On 5 October 2022, the Supreme Court of the United Kingdom (UKSC) delivered a landmark judgment regarding directors’ duties in an insolvency context. In BTI 2014 LLC v Sequana S.A. [2022] UKSC 25, the UKSC considered the circumstances in which directors must have regard to the interests of creditors when exercising duties owed to the company and what obligations that imposes on directors. We expect it will be of interest to directors, insolvency practitioners and others monitoring developments in what is currently a fertile area for developments in the law, our Supreme Court having recently released its decision in Debut Homes and heard the appeal in Mainzeal.

Background

In May 2009, AWA, a wholly-owned subsidiary of Sequana, issued a €135m dividend to Sequana. The dividend extinguished the majority of a slightly larger debt owed by AWA to Sequana. AWA was solvent at the time of the dividend payment but possessed an uncertain amount of pollution-related contingent liabilities, which had been recorded in Sequana’s accounts at a fraction of their potential value. When those liabilities turned out to be significantly greater than estimated, AWA was placed in insolvent administration in October 2018.

The appellant, BTI, was assignee of AWA’s claims. BTI sought to recover the amount of the dividend from AWA’s directors. BTI argued that AWA’s directors had a duty to consider the interests of creditors when deciding to pay the dividend because there was a real risk of AWA becoming insolvent.

In both the High Court and the Court of Appeal, BTI’s claim was dismissed on the basis that AWA’s directors were not required to consider creditors’ interests until the company was actually insolvent, or more likely than not to become insolvent. A “real risk” of insolvency was insufficient. In May 2009, AWA was solvent, and insolvency was neither probable nor imminent.

BTI’s appeal in the UKSC centred on the argument that a “real risk” of insolvency was sufficient to require AWA’s directors to consider creditors’ interests.

Decision

The UKSC dismissed the appeal. It emphasised that there is no distinct duty owed by directors to creditors. Rather, at a certain point of a company’s journey from solvency to insolvency, the interests of the company (usually otherwise synonymous with those of its shareholders) should be understood as including the interests of its creditors. The UKSC’s task was identifying when that point arises.

The UKSC was unanimous that a “real risk” of insolvency was insufficient, which was enough to dispose of the appeal. The majority went further in finding that the trigger is when directors know, or ought to know, that the company is insolvent or bordering on insolvency (in either a balance sheet or cashflow sense), or that a formal insolvency appointment is probable. While otherwise broadly agreeing with the majority’s formulation of the triggering circumstances, the minority left the question of the directors’ knowledge open. As for the content of the duty, the UKSC was more or less unanimous that it will depend on the facts but that the creditors’ interests will weigh more heavily as the probability of insolvency increases and will (or, at least, could) displace the shareholders’ interests once insolvency is inevitable.

Our view

This case is an important contribution to what is an area of clear interest for Commonwealth appellate courts at the moment. The finding that directors must consider creditors’ interests when the company is insolvent or bordering on insolvency reflects the approach taken by New Zealand courts, particularly in the context of s 131 of the Companies Act 1993 (duty to act in good faith and in what the director believes to be the best interests of the company). It is nevertheless a reminder that directors of companies in a perilous financial position must assiduously monitor the company’s financial affairs by maintaining up-to-date accounting information and constantly and rigorously updating their assessment of the company’s solvency.  If it seems that insolvency is imminent, directors should respond by considering how creditors will be affected by the board’s decision-making—including the decision to continue trading.

In Sequana, the UKSC took a deep dive (in a 160 page decision) into the principles at play in scrutinising governance of financially distressed companies. We wait with interest to see how our Supreme Court builds on these concepts in Mainzeal. While that appeal engages different insolvency-related duties under the Companies Act 1993 (sections 135 (reckless trading) and 136 (duty with respect to incurring obligations)), the Court will nevertheless be concerned with how directors ought to respond to insolvency and how to calculate the loss to the company where directors fail to act appropriately.

This article was co-authored by Thomas Leggat, Senior Solicitor and Siobhan Pike, Solicitor in our Litigation and Dispute Resolution team.