Debtors & dumping: lessons for Insolvency Practitioners
On 5 October 2022, judgment was handed down by the Supreme Court in the case of BTI 2014 LLC v Sequana SA (Sequana) and others. The judgment is significant to company directors, insolvency practitioners and litigators as it clarifies how directors should comply with their duties to creditors in the context of insolvency.
Lord Reed commented that the issues “go to the heart of our understanding of company law, and are of considerable practical importance to the management of companies”.
Specifically, the judgment concerns the duty of directors to act in good faith in the interests of the company. In particular, whether directors owe a duty to act in accordance with the interests of the company’s creditors when the company approaches or is at real risk of insolvency, or is in fact insolvent (the so-called ‘creditor duty’).
In 2009, a company called AWA distributed a dividend of 135 million euros to its sole shareholder, Sequana. It was agreed between the parties to the proceedings that the dividend payment: (i) complied with Part 23 of the Companies Act 2006 which governs the payment of dividends; (ii) was made when AWA was not insolvent (on either basis under s213, Insolvency Act 1986); and (iii) did not breach common law rules relating to maintenance of capital. However, AWA had certain contingent liabilities relating to environmental matters of an uncertain amount which meant there was the risk that AWA might become insolvent at some point in the future. That risk later materialised with AWA becoming insolvent.
BTI (2014) LLC, as assignee of AWA’s claims, sought to recover the dividend payment from AWA’s directors on the basis that the payment was a breach of the company’s duty owed to its creditors. In addition, AWA’s creditors applied to have the dividend payment set aside as a transaction at an undervalue which prejudiced creditors as a whole (under s423, Insolvency Act 1986).
High Court and Court of Appeal decisions
These claims were heard together in the High Court, where it was held that: (i) the dividend payment was made in breach of s423, Insolvency Act 1986 and accordingly was set aside (although Sequana did not repay the dividend as it too went into insolvent liquidation); and (ii) the claim to recover the dividend payment from AWA’s directors failed as, whilst the creditor duty did exist, it was not engaged when the payment was made in 2009. This was because AWA was not insolvent at the time and, whilst there was a real risk that it would become insolvent in the future, this was not imminent or even probable given the contingent liabilities were so uncertain.
In the Court of Appeal it was once again held that the creditor duty did exist, but that it did not arise until a company was in fact insolvent, on the brink of insolvency or probably headed for insolvency. Accordingly, the duty was not engaged when the payment was made in 2009.
The decision of the Court of Appeal was appealed to the Supreme Court.
In the Supreme Court, BTI argued that a real risk of insolvency was sufficient for the creditor duty to be engaged. In addition, the directors argued that the Court of Appeal was wrong to decide that the creditor duty existed at all. If it did exist, however, it could: (i) not as a matter of law affect a dividend payment which was lawful under Part 23 of the Companies Act 2006; and (ii) only be engaged when there was actual or likely imminent insolvency.
The Supreme Court held as follows:
- The creditor duty exists, although it does not exist on a standalone basis. Rather, it exists as a modification of the ordinary fiduciary duty to act in good faith in the interests of the company. Where the duty is engaged, the company’s interests are equivalent to the interests of the members of the company as a whole. This extends to including the interests of the creditors as a whole when the company is on the brink of insolvency or is in fact insolvent.
- The creditor duty can apply to the payment of a dividend that otherwise complies with Part 23 of the Companies Act 2006 and/or the common law requirements in relation to the maintenance of capital.
- As to when the creditor duty is engaged, it is not enough that a company faces a real risk of insolvency. Accordingly, BTI’s appeal failed. The Supreme Court left open the question of precisely when the creditor duty is engaged before a company is in fact insolvent, although it suggested that it could be engaged where there is imminent insolvency which the directors are or ought to be aware of.
The case is seminal as it clarifies that the creditor duty does indeed exist and why that is the case. That said, the Supreme Court expressly left open the question of when the creditor duty is engaged before a company is technically insolvent. This leaves directors in the position of needing to tread carefully where there is a risk (however uncertain) of future insolvency.
It is likely that future cases will test the question of when the creditor duty is engaged, but for now directors will need to err on the side of caution when considering their fiduciary duties.