Long awaited clarity (of sorts) on the Creditor Duty: The Supreme Court judgment in BTI v Sequana

60 second speed read:

• The UK Supreme Court has confirmed that directors do owe a duty to consider the interests of creditors of their companies.
• Courts will adopt a commercial approach – the Creditor Duty is not engaged simply where there is a real risk of insolvency.
• The Creditor Duty is engaged when a company is cashflow or balance sheet insolvent, or bordering on insolvency, or where an insolvent administration or liquidation is probable.
• The weight to be given to creditors’ interests increases the greater a company’s financial difficulties become – once insolvent administration or liquidation is inevitable, the creditors’ interests are paramount.
• When facing financial difficulties, we would advise directors to seek professional advice sooner rather than later; to ensure that they keep a record of their decisions and the basis for making them; and to ensure that they keep themselves informed with up-to-date financial reporting.

After a 17-month rumination, the UK Supreme Court has delivered its judgment in BTI 2014 LLC v Sequana SA and others [2022] UKSC 25 (BTI v Sequana). The decision has confirmed the existence of a common law requirement for company directors to act in the interest of creditors in certain circumstances (which the leading judgment referred to as the Creditor Duty) and has provided guidance as to when, and to what extent, this requirement takes effect.

Whilst upholding the Court of Appeal’s judgment that a real risk of future insolvency does not require a company’s directors to prioritise the interest of creditors over shareholders, the Supreme Court found that their duty to do so was engaged when the company faced imminent or actual insolvency or probable insolvent liquidation or administration (rather than likely insolvency, as the Court of Appeal had held).

The guidance provided by BTI v Sequana does not, however, offer as much clarity as practitioners might have hoped – largely because, although reaching the same outcome, the five Supreme Court Judges took very different routes. In this article, our Litigation and Restructuring teams remind us of the facts of BTI v Sequana, digest the Supreme Court judgment, and consider what it means for directors and for potential claimants.

The history

A reminder of the background

As Lord Briggs, delivering the leading judgment, noted “the resolution of the issues in this appeal is not fact sensitive”. It is useful however for context to remind ourselves briefly of how the BTI v Sequana appeal came about.

In 2009, an English company, Arjo Wiggins Appleton Limited (AWA) paid a dividend to its shareholder, Sequana SA (Sequana). At the time, AWA was balance sheet and cashflow solvent but faced a real risk of future (although not imminent) insolvency due to a pollution liability and an insurance portfolio of uncertain value. In 2018, AWA entered insolvent administration and its potential claims against its former directors and former shareholder were assigned to BTI 2014 LLC (BTI). BTI then sought to recover the dividend from AWA’s former directors and Sequana on the grounds that they had breached their common law duty to act in the interests of AWA’s creditors.

The High Court and Court of Appeal both rejected BTI’s claim. In his 2019 Court of Appeal Judgment, Lord Justice David Richards (as he then was) found that company directors do have a common law duty to give primacy to the interest of creditors but that this duty is only engaged when a company either becomes insolvent or faces likely (i.e. probable) insolvency – a real risk of future insolvency is insufficient. Here, insolvency can be taken to mean cashflow or balance sheet insolvency, rather than entry into an insolvency process.

The appeal to the Supreme Court

BTI appealed the Court of Appeal decision, arguing that the real risk of AWA’s future insolvency triggered the directors’ common law duty to act in the interests of creditors rather than shareholders and that AWA’s directors had breached this duty by paying the dividend.

Sequana and the AWA directors argued that: first, that there is no duty to act in the interests of creditors under English common law; secondly, if such a duty does exist it cannot apply to restrain the payment of a lawful dividend; and thirdly any such duty does not come into effect until a company’s actual or imminent insolvency.

The present - what did the Supreme Court decide?

Are directors subject to a Creditor Duty?

Despite disagreeing as to whether it constituted a duty in its own right, the Supreme Court was unanimous in finding that, in certain circumstances, company directors do need to take into account the interests of creditors. This finding was supported by authority, notably West Mercia Safetywear v Dodd [1988] BCLC 250 (indeed Lady Arden and Lord Reed used the term “the Rule in West Mercia” instead of Creditor Duty), and established legal principles. The Creditor Duty does not create a right of action for the creditors themselves – any action rests with the company and so in practice would be taken by a liquidator or administrator.

The reasoning of the Supreme Court judges in finding that the Creditor Duty exists was one of the points on which they differed. Lord Briggs, in the majority judgment, found that the s.172(3) Companies Act 2006 (CA 2006) qualification that the statutory requirement to promote the interests of the shareholders is “subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company” affirmed the common law Creditor Duty.

Lady Arden and Lord Reed, however, suggested that s.172(3) CA 2006 merely preserved the possible existence of the creditor interest duty, instead basing their interpretation of the requirement on the Rule in West Mercia.

Can the Creditor Duty make a decision to pay an otherwise lawful dividend unlawful?

The Supreme Court found that the lawful dividend regime set out in Part 23 CA 2006 is subject to any rule of law to the contrary (as set out in s.851(1) CA 2006). Accordingly, the Creditor Duty can apply to restrain the payment of otherwise lawful dividends. However, in this particular case, it did not.

When is the Creditor Duty engaged?

One of the most contentious aspects of the Court of Appeal decision had been the finding that the Creditor Duty kicks in where a company is insolvent, or where it is likely (i.e. probable) that the company will become insolvent.

This is the one area in which the Supreme Court differed substantially, and crucially, from the Court of Appeal. Like the Court of Appeal, the Supreme Court held that a “real risk of future insolvency” (which is what the claimants – and, at this stage, appellants – argued) was a risk too remote to engage the directors’ duty to act in the interests of a company’s creditors and thus dismissed the appeal. However, the Supreme Court rejected Lord Justice David Richards’ finding that the creditor interest duty is triggered when directors know, or ought to know, that a company faces probable insolvency.

Instead, the majority decision of the Supreme Court found directors should continue to act in the interests of shareholders as a whole until the directors know or ought to have known that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable. The point at which the Creditor Duty kicks in is, therefore, now later than the Court of Appeal had suggested. In this context “bordering on insolvency” is used to mean bordering on cashflow or balance sheet insolvency (rather than entry into an insolvency process). The question of knowledge was strictly obiter and two of the judges expressed reservations on this point – it is possible therefore that this will be an issue to be debated in future litigation.

What is the content of the Creditor Duty?

Although this issue was not considered by the Court of Appeal, the Supreme Court found that full analysis of the issues relevant to the Creditor Duty could not “sensibly be carried out in a mental state of pure agnosticism about its content” – it is all very well to conclude that the Creditor Duty exists, but what does that actually require of directors?

Where the Creditor Duty is engaged – i.e. where the company is bordering on insolvent or insolvent, or where an insolvent liquidation or administration is probable – but the company is not yet at the point where insolvent liquidation or administration is inevitable, the directors should consider the interests of creditors, balancing them against the interests of shareholders where those interests diverge. The worse the company’s financial difficulties, the more its directors should prioritise the interests of creditors. Where insolvent liquidation or administration is inevitable, the creditors’ interests should be considered paramount.

Where the directors know, or ought to have known, that there is no reasonable prospect of the company avoiding insolvent liquidation or administration, directors are of course required under s. 214 Insolvency Act 1986 (wrongful trading) to take every step to minimise the losses to creditors – nothing in the BTI v Sequana judgment changes that obligation.

Can shareholder ratification get round a breach of the Creditor Duty?

This is a question which the majority of Supreme Court Judges did not cover in their otherwise extensive judgments. However, it is a point that exercised Lord Reed and Lady Ardenwho confirmed that where the Creditor Duty is engaged, the shareholders cannot cure a breach of that duty by authorisation or ratification.

While this was technically obiter – so would be persuasive, but not binding, in any further decisions –it seems a sensible conclusion reached via a thorough review of the law on the subject, and it would be a brave (and perhaps misguided) board that sought to flout it.

The future - where does this leave us?

We now know that the Creditor Duty exists and is here to stay. Where a company has reached the point of imminent or actual insolvency, or where an insolvent administration or liquidation is probable, the Creditor Duty will be engaged, and its importance will grow as the company moves closer to inevitable insolvent administration or liquidation. Boards, together with those advising them, will need to be mindful of the need to take account of, and give appropriate weight to, the interests of creditors, and to balance them against the interests of shareholders where they begin to diverge.

However the however, of balancing creditors’ and shareholders’ interests is incredibly complex – it remains difficult in any given fact scenario to pinpoint the exact time at which the Creditor Duty is engaged. Boards would be well advised to seek legal and/or financial advisory support in advance of needing to make those decisions.

Switch to prioritising the creditors’ interests too early, and there will be a risk of shareholder action against the directors on the basis of breach of s. 172 CA 2006. Consider or prioritise the creditors’ interests too late, and should the company ultimately fail, there will be a risk of action by the liquidator or administrator for breach of the Creditor Duty.

The Supreme Court recognised that progress towards insolvency is not always linear – things can get better and subsequently worsen again. As reiterated by Lady Arden in her judgment, it is always good practice for directors to ensure that they stay informed of the company’s current financial position, and receive up to date financial information. It is also important make a record of decisions taken and the reasoning behind them. Those records may well be crucial if litigation is subsequently brought.

The BTI v Sequana saga has placed the Creditor Duty at the forefront of discussion in the restructuring world for three years now. With the Supreme Court decision, some resolution has finally been reached. However, this may well not be the end of the story, and we can anticipate a sequel (and perhaps more clarity) when the lower courts come to interpret the differing views the Supreme Court Judges expressed. As Lady Arden noted in her conclusion, that process “is part of the way the common law works”.