminent) insolvency and apply to the payment of an otherwise lawful dividend.

Decision

The Supreme Court unanimously agreed that the so-called "Creditor Duty" was not applicable on the facts (or at least not to the extent that the Dividend ought not to have been authorised), and therefore dismissed the appeal. The key points from the judgment were as follows:

  • there is no standalone Creditor Duty per se; rather, the duty is better considered an adjustment of the ordinary fiduciary duty of directors to act in the interests of the company;2
  • the decision in West Mercia3 is authority for the principle that the common law duty to act in good faith in the interests of a company sometimes requires the interests of creditors to be considered alongside a company's members. The common law rule has effectively been codified in section 172(3) of the Companies Act 2006, which contemplates that the statutory duty to promote the best interests of the company in Section 172 is effective subject to any "rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company”;4
  • in such circumstances, directors need to give appropriate weight to creditor interests, and balance these interests with those of the members where they may conflict. The scale will naturally tip towards the interests of creditors as the company's financial problems become more grave5; and
  • a "real risk" of insolvency is not a sufficient trigger for engaging the duty; rather, the duty is engaged when a company is insolvent or bordering on insolvency, or when an insolvent liquidation or administration is probable.6  The majority held that, in each case, this assessment should be based on what the directors know or ought to know – however, the minority left this question open.7

Analysis

The decision offers helpful guidance for directors as to the nature of the duties they might owe to their various stakeholders and the points at which their focus might (and should) shift – in particular, when it becomes clear that insolvency is probable or imminent. The conclusion should be comforting to directors who may agree with Lord Briggs' comment that: "practical common-sense points strongly against a duty to treat creditors' interests as paramount on the onset of what may be only a temporary insolvency".8

It is yet to be seen what impact this decision may have. The Court's decision may give rise to further disputes as to whether or not a company's directors were aware or ought to have been aware that their company would probably enter insolvency. This is particularly the case in scenarios where the relevant company possesses uncertain contingent liabilities or holds assets of uncertain value. Valuation evidence may become increasingly relevant when a company is considering restructuring or workout strategies. Finally, there is the prospect of shareholder action as directors struggle with the parameters of their fiduciary duty. Directors will need to balance the need to recognise their duties to their creditors with the risk of giving too much weight to creditors' interests at a stage where insolvency is not sufficiently imminent or probable and thereby disadvantaging shareholders and other stakeholders.

For the time being, however, the Court's judgment reinforces that a prudent approach to corporate governance is essential. Best practice requires directors to:

  • continue to inform themselves of the company's financial position – both in the short term and longer term – and continue to carefully review and consider the company’s solvency;
  • seek appropriate workout / turnaround advice early if they have any concerns, particularly if they consider there is a probability that the company could enter into insolvent liquidation or administration; and
  • deliberately and regularly consider the subjects and scope of their duties, and ensure accurate and up-to-date records are kept to reflect this consideration.

1 [2022] UKSC 25.
2 See for example, the judgments of Lord Reed at [11], and Lord Hodge at [246].
3 West Mercia Safetywear Ltd (in liq) v Dodd [1988] BCLC 250.
4 See the judgments of Lord Reed at [111], Lord Briggs at [153], and Lord Hodge at [209].
5 See the judgments of Lord Reed at [81], Lord Briggs at [176], and Lord Hodge at [247].
6 See the judgments of Lord Reed at [83] and [88], Lord Briggs at [191]-[192] and [199], and Lord Hodge at [247].
7 See the judgments of Lord Briggs at [203], Lord Hodge at [238], and Lord Reed at [90].
8 [2022] UKSC 25 at 173.

Millie Lehman (Associate, White & Case, London) contributed to the development of this publication.

This publication is provided for your convenience and does not constitute legal advice. This publication is protected by copyright.
© 2022 White & Case LLP

Top