When does directors’ duty to creditors arise?
Introduction
The UK Supreme Court has recently
delivered a landmark decision in the case of BTI 2014 LLC v Sequana S.A. [2022] UKSC 25. The decision is
of great importance as the Supreme Court considered in detail whether the
trigger for the directors’ duty to consider creditors’ interest is merely a
real risk, as opposed to a probability of or close proximity to, insolvency.
Background
In May 2009, the 2nd and 3rd
Respondents, who were the directors of AWA (the “Company”), caused the Company to distribute a dividend of €135
million (the “Dividend”) to the
Company’s sole shareholder (the “1st
Respondent”) by way of setting off the debt that the 1st Respondent
owed to the Company. At the time the Dividend was paid, the Company was solvent
on both balance sheet and cash flow basis. However, the Company had a long-term
pollution related contingent liability of an uncertain amount which gave rise
to a real risk that the Company might become insolvent in the future.
In October 2018, the Company went into
insolvent administration and BTI 2014 LLC (“BTI”), the assignee of the Company’s claim, sought to recover an
amount equivalent to the Dividend on the basis that the 2nd and 3rd
Respondents’ decision to distribute the Dividend was a breach of the creditor
duty pursuant to section 172(3) of the Companies Act 2006 (i.e. the directors
must have proper regard to the interests of the creditors of the company in
certain circumstances).
The Court of
Appeal decision
The claim was rejected by the English High
Court. On appeal, the Court of Appeal maintained the decision finding that the
creditor duty did not arise until the Company was insolvent or headed for
insolvency. A risk of insolvency in the future was insufficient for a
creditor’s interest duty to arise unless it amounted to a probability. As the
Company was still solvent at the time of the distribution of the Dividend in
May 2009, the creditor duty claim had to fail. BTI appealed to the UK Supreme
Court (the “Appeal”).
The Supreme
Court decision
The Supreme Court dismissed the Appeal
after considering the following issues:
1.
whether there is a common law creditor duty;
2.
if so, when is the creditor duty engaged;
3.
what is the content of the creditor duty; and
4.
whether the creditor duty apply to a decision by the directors to pay an
otherwise lawful dividend.
Common law
creditor duty
The Supreme Court unanimously held that a
creditor duty is considered as part of the directors’ fiduciary duty to act in
the interests of the company. Pursuant to section 172(1) of the Companies Act
2006, a director of a company must act in good faith to promote the success of
the company for the benefit of the shareholders as a whole. With that being
said, in certain circumstances, this duty is modified by the common law that
the company’s interests are taken to include the interests of the company’s
creditors as a whole.
The timing of
the engagement of creditor duty
The majority of the Supreme Court considered
that the creditor duty arises when the directors of the company knew or ought
to know that the company was insolvent or bordering on insolvency, or that an
insolvent liquidation or administration is probable. The creditor duty does not
apply merely because the company was at a real and not remote risk of
insolvency. On the facts of this case, all of the members of the Supreme Court
agree that the creditor duty was not engaged. This is because, at the time the
Dividend was distributed, the Company was not actually or imminently insolvent,
nor was insolvency even probable.
The content of
creditor duty
As mentioned above, a creditor duty is a
duty to consider the creditors’ interests and to balance them against
shareholders’ interest where they might conflict. The Supreme Court held that before
liquidation becomes inevitable, to balance the relative interests of creditors
and shareholders is a fact sensitive issue and the directors are sometimes
required to treat shareholders’ interests as subordinate to those of the
creditors. Furthermore, when the company is irretrievably insolvent, the
interests of the creditors must become a paramount consideration in the
directors’ decision-making. However, Lady Arden stated that the duty was to
consider and not to materially harm the creditor’s interests but the directors
are not obliged to act for the benefit of the creditors.
Application of
creditor duty to payment of a lawful dividend
Although the Supreme Court determined that
the creditor duty was not engaged in the current case, it unanimously held that
the creditor duty can apply to a decision by directors to pay an otherwise
lawful dividend. Pursuant to Part 23 of the Companies Act 2006, the payment of
dividends is subject to any rule of law to the contrary. As established above,
the creditor duty is part of the common law. Therefore, the payment of dividend
is not excluded by Part 23 of the Companies Act. Additionally, it is possible
for a company to have a surplus in the balance sheet whilst at the same time
being cash flow insolvent.
Takeaway
The decision is certainly of considerable
importance for company law. Directors are reminded to exercise great care when the
company becomes insolvent or bordering on insolvency, or that an insolvent
liquidation or administration is probable. Due regard should be paid to
creditors’ interest. Lastly, although this is a decision from the UK Supreme
Court, it is expected that the decision will be a persuasive authority for the
Hong Kong courts once the insolvent trading provisions are enacted in Hong
Kong.
For enquiries,
please feel free to contact us at: |
|
E: insolvency@onc.hk T: (852)
2810 1212 19th Floor, Three Exchange Square, 8 Connaught
Place, Central, Hong Kong |
|
Important: The law and procedure on
this subject are very specialised and
complicated. This article is just a very general outline for reference and
cannot be relied upon as legal advice in any individual case. If any advice
or assistance is needed, please contact our solicitors. |
|
Published by ONC Lawyers © 2022 |
