Please note that this News item is not maintained, and reflects the law as at the date of publication or update.
It is well known that company directors owe various duties to the company they are directors of. Most people will also know that a number of these duties are set out in the Companies Act 2006. However, some directors’ duties are not set out in statute and so their existence and their precise nature is less certain.
Similarly, it is fairly well known that directors of a company that is insolvent must conduct the affairs of the company having regard to the interests of the company’s creditors. However, there has been some uncertainty as to when this duty is triggered and how it interacts with the normal duty to conduct the affairs of the company in the interests of its shareholders.
In October 2022, the Supreme Court handed down a judgment which has given some clarity on these issues. The case is BTI 2014 LLC v Sequana SA. It concerned a dividend paid by a paper company called Arjo Wiggins to its shareholder, Sequana SA. The dividend was €135 million and it was paid to Sequana in May 2009. At the time, Arjo Wiggins was solvent based on the two normal tests: the balance sheet test and the cashflow test.
A company is solvent on the balance sheet test if the value of its assets does not exceed the value of its liabilities, taking into account both contingent and prospective liabilities.
A company is insolvent on a cashflow basis if it is unable to pay its debts as they fall due.
However, at the time of the dividend, Arjo Wiggins had certain long term pollution-related contingent liabilities (the amount of which were uncertain) and its assets included an insurance portfolio which had an uncertain value. There was therefore a real risk that Arjo Wiggins might become insolvent in the future, even though insolvency was not imminent or even probable.
In fact, Arjo Wiggins went into administration almost ten years later. After this, the right to bring claims against the company’s directors (for breach of duty) was transferred to BTI 2014 LLC and BTI brought a claim against Sequana and its directors attempting to recover the May 2009 dividend. BTI argued that the directors’ decision to pay the dividend was in breach of the duties they owed to the company’s creditors.
The main issues considered by the Supreme Court were (i) when does the duty to have regard to the interests of company creditors become engaged and (ii) what does it mean when it is engaged. For BTI, if it could not prove that the duty was engaged and had been breached, then there was no basis for attacking the dividend.
Firstly, Sequana and the directors tried to argue that there was in fact no duty to creditors. The Supreme Court rejected this argument. It found that there is such a duty and it arises under the common law (i.e. it is not derived from statute, but the duty exists nonetheless). The court found that it is an aspect of a director’s fiduciary duties rather than a freestanding duty. Further, the duty is owed to the company and not directly to the creditors concerned. When the creditor duty is engaged, directors must take creditors’ interests into account and give them appropriate weight. What this means in practice depends on the actual developing financial position of the company (see below).
Secondly, Sequana and the directors tried to argue that, whether or not there was a duty owed to the creditors, it could not be breached if the payment of the dividend complied with all normal requirements. Again, the court rejected this submission. It found that directors could make a decision to pay a lawful dividend but still be in breach of the duty to creditors.
The final issue the court considered was at what stage the duty to creditors becomes paramount (i.e. it becomes more important than any other director duties). Here, the court rejected BTI’s arguments that as soon as a company was of doubtful solvency, or on the verge of insolvency, the duty to creditors became paramount. Rather, it found:
- Where a company is insolvent or bordering on insolvency, but not faced with inevitable liquidation or administration, then the duty to creditors is a duty to consider their interests, to give them appropriate weight and to balance them against shareholders’ interests (if they conflict). In some circumstances, directors may have to treat shareholders’ interests as subordinate to creditors’ interests – a lot will depend on what prospects the company has for turning things around.
- Where an insolvent liquidation or administration is inevitable, then the interests of creditors are paramount.
The court also held that the duty to creditors becomes engaged when directors know, or ought to know, that either (i) the company is insolvent or bordering on insolvency (that is, insolvency is just around the corner) or (ii) an insolvent liquidation or administration is probable.
For more information on this topic, please contact Jeremy Laws.
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