Summary of the Court’s decision
On 5 October 2022, the Supreme Court handed down its long-awaited decision in the appeal of BTI 2014 LLC v. Sequana S.A. and Others.
The Supreme Court held that directors owe a duty to consider creditors’ best interests when a company is insolvent, or when they ought to know that the company will become insolvent. This duty is owed to the company, not to individual creditors. Breach of the duty cannot be authorised by the directors, or ratified by the company’s shareholders.
As Lady Arden said, this is a “momentous” decision in English company law, examining fundamental principles of company law. The decision changes the long-held view that there is no statutory duty on directors to act in creditors’ best interests.
Even after this decision there is still doubt as to when the duty to creditors applies, particularly where it is not clear if the company is already insolvent, or that its insolvency is probable.
The rest of this post examines the facts of the case, including considering when the new duty may affect common types of corporate transactions. The end of the post considers what comes next for the broader English litigation stemming from this dividend, in light of the claims against other professional advisors involved.
Factual background
The case concerned a €135 million dividend paid in May 2009 by a company called ArjoWiggins Appleton (“AWA”) to its sole shareholder, Sequana. The dividend amounted to all bar around €2 million of AWA’s assets. AWA had previously paid a €443 million dividend to Sequana in December 2008, but that decision was not challenged on appeal. AWA had no trading business. AWA’s corporate function was to manage a multi-million dollar historic U.S. environmental indemnity obligation. The scale of the indemnity liability depended on the outcome of long-running litigation in the U.S. federal courts.
The claim against the directors for breach of duty arose because, in early 2012, AWA stopped paying the environmental indemnity obligation. AWA is a former subsidiary of British American Tobacco (“BAT”). In late 1990, BAT divested AWA by listing it as a separate company. Sequana acquired AWA in around 2001. In 2014, following a separate dispute, BAT assumed AWA’s responsibilities, in exchange for certain third party contributions toward the liability and an assignment of AWA’s claims in relation to the dividends. BAT’s exposure is estimated at £270 million. BAT incorporated BTI to manage the environmental liability and the assigned claims. BTI, as AWA’s assignee, sought to recover the dividend from two of the company’s former directors, who also served simultaneously as directors of Sequana.
The parties agreed that AWA was solvent in May 2009. BTI contended that there was a real risk in May 2009 that AWA would become insolvent over the medium to long-term. AWA in fact only entered insolvent administration in late 2018. AWA’s creditors have proved for debts of around £350 million in that administration.
BTI argued that the two directors owed a duty to consider creditor interests and that the dividend was in breach of that duty. BTI claimed that there was a real risk AWA might become insolvent as a result of the dividend because, mere minutes after the dividend was declared, Sequana sold AWA to a company controlled by two of its former advisors. The buyer had no means of meeting AWA’s obligations, beyond money left in an insurance policy. BTI further argued that, as a result of the dividend, AWA’s creditors were therefore deprived of access to Sequana’s greater financial resources. As above, AWA did in fact run out of money in around 2012.
In 2016, the High Court found, and in 2019 the Court of Appeal agreed, that this otherwise lawful dividend was a transaction defrauding creditors under section 423 of the Insolvency Act 1986. The section 423 finding was made only against Sequana, not against the two directors.
Also in 2016, the High Court found there was no duty on the directors to consider creditor interests in relation to the May 2009 dividend. In 2019, the Court of Appeal agreed.
The Supreme Court only considered the directors’ duties on this appeal. The Supreme Court unanimously dismissed BTI’s appeal. The Court recognised a duty on directors to consider creditor interests, but found that it was not breached in this case. However, the Justices’ reasoning differs on the timing and knowledge required to trigger the duty.
Previous authority on the directors’ duty to consider creditor interests characterises the obligation as a separate “creditor interest duty”, known as the rule in West Mercia Safetywear Limited v. Dodd [1988] BCLC 250. The Supreme Court held that this rule in fact forms part of a director’s statutory duty under section 172 of the Companies Act 2006 to act in the company’s best interests.
The majority of the Supreme Court held that this rule modifies directors’ duty to act in the company’s best interests. Once a company is insolvent, or directors ought to know it is going to become insolvent, the directors become duty-bound to act in creditors’ best interests.
The Justices in the minority said that whether or not the test was triggered should be a fact-sensitive question. The Justices in the minority doubt whether a fact-sensitive test meant anything different in practice from the test preferred by those in the majority. The Justices in the minority said that this was not the case to decide such an issue. The minority Justices also held that directors owed a duty to inform themselves of the company’s affairs at all times, including its solvency (In re Westmid Packing Services Ltd (No 3) [1998] 2 BCLC 646).
What does “insolvent” mean and when should directors know of that insolvency?
The decision is of potentially broad application. The trigger for the rule to apply, which is when the directors know a company is insolvent, or that insolvency is “probable”, seems to be deferential to directors’ contemporaneous commercial judgment. This formulation of the test mirrors the test for wrongful trading under section 214 of the Insolvency Act 1986.
For the purposes of triggering a director’s duty a company is “insolvent” if it cannot pay its debts as they fall due, or if its liabilities exceed its assets. There can be some complexity to this, particularly if a company’s liabilities will only become clear over a long period of time (BNY Corporate Trustee Services Limited v. Eurosail [2013] 1 W.L.R. 1408).
The Supreme Court’s decision does not clarify when the directors “ought to know” if insolvency is probable, or what kind of facts would demonstrate such a probability to a director. We will have to wait for another case to see, but it seems that any director found to be in breach of duty to creditors will be judged by the standard of reasonable director with the same knowledge and experience in the same situation.
The oddity in this case is that the same dividend that has been found not to infringe the directors’ duty to consider creditors’ interests was also found to be a section 423 transaction.
The decision in this case means that there are different tests under section 172 of the Companies Act 2006 and section 423 of the Insolvency Act 1986, even if the impugned transaction under both sections is the same. The outcome in this case feels intuitively strange because the two directors declared the dividend which was found to be section 423 transaction, but were personally found not to have intended to put assets beyond the reach of creditors and, in this decision, not to have breached their duties to the company.
What does this decision mean for directors in practice?
The decision clarifies that the duty to act in the best interests of the company means that creditors’ interests must be considered alongside those of shareholders whenever the company’s solvency is in doubt.
From now on, properly advised directors should be careful to show that they have considered creditor interests whenever there is any question of solvency. Examples of situations in which the duty may be triggered may include:
- Declaring lawful dividends. Paying a dividend that poses a probable risk of insolvency means that the directors will be required to think about whether to pay the dividend at all. Directors may have to consider paying a lesser amount. Directors may also have to consider alternatives, such as a dividend paid predominantly in shares instead of cash.
- Reductions of capital by solvency statement. Under section 643 of the Companies Act 2006 a director’s statement of solvency in support of a capital reduction must state that the director has formed the view that the company will be able to pay its debts in full for at least 12 months after the reduction. Making such a statement now appears to require a director to show more careful consideration of creditor interests.
- Mergers and acquisitions: as in this case, the sale of the entire issued share capital of one company to another may require greater consideration of how the sale will affect creditors, particularly if the seller is distressed. As explained above, the bar seems to be set very high before creditors’ interests supplant shareholders’ interests in such transactions.
- Internal reorganisations: it is common in large corporate groups for intercompany debts between parent and child companies to be settled by the lender company reducing capital by solvency statement to create reserves that can be paid as a dividend to the borrower and set off against the intercompany debt. This happened in AWA’s case. Where there is any doubt over the solvency of any companies involved in such reorganisations, careful consideration will need to be given to the potential effect on third-party creditor interests, even if all of the transactions are intragroup.
- Cross-guarantees: it is common for companies within corporate groups to cross-guarantee loans taken by other companies from which they may not benefit immediately (or at all). This has always raised the issue of whether directors can approve such cross-guarantees. The BTI decision perhaps brings such issues into sharper focus, particularly where cross-guarantees are required in the context of a refinancing of a distressed group with subsidiaries in different states of solvency.
Water under the bridge?
The AWA litigation comprises several different claims that have been running in the English courts for the past 11 years. The Supreme Court’s decision is not the last the English courts are likely to hear about AWA. BTI has been assigned two other claims by AWA against professional firms involved in advising on the matter.
Prospects of BTI recovering on the earlier section 423 judgment against Sequana appear remote. In January 2019 the English Court of Appeal upheld the section 423 finding against Sequana. In May 2019, Sequana entered liquidation in France. In 2020, Sequana’s liquidator sold off its last trading business – the paper distributor Antalis – to a Japanese buyer. The only remaining value in Sequana is believed to be the money remaining in a directors’ and officers’ insurance policy.
Theoretically, BTI can prove in Sequana’s liquidation to try and recover the €135 million May 2009 dividend under the section 423 judgment, which still stands. The chances of recovering anything on that judgment appear to be slight, varying on the finer points of French insolvency law. BAT’s accounts show that BTI has not recovered anything from Sequana to date.
BTI was also assigned AWA’s claims against its former auditor, PwC. BTI claims PwC was negligent in relation to the audit AWA’s 2008 and 2009 accounts. BTI argues PwC had a duty to qualify the audit opinion on AWA’s 2008 and 2009 accounts because paying the dividends posed a material risk to AWA’s solvency. PwC’s 2009 audit report in fact only included an emphasis of matter paragraph in relation to AWA’s exposure under the environmental liability.
It is unknown if the PwC claim will produce significant damages. The Supreme Court’s 2021 decision in Manchester Building Society v. Grant Thornton UK LLP [2022] A.C. 783 may assist BTI in pursuing recoveries from PwC. In Manchester Building Society the Supreme Court held that the so-called SAAMCO cap, whereby damages for professional negligence may be limited only to the consequences of providing negligent information, was only a principle to be considered and not an absolute cap on damages. Auditors and other professionals may still be liable for their clients’ full loss if that loss is within the scope of the professional’s duty of care.
The Supreme Court’s decision in this case may strengthen PwC’s defence. Now that the directors of AWA have been found not to have breached their duties in paying the May 2009 dividend, PwC may argue the auditor owed no wider duty than the directors to warn about that same dividend, particularly considering AWA was solvent when the dividend was paid in May 2009.
BTI has also been assigned AWA’s claim against Freshfields Bruckhaus Deringer, who advised Sequana and AWA on the May 2009 dividend and back-to-back sale of AWA. That claim appears to have been stayed for some years, without a defence being filed, so it is unclear whether it will ever come to trial. Any claim against Freshfields may face the same difficulties as the claim against PwC.