Supreme Court clarifies a director’s duty to creditors

The Supreme Court handed down judgment in the case of Sequana, considering the circumstances in which a director owes a duty to consider the interests of a company’s creditors.

The Supreme Court has handed down judgment in the case of BTI 2014 LLC v Sequana SA and others [2022] UKSC 25. The appeal considers and clarifies the circumstances in which a director owes a duty to consider the interests of a company’s creditors, holding that such a duty does exist (albeit that it forms part of the duty to the company rather than being a stand-alone duty) and that creditors’ interests carry greater weight the closer a company gets to insolvency.

The law

Section 172(1) of the Companies Act 2006 requires directors to act in good faith to promote the success of the company for the benefit of its members. Section 172(3) modifies this duty, making it “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”. The ambit of any duty to creditors however was left to the courts.

The facts

The case concerned a dividend of €135 million paid to Sequana by its subsidiary, AWA, in May 2009. The dividend was lawfully declared. At the time AWA was solvent on a balance sheet and cash flow basis but had long-term contingent liabilities of an uncertain value.

Almost ten years later, in October 2018, AWA went into administration. The appellant sought to recover the €135 million from AWA’s directors on the basis that they had failed to consider the interests of AWA’s creditors when declaring the dividend, and that this amounted to a breach of duty. This was rejected by the High Court and the Court of Appeal. The appellant appealed further to the Supreme Court.

The appeal

The Supreme Court considered the duty directors have to creditors and whether that duty could potentially apply to a declaration of a dividend that was otherwise lawful, looking at how it arises, when it is engaged, and what form it takes. It found as follows:-

1. There is a common law duty on directors to consider the interests of creditors, although this forms part of a director’s duty to the company rather than being a separate, free-standing duty.
2. This duty could be applied to the decision of the directors to declare a dividend that was otherwise lawful.
3. The nature of the duty is a requirement on the directors to consider the interests of creditors, balancing them against the interests of shareholders where they may conflict.
4. The duty is engaged when the directors know, or ought to know, that the company is insolvent or is bordering on insolvency, or when an insolvent liquidation or administration is probable.

The appeal was dismissed. The Supreme Court agreed that, at the time of the dividend, the directors were not under a duty to consider the interests of AWA’s creditors as AWA was not actually or imminently insolvent, nor was insolvency even probable. It was not enough for the company to be at a “real and not remote” risk of insolvency at some point in the future.

Comment

This appeal is significant as it is the first opportunity that the Supreme Court has had to consider the existence, scope and engagement of a director’s duty to consider, or act in accordance with, the interests of creditors. It confirms that it is not sufficient for directors to consider the interests of creditors only when insolvency proceedings become inevitable. Once the company is insolvent, bordering on insolvency, or an insolvent liquidation or administration is probable, then directors must consider the interests of creditors and balance these against the interest of the shareholders where necessary. Once insolvent liquidation or administration is inevitable, however, the interests of creditors are paramount as the interests of the members cease to have any weight.  The result is that directors must place greater weight on creditor interests as the company’s finances worsen.

The judgment of the Supreme Court, supporting the decisions of the lower courts, is reassuring and provides useful and necessary guidance for directors. The judgment emphasises the importance of directors actively monitoring the company’s finances so that whether a company is insolvent or bordering on insolvency is known as soon as possible.

If you are concerned about your company’s finances or your duties of a director, please do not hesitate to contact one of the insolvency specialists in our Commercial Dispute Resolution Team.