Article by Iffah Sheikh (6th March 2023)
On 5 October 2022, the Supreme Court released its long awaited 160-page judgment for BTI 2014 LLC v Sequana SA[1] in which they answered whether the trigger for the directors’ duty to consider creditors is merely a real risk of, as opposed to a probability of or proximity to, insolvency. The case was important for several reasons as, Lord Reed points out, it goes to the ‘heart of our understanding of company law’ and raises significant practical importance for company management.[2] Secondly, this is the first case in this jurisdiction which raises the question of whether directors are under a duty to act in or at least consider creditors’ interests prior to insolvency. Finally, whether this duty arises where the company is solvent that is either or both balance sheet and cash flow solvent at the material time.[3] There were five Supreme Court judges sitting on the bench namely, Lord Reed, Lord Hodge, Lord Briggs, who delivered the leading judgement, Lady Arden and Lord Kitchin.
Case Facts
Arjo Wiggins Appleton Ltd (”AWA”), was a UK registered company acquired by Sequana SA (”Sequana”) from BAT Industries plc (”BAT”) in 2000. AWA was in the business of manufacturing paper and performed its business near the Lower Fox River in Wisconsin, USA. Between 1950s and 1960s AWA’s subsidiary company incurred significant environmental liability for clean-up costs of pollutants in the Fox River. AWA’s directors determined that their insurance and investment policies were deemed to cover these clean-up costs. In 2008, the AWA’s directors concluded that there was a real possibility that AWA’s long term contingent environmental liability could be in excess of their policies limit, and an additional €60 million provision was entered into AWA’s account.
In 2008, AWA’s directors distributed to Sequana a dividend of €443 million. On 18 May 2009, AWA paid a further €135 million (“the May dividend”) to Sequana, when it was deemed that the policies were likely to cover the environmental liability. The May dividend complied with Part 23 of the Companies Act 2006 and with the maintenance of capital common law rules. AWA was still balance sheet and cash flow solvent when the dividends were paid and remained so for almost ten years. It was revealed that their contingent environmental liabilities were greater than what was originally estimated as there was uncertainty as to the insurance portfolio value. Consequently, AWA went into insolvent administration in October 2018. By then AWA had commenced proceedings against the directors for breach of fiduciary duty. In 2009, Sequana had sold AWA to limit their future exposure of environmental liabilities regarding the Fox River. BAT set up a special purpose vehicle, BTI 2014 LLC (”BTI”), and assigned the claim against AWA’s former directors, the second and third respondents, for breach of fiduciary duty in distributing the May dividend to Sequana, the first respondent.
Decision of the High Court
At first instance Rose J found that the May dividend was lawfully made and did not contravene Part 23 CA 2006.[4] Second, distributing the May dividend was a transaction defrauding creditors contrary to s.423 IA 1986 as the transaction externalised the underlying Fox River risk and could not be accessed by creditors if the clean-up costs exceeded the estimated provision entered.[5] Finally, Rose J held that the May dividend did not breach the common law creditors interest duty as it would be wrong in principle and a ‘significant inroad into the normal application of directors’ duty’ if it applied whenever a company makes an estimated provision for a long-term liability which turn out to be larger than expected.[6]
Decision of the Court of Appeal
The Court of Appeal dismissed the appeal.[7] David Richards LJ held the May dividend was a transaction defrauding creditors contrary to s.423 IA 1986 confirming the High Court’s decision. David Richards LJ stated that the Court of Appeal are bound by the decision held in West Mercia[8] and that the rule in West Mercia[9] was engaged at the material time. To determine when the creditors interest’ duty was triggered, the Court held that the ‘duty arises when the directors know or should know that the company is likely to become insolvent… In this context ‘likely’ means probable”.[10] Further, ‘a real as opposed to a remote risk of insolvency’ is an inappropriate test for the Court to formulate and develop the common law given policy considerations and the Companies Act 2006.[11] David Richards LJ stated that ‘where the directors know or ought to know that the company is presently and actually insolvent, it is hard to see that creditors’ interests could be anything but paramount”.[12]
The content of the director’s duty or how much weight should be given to the creditors’ interests in being either a sole factor or one of many was left unanswered by the court.
Supreme Court
The Supreme Court answered three main questions which were whether the duty existed at all, if so what were the directors’ duty and at what point does the directors’ duty to consider the creditors’ interests arise.
BTI appealed the Court of Appeal’s decision and argued that a real risk of insolvency is sufficient to engage the creditor duty, this was similar to the argument they had put previously to the High Court and Court of Appeal. BTI argued that the creditors’ interests duty had been engaged, and breached when the May dividends were declared.[13]
The first and second respondents argued that the Court of Appeal was wrong to conclude that the creditor duty existed at all, and if it did then it could apply to the lawful dividend payment or that the creditor duty “could be engaged short of actual, or possibly imminent, insolvency”.[14] Finally, that the Court of Appeal was right in holding that a “real risk of insolvency… was not enough to engage the creditor duty”,[15] as it tracked the development of a real risk of prejudice to the creditors arising from the changing accounts of the company.[16] Additionally, where the creditors’ interests become paramount when the company is actually insolvent then, this leaves little room to consider and balance their interests unless, the creditor duty was triggered at some earlier point before actual insolvency.
Decision of the Supreme Court
The Supreme Court unanimously dismissed BTI’s appeal. Lord Reed stated that the creditors’ interest duty or the West Mercia rule does exist,[17] and that the rule in West Mercia does not create a separate duty owed to the creditors,[18] it is merely a duty owed to the company. Lady Arden who agreed with the respondent’s argument of the success duty[19] is transformed by s.172(3) CA 2006[20] whereby the creditors’ interests become the company’s interest upon the onset of insolvency.[21]
As to the content of the duty, Lord Reed’s ratio is as follows: “prior to actual insolvency a balancing exercise is conducted between the creditors’ and shareholders’ interests where they conflict”.[22] Additionally, “The weight to be given to [the creditors’] interests, insofar as they may conflict with those of the members, will increase as the company’s financial problems become increasingly serious. Where insolvent liquidation or administration is inevitable, the interests of the members cease to bear any weight, and the rule consequently requires the company’s interests to be treated as equivalent to the interests of its creditors as a whole”.[23] In Lord Briggs’ judgment, directors should look to see if there is ‘light at the ends of the tunnel’ and determine how bright that light is to decide whether it is necessary to treat the creditors’ interests as paramount.[24]
The Supreme Court differs from the Court of Appeal in deciding when the creditor duty arises. Instead of the company likely to become insolvent at some point in the future in terms of probability, Lord Reed found that the duty was engaged when a company was ‘insolvent or bordering on insolvency’.[25] Lord Briggs preferred the formulation of insolvency being ‘imminent’ or insolvent liquidation or administration was ‘likely’ or probable.[26] Lord Briggs suggested that the probability-based trigger may be needed for directors to assess the consequences of insolvency or administration.
Key points of Supreme Court’s Decision
- The rule in West Mercia continues to apply and directors are required to consider the creditors’ interests at some point before actual insolvency prior to or during the twilight zone, the period between the company becoming insolvency and entering an insolvency process (liquidation or administration).
- A real rather than a remote risk of insolvency was not enough to trigger the West Mercia rule.
- Prior to insolvency, directors must consider creditors’ interests along with the shareholders’ interests according to the company’s financial health and lies between insolvency being likely but earlier than when the directors knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation under s.214 IA 1986.
- Where insolvency becomes irreversible, the creditors’ interests become paramount as the creditors have the main economic interest in the company, based upon their entitlement to share pari passu the debts owed to them.[27]
- The directors’ duty is engaged when insolvency is imminent or insolvent liquidation or administration is likely.
- The duty applies where dividends are lawful.
- Where the duty is engaged, the members’ powers to ratify decisions and policies ceases. The Supreme Court recognised the interaction between the West Mercia rule and the ratification principle[28] and that they cannot operate simultaneously where the latter ceases because the company is or would be rendered insolvent.[29]
General Comments on the Supreme Court Decision
- The merit of the Court of Appeal decision of using probability in determining insolvency is that it is an easier measurement and test for both directors and judges to conduct compared to the Supreme Court using the ‘imminent’ test. The difference between ‘likely’ or probable and ‘imminent’ is that the former can be quantitatively and objectively determined whilst the latter relies on a more subjective qualitative scale. Further, future cases would need to clarify, and possibly quantify, what the court meant by ‘imminent’ in terms of time either days, months or even years.
- The content of the duty relies on the age-old problem of ‘well… it depends on the facts of the case’. Sequana therefore arguably, is not the clearest case law in determining what the directors’ duties are towards the creditors. Directors need to judge whether there is ‘light at the end of the tunnel’, which is easier said than done, and is a significantly easier task with the benefit of hindsight than what the directors are dealing with at the material time.
- Lastly and more controversially, Sequana is anticlimactic in that it merely affirms the rule in West Mercia but there is no deeper analysis on how directors should act when the rule is engaged or how directors should act since members or shareholders are unable to ratify decisions. Therefore, it may be either up to the Court or Parliament to outline how directors should conduct themselves with their creditors since the ratification process ceases when insolvency is triggered.
[1] [2022] UKSC 25
[2] Ibid [7] Lord Reed
[3] Ibid [8] Lord Reed
[4] BTI 2014 LLC v Sequana S.A. and Others [2016] EWHC 1686 (Ch) [454]
[5] Ibid [20]
[6] Ibid [479]
[7] BTI 2014 LLC v Sequana S.A. and Others [2019] EWCA Civ 112
[8] West Mercia Safetywear Ltd (in liq) v Dodd [1988] BCLC 250
[9] now codified by s.172(3) CA 2006. The rule in West Mercia states that directors have a duty to consider the interests of the creditors when the directors know, or ought to know, that the company is or is likely to become insolvent.
[10] [2019] EWCA Civ 112 [220]
[11] Ibid [215]
[12] Ibid [222]
[13] Ibid [117]
[14] Ibid [117]
[15] Ibid [117]
[16] Ibid [189]
[17] BTI 2014 LLC v Sequana S.A. and Others [2022] UKSC 25 [111]
[18] Ibid [261] Lady Arden
[19] Success duty is the duty to promote the success of the company for the benefit of members as a whole s.172(1) CA 2006.
[20] Section 172(3) Companies Act (CA) 2006 states that directors have a duty to promote the success of the company for the benefit of creditors.
[21] Ibid [161] Lord Briggs
[22] Ibid [81] Lord Reed
[23] Ibid [11] Lord Reed
[24] Ibid [164] Lord Briggs
[25] Ibid [72] Lord Reed
[26] Ibid [203] Lord Briggs
[27] Ibid [12] and [192]
[28] Codified in s.236 CA 2006
[29] [2022] UKSC 25[312]
The views expressed in this material are those of the individual author and do not necessarily reflect the views of the Company Insolvency Pro Bono Scheme (COIN). This material is provided free of charge by COIN for general information only and is not intended to provide legal advice. No responsibility for any consequences of relying on this as legal advice is assumed by the author or the publisher. The contents of this material must not be reproduced without the consent of the author.
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