Insights

Chris Ward

Published 21 November 2022
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Directors’ Creditors’ Interest Duty

In October, the Supreme Court delivered its judgment in BTI 2014 LLC v. Sequana S.A. [2022] UKSC 25, on directors’ fiduciary duties in an insolvency situation.

The key rulings were:

  • The duty to consider the interests of creditors arises when the directors know, or ought to know, that the company is “insolvent or bordering on insolvency”. This is the creditors’ interest duty.
  • A “real risk of insolvency” is not sufficient to trigger the creditors’ interest duty.
  • When an insolvent liquidation or insolvent administration is inevitable, then the directors must treat the interests of creditors as paramount.

The facts

The facts of this case were complicated and involved an English company that had inherited a liability for river pollution (from the 1950s and 1960s in the US). Having made an attempt to estimate the cost of this liability, but before the liability had crystallised, the company declared two dividends. Some years later the company went into administration.

The dividends were lawful at the time because the company had sufficient distributable reserves. However, the company was no longer trading and had limited assets of uncertain value. In the event, the estimate in respect of the clean-up operation for the pollution was much too low.

The payment of the dividends was subsequently challenged on the basis (among other grounds) that the directors were in breach of their directors’ duty to take into account creditors’ interests. It was argued that the directors should have taken into account the possibility that their estimate of the pollution liability was too low.

What is the creditors’ interest duty?

Directors have a fiduciary duty to act in a way most likely to promote the success of the company for the benefit of its shareholders. However, in certain circumstances (such as a company’s insolvency) there is a common law rule that the company’s interests equate to those of its creditors, which directors must therefore consider. This is the creditors’ interest duty.

The issue in this case, therefore, arose as to how close to insolvency does a company need to be in order to trigger this creditors’ interest duty.  The Judge at first instance found that the company’s risk of insolvency at the time the dividend was paid was not sufficient to trigger the duty. The Court of Appeal and the Supreme Court both dismissed the subsequent appeals again finding that insolvency was not even probable at the relevant time and therefore the creditors’ interest duty was not triggered.

However, the decision went on to consider 4 further issues:

Is there such a thing as the creditors’ interest duty?

The decision confirmed that there is such a thing as a creditors’ interest duty.

When is the creditors’ interest duty triggered?

The Supreme Court referred to various triggers that give rise to this duty including ‘imminent insolvency’ or the ‘probability of an insolvent liquidation or administration’, which the directors ‘know or ought to know about’ and when the company is ‘insolvent or bordering on insolvency’. However, the court did not accept that ‘a real and not remote risk of insolvency’ was sufficient.

How to discharge that duty

When the creditors’ interest duty arises, the directors should consider creditors’ interests and balance these against shareholders’ interests. The more serious the company’s financial situation, then the greater priority to be given to creditors’ interests. Where an insolvent liquidation or administration is inevitable, creditors’ interests become paramount. That said, the interests of creditors refers to creditors as a general body, not of specific individual creditors.

What about otherwise lawfully paid dividends?

The court held that the creditor duty can still arise when directors are considering the payment of an otherwise-lawful dividend. A company may be balance-sheet solvent (having distributable reserves as the statutory test for payment of dividends requires) but cash-flow insolvent. In such circumstances, technical compliance with the statutory tests would not be enough to protect directors from liability.

Commentary

The existence of the creditors’ interest duty and its triggers have been uncertain and unclear for some time and therefore this judgement is to be welcomed by both directors and practitioners.

However, caution is still needed because directors who get it wrong can be personally liable. That means that directors need to ensure they are financially well informed at all times with up-to-date accounting and information about cash reserves and or the company asset base.

If you are concerned about the implications of this decision or have questions about directors’ duties, please get in touch.

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