Today, 5 October 2022, the UK Supreme Court considered for the first time the existence, content and engagement of the so-called “creditor duty”: the alleged duty of a company’s directors to consider, or to act in accordance with, the interests of the company’s creditors when the company becomes insolvent, or when it approaches, or is at real risk of, insolvency.
The eagerly awaited judgment in the matter of BTI 2014 LLC (Appellant) v Sequana SA and others (Respondents) ( UKSC 25) addresses questions of considerable importance for directors and stakeholders of UK companies and their advisors.
The Supreme Court held that the creditor duty is engaged when the directors know, or ought to know, that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable.
In doing so, the Supreme Court dismissed BTI’s appeal and largely upheld the Court of Appeal’s judgment ( EWCA Civ 112). However, the Supreme Court disagreed with the Court of Appeal’s conclusion that the creditor duty is engaged when the directors know or should know that the company is or is likely to become insolvent, “likely” meaning probable.
Supreme Court Judgment on the “creditor duty”
Following the judgment, the established position is as follows (the Supreme Court press summary is available here):
- The duty on directors to act in the way that they consider, in good faith, would be most likely to promote the success of the company for the benefit of the members as a whole, under section 172(1) of the Companies Act 2006 is, in certain circumstances, modified by the common law rule that the company’s interests are taken to include the interests of the company’s creditors as a whole (the so-called “creditor duty”).
- The five Supreme Court judges agreed either on a unanimous or majority basis that the creditor duty should be affirmed for the following reasons:
- it has been supported by a line of UK, Australian and New Zealand authorities, which began in the mid-1980s;
- it is affirmed or preserved by section 172(3) of the Companies Act 2006; and
- it has a coherent and principled justification. Creditors always have an economic interest in the company’s assets, but the relative importance of that economic interest increases where the company is insolvent or nearing insolvency. In those circumstances, the directors should manage the company’s affairs in a way which takes creditors’ interests into account and seeks to avoid prejudicing them.
- The creditor duty is an aspect of the directors’ duty to the company, rather than a free-standing duty of its own. Put another way, the creditor duty is not a duty owed by directors to creditors but by directors to the company.
- The shareholder authorisation or ratification principle does not prevent the recognition of the creditor duty. Where the directors are under a duty to act in good faith in the interests of the creditors, the shareholders cannot authorise or ratify a transaction which is in breach of that duty.
- The creditor duty can apply to a decision by directors to pay a dividend which is otherwise lawful. Directors of a cash flow insolvent company cannot lawfully distribute a dividend.
- Where the company is insolvent, or bordering on insolvency, but is not faced with an inevitable insolvent liquidation or administration, the directors should consider the interests of creditors, balancing them against the interests of shareholders where they may conflict. The greater the company’s financial difficulties, the more the directors should prioritise the interests of creditors.
- The interests of creditors are the interests of creditors as a general body. The directors are not required to consider the interests of particular creditors in a special position.
- Where an insolvent liquidation or administration is inevitable, the creditors’ interests become paramount as the shareholders cease to retain any valuable interest in the company.
- The majority of the Supreme Court judges held that the creditor duty is engaged when the directors know, or ought to know, that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable. This is therefore the settled position for now, but Lord Reed and Lady Arden left open the question of whether it is essential that the directors know or ought to know that this is the case: the issue of whether the directors’ knowledge of insolvency is required may therefore be open for further judicial consideration.
The Supreme Court has helpfully affirmed the existence of the “creditor duty” and provided some much needed clarity on the content of the creditor duty and when the creditor duty is engaged. However, the judgment sees a shift away from the Court of Appeal’s formulation of the creditor duty, finding that it is not enough that insolvency itself is likely (or probable) before the duty is engaged. The company must be insolvent or bordering on insolvency, or an insolvent liquidation or administration probable, introducing a later test for the engagement of the creditor duty. The decision acknowledges that facing a real risk of insolvency is a common feature of companies and may be temporary.
On the facts of the Sequana case, the creditor duty was not engaged: this is because, at the time of the dividend, the company was not a trading company and was not actually or imminently insolvent, nor was insolvency even probable. Therefore, although the judgment is helpful in clarifying the engagement and content of the creditor duty, this remains an area that must be carefully considered by directors and their advisors in cases involving trading companies or companies with complex financial arrangements where the factual matrix may be more complicated.
While the creditor duty test is confirmed for now, the judgment does not address every relevant question when considering the creditor duty, including the consequence of a breach of the duty and the forms of relief available. This remains an area we expect to see further developments in the future.
If you would like to discuss anything in this bulletin, please contact your usual Weil contact.
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