When must directors start to consider the interests of creditors as a company approaches insolvency? (BTI 2014 LLC v Sequana SA & Ors)

The recent case of BTI 2014 LLC v Sequana SA & Ors considers the circumstances in which the directors of a company are required to consider the interests of creditors and the extent to which the payment of a dividend by a company can be susceptible to challenge under section 423 of the Insolvency Act 1986 (IA 1986).

Original news

BTI 2014 LLC v Sequana SA & others, BAT Industries plc v Sequana SA and another [2016] EWHC 1686 (Ch)

What is the background to this case?

This complex case (and resulting lengthy judgment) centred on the payment of two interim dividends by a company called Arjo Wiggins Appleton Limited (AWA). The claimants argued the accounts on which the directors relied were incorrect and did not give a true and fair picture of the state of AWA's finances. The reason for this was AWA was liable to indemnify one of the claimants (BAT) in relation to historic environmental liabilities which resulted in a provision being included for a number of years in AWA's accounts to reflect the directors' best estimate of the value of that liability. The claimants argued that the decision to pay both dividends was a breach by the directors of their fiduciary duties towards AWA and that the dividends constituted transactions which contravened IA 1986, s 423.

What was decided in relation to the 'creditors interests duty'?

The claimants argued that AWA's directors had breached their fiduciary duties in declaring the dividend and that they should have had regard to the interests of AWA's creditors given the company's financial situation.

Section 172(1) of the Companies Act 2006 (CA 2006) provides that a director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole (having regard to a number of matters). CA 2006, s 172(3) provides that the duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.

The court noted that the following principles were not in dispute:

  • the effect of CA 2006, s 172(3) was to retain the common law principles as to when the creditors' interests duty arises
  • where the creditors' interests duty had arisen, this duty was owed to the company—there was no cause of action conferred on the creditors by a breach of the duty
  • there was a single threshold for when the creditors' interests duty arose for all decisions taken by the directors (ie it was not possible for the duty to arise in respect of certain decisions of the directors, but not others)
  • the content of the duty did not vary according to the degree of risk of insolvency that had arisen
  • if the court decided that the creditors' interests duty did arise, but the directors did not in fact take the interests of the creditors into account in their decision making, that was not of itself a breach of fiduciary duty, invalidating everything done automatically

The court considered a number of cases relating to the question of when the creditors' interest duty arises. The court did not accept that they established that whenever a company was 'at risk' of becoming insolvent at some indefinite point in the future, then the creditors' interests duty arose unless that risk could be described as 'remote'. The essence of the test was that the directors ought in their conduct of the company's business to be anticipating the insolvency of the company because when that occurs, the creditors have a greater claim to the assets of the company than the shareholders.

In the present case, AWA's balance sheet showed no deficit of liabilities over assets and there were no unpaid creditors knocking at AWA's door. It was not in the downward spiral of accumulating trading losses, with no income and no prospect of any income. AWA could not be described as on the verge of insolvency or of doubtful insolvency, or as being in a precarious or parlous financial state. The risk it faced that the best estimate of its financial position would turn out to be wrong and that the company might not have enough money, when called upon in the future, was a risk that faced many companies that have provisions and contingent liabilities reflected in their accounts. It was not enough to create a situation where the directors were required to run the company in the interests of the creditors rather than the shareholders of the company.

The court also considered whether an emphasis of matter that PwC included in the 2008 final accounts should have acted as a 'red flag' alerting the directors to the risks of AWA tipping over into insolvency. Witnesses offered different views on what the emphasis of matter was intended to mean in the circumstances but Mrs Justice Rose did not accept that anything can be inferred from the emphasis of matter about PwC's views, other than they had concluded that the conditions set out in the accounting standard for when an emphasis of matter is appropriate had been satisfied. If PwC had been unhappy with the accounts, they could have qualified their audit report.

The court held that the creditors' interests duty had not arisen at the time of the directors' decision to pay the dividends.

Dividend payments and transactions defrauding creditors claims under IA 1986, s 423

IA 1986, s 423 allows claims to be brought where, essentially, a company or individual disposes of its property at an undervalue for the purpose (the IA 1986, s 423 purpose) of putting that asset out of the reach of a person who is making, or may at some future time make, a claim against it. The claim does not need to be brought by an insolvency office-holder (indeed, the offending company or individual does not need to be subject to a formal insolvency process), and can be brought by a victim of the transaction under challenge and, despite the claim's name, there is no requirement that fraud be shown.

The first question for the court was whether the payment of the dividends by AWA was a 'transaction' for the purpose of IA 1986, s 423. Relying on the House of Lords decision in Inland Revenue Commissioners v Laird Group plc, it was argued on the first defendant's (Sequana) behalf (as being the recipient of the dividends and therefore the only defendant to that particular claim) that the payment of a dividend was not a transaction but was simply giving effect to the rights of members to participate in a company's profits—in effect, members simply receive what is already theirs, subject to the terms of the company's articles of association. However, the judge disagreed, and held that, in construing IA 1986, s 423 (which was not the provision in issue in Laird), the wording is deliberately wide in order to prevent assets being moved from a potential debtor to the detriment of creditors. Further, the payment of a dividend is not the satisfaction of an earlier obligation, for example a contractually due payment, where the decision in relation to a dividend is at the discretion of the directors, both in terms of quantum and whether any dividend is in fact to be paid.

The second question for the court was whether, in respect of each of the dividend payments, the directors of AWA had the IA 1986, s 423 purpose. That purpose (which is assessed subjectively and not objectively) need not be the dominant purpose, but must also not simply be a consequence of the transaction (Inland Revenue Commissioners v Hashmi):

  • in relation to the first dividend, the court found that the IA 1986, s 423 purpose was not present. The dividend was paid following a capital reduction exercise and to remove surplus cash from a non-trading subsidiary (AWA) so that it could be utilised elsewhere, rather than to simply sit on AWA's balance sheet—that was the purpose. Further, there was no settled intention to sell AWA outside of the group, and the evidence before the court was that Sequana would stand behind AWA in respect of any of it's liabilities in any event, which therefore meant that AWA's creditors were not prejudiced
  • however, in relation to the second dividend, the court found after some hesitation that the IA 1986, s 423 purpose was present. Between the time of first and second dividends various developments had occurred. In particular, AWA was to be sold outside of the Sequana group on terms which would relieve Sequana of any further obligation in relation to AWA's liability to BAT, but because of a large debt owed from AWA to Sequana—with no certainty that that debt would be paid following the sale—the second dividend had to be paid in order to pay down that debt before the sale could be concluded. The judge held that the circumstances had to be looked at as a whole and not just limited to the payment of the second dividend in order to determine the purpose. It was argued on Sequana's behalf that, as long as sufficient provision had been made in AWA's accounts in respect of its liability to BAT, IA 1986, s 423 was not and could not be engaged. However, the judge held that it was inherent in the wording of the first part of the IA 1986, s 423 purpose (putting assets beyond the reach of a person who is making or may make a claim) that the transaction resulted in the debtor having insufficient funds with which to satisfy any claim. In this case, AWA's liability was subject to great uncertainty that would likely only be finally determined over a number of years. Without recourse to any other means (AWA being a non-trading company), BAT was prejudiced by the payment of the second dividend

The final question for the court in relation to the IA 1986, s 423 claim was Sequana's change of position defence—that having received the second dividend and sold AWA, it had lost control of the management of AWA's exposure to environmental liabilities. Had the second dividend not been paid, then AWA would not have been sold. However, the judge held that such points only go to the question of what is the appropriate relief to grant were it is found that there has been a transaction defrauding creditors under IA 1986, s 423 and do not provide a complete defence. In any event, the judge held that the facts in this case were different to the leading case on change of position in respect of IA 1986, s 423 claims (4Eng Ltd v Harper), especially as in this case Sequana knew of and shared the IA 1986, s 423 purpose and was a beneficiary of the overall transaction.

Further Reading

If you are a LexisPSL subscriber, click the links below for further information:

Director's guide to dealing with a company in financial difficulty

Transactions defrauding creditors—claims under section 423 of the Insolvency Act 1986

Not a subscriber? Find out more about how LexisPSL can help you and click here for a free trial of LexisPSL Restructuring and Insolvency.

First published on LexisPSL Restructuring and Insolvency

Relevant Articles
Area of Interest