Hogan Lovells represented BTI 2014 LLC (“BTI”) a subsidiary of BAT Industries (“BAT”), in the Supreme Court Hearing against Sequana S.A. (“Sequana”) and the former directors of Windward Prospects Limited (formerly called “AWA”) (“AWA”). BTI brought the claims against Sequana and the former directors as an assignee of AWA.
Relevant Background and Facts
The case involved a number of issues relating to the duties of directors when authorising dividend payments in circumstances where the company was at real (not remote) risk of insolvency and where the dividends had been found by the Court to be in breach of s423 Insolvency Act 1986 (transaction at an undervalue intended to prejudice creditors). It represents the most significant decision in this area of the past 30 years.
The relevant facts are summarised by Lord Briggs at paragraph 115 in his Judgment as follows:
“In May 2009 AWA’s directors… caused it to distribute a dividend … (“the May dividend”) to its only shareholder… Sequana SA, which extinguished by way of set-off almost the whole of a slightly larger debt which Sequana owed to AWA.”… “the May dividend was distributed at a time when AWA was solvent, on both a balance sheet and a commercial (or cash flow) basis. Its assets exceeded its liabilities and it was able to pay its debts as they fell due. But it had long-term pollution-related contingent liabilities of a very uncertain amount which, together with an uncertainty as to the value of one class of its assets (an insurance portfolio), gave rise to a real risk, although not a probability, that AWA might become insolvent at an uncertain but not imminent date in the future. In the event AWA went into insolvent administration almost ten years later, in October 2018.”
At first instance and before the Court of Appeal, BAT had succeeded against Sequana in its claim under s423 Insolvency Act 1986 to recover the dividend. However, Sequana did not satisfy that Judgment. BTI therefore pursued a claim against the former AWA directors on the basis that their decision to approve the dividend was a breach of the creditor duty. That claim did not succeed at first instance or before the Court of Appeal. This was because the directors had not been found to have a duty to have regard to the creditors’ interests in the relevant circumstances. This led to the current appeal.
Issue before the Supreme Court
The issue before the Supreme Court was whether, in authorising payment of the May dividend, the directors of AWA acted in breach of duty by not taking sufficient or indeed any account of the interests of its creditors. BTI contended that the directors had a duty to consider the interests of the body of creditors (as well as shareholders) when authorising the dividend in the relevant circumstances. Those circumstances involved a real (not remote) risk of insolvency for AWA.
In response, the former directors of AWA who authorised the May dividend argued that:
- No such creditor duty existed at all.
- That, if it did, it did not apply to the payment of a dividend which was lawful.
- Alternatively, that such a duty could not be engaged short of actual, or possibly imminent, insolvency.
- In the final alternative to the above, that a real risk of insolvency, falling short of a probability, was not enough to engage the creditor duty.
Findings of the Supreme Court
The Judgment of the Supreme Court consists of four separate judgments from Lord Reed, Lord Hodge, Lady Arden and Lord Briggs - with Lord Kitchin concurring with Lord Briggs. The reasoning and emphasis in each of the four judgments differs in various respects but the following points emerge:
- there is a creditor duty owed by directors of a company. That duty is not a self-standing duty owed directly to the creditors. The duty is owed to the company. It arises by virtue of common law and is preserved by s172(3) Companies Act 2006. It can also be seen as a modification of the directors duties to act in good faith under s172 generally;
- this duty is triggered at a point short of actual insolvency. However, that point is not simply when where is a real risk of insolvency;
- the content of the creditor duty, when triggered, is that the interests of the company’s creditors as a whole, as well as those of the shareholders, should be considered in respect of a particular decision (such as paying a dividend). When the company is irretrievably insolvent, the creditors’ interests will be the paramount consideration in directors’ decision making;
- the shareholders’ right to ratify decisions and actions of the directors ceases to exist when the creditor duty is engaged; and
- the creditor duty (if triggered) applies to decisions to declare and pay a dividend (even if the dividend would otherwise be lawful).
The Supreme Court has provided clarification that the creditor duty exists. Also, the Court has largely endorsed BTI’s contentions that when circumstances trigger the duty its content is such that the affected directors need to have regard to the interests of the body of the company’s creditors, as well as the shareholders, when making decisions. Such decisions include authorising dividend payments. The general basis for the creditor duty appears to be the economic rationale and that creditors have ‘skin in the game’ when a company is approaching insolvency.
Nevertheless, various issues arise.
First, there is still not total clarity as to the precise timing or trigger point for the engagement of the duty. One thing is clear is that it is not a ‘real risk of insolvency’ which BTI contended for and which has been used in some of the Australian authorities and approved in some English authorities. Different formulations have been suggested by members of the Supreme Court. These include “imminent insolvency” (i.e. an insolvency which directors know or ought to know is just around the corner and going to happen) or the probability of an insolvent liquidation (or administration) or “bordering on insolvency”.
It would seem therefore that if a risk of insolvency is not imminent, and insolvent liquidation is not probable then the duty does not apply. Accordingly, if the chance of insolvent liquidation occurring is say 49% or even 50% then the duty does not appear to apply, yet if the chance of it occurring were 51% then the duty would presumably apply. The ‘real risk’ test seems to have been rejected for reasons which logically could be thought to have more application to a remote risk test.
The issue which remains is quite when does a ‘real’ risk of insolvent liquidation tip over into a probable one. How is this to be assessed in practice? Put another way, how can a director be comfortable that the risk is say 49%, or 50% and not 51%?
Directors can have regard to the economic rationale in relation to a transaction but this does not necessarily provide them with clear guidance on this potentially crucial issue. Ultimately, perhaps the question needs to be considered in its particular factual context in each given situation.
Second, it seems odd that the Court should find a transaction to be in breach of s423 Insolvency Act 1986 (which is a section headed “Transactions defrauding creditors”) and the recipient of a dividend liable to repay it but at the same time the directors authorising the dividend payment are not in breach of the creditor duty for having done so. It seems clear that such a transaction is not in the interests of the company’s creditors and it seems questionable that the creditor duty should not arise in such circumstances.
Third, much of the rationale underpinning the Judgment is focused on the need for directors to promote the economic activities of a company. This involves that company making payments to effect investments to increase its fortunes. Here, AWA was a non-trading company, was not making investments and the transaction in question was a payment of a dividend (a transaction which is a zero sum game for the company or its investors). An issue arises as to whether the trigger point for such type of transaction by such a company should be viewed differently from one where say a trading company is actively operating and making investments. Should different considerations arise?
The Supreme Court Judgment will be construed by a wide range of affected people. These include directors, shareholders, financiers, auditors, insurers, investors, and insolvency practitioners, as well as lawyers and academics, to name just some of them. It covers a broad range of issues affecting, or of interest to, all of these individuals. This note is intentionally only focused on a narrow subset of these issues.
If you would like to discuss any of the issues raised in this note and how they may affect any of the above affected categories of people please contact our team.
The Hogan Lovells team was led by Kevin Lloyd (Partner) and includes Richard Lawton (Partner) and Ardil Salem (Partner).
Authored by Kevin Lloyd, Richard Lawton, Ardil Salem, and Frederick Rathore.