UK Supreme Court delivers landmark judgment on directors’ duties when a company faces insolvency

Why is the decision important?

For the first time, the Supreme Court has considered whether there is a common law duty on directors to act in the interests of creditors when a company faces insolvency, but is not yet in an insolvency process (the so-called twilight zone) (the Creditors’ Duty). Unanimously agreeing that such a duty does exist, the judgment provides important guidance on when that duty arises and what it requires of directors.

What were the facts?

In 2009, a company, AWA, paid a substantial dividend of nearly all its net assets to its parent company, Sequana (the respondent). The company existed to pay a future environmental liability (the exact amount of which was unknown, and therefore a contingent liability) in respect of pollution clean-up costs. The dividend was paid in accordance with the Companies Act 2006 and the company was solvent at the relevant time.

Several years later it became clear that the cost of meeting the environmental liability was much greater than anticipated and AWA entered administration. Eventually the appellant, BTI 2014 LLC, took an assignment of AWA’s claim to recover from the directors an amount equivalent to the dividend. The Court of Appeal gave judgment in 2019, agreeing with the High Court that the dividend was lawful. The Court of Appeal commented on the Creditors’ Duty and when it would be engaged. On the facts of the case the Court of Appeal considered that the Creditors’ Duty was not engaged at the time that the dividend was paid.

What do I need to know?

The Supreme Court unanimously dismissed the appeal, finding that the Creditors’ Duty had not been triggered and therefore the dividend was lawful. There are five different judgements from the Justices, the leading judgment being given by Lord Briggs.  The judgments agree on some points and not on others. Although the decision intentionally leaves some issues unresolved, the law has been clarified in some key respects:

• The Creditors’ Duty was confirmed.
• The Supreme Court set out a different formulation of the Creditors’ Duty in the twilight zone. The Justices say that the duty is engaged later than was suggested by the Court of Appeal. The test is not merely when there is a real and not remote risk of insolvency. The trigger is now later.
• Directors must consider the interests of creditors when:
  • the company is insolvent on a balance sheet basis or is unable to pay debts as and when they fall due and therefore insolvent on a cashflow basis.
  • the company is bordering on insolvency
  • insolvent liquidation or administration is probable, or
  • the particular transaction would create one of the above situations
• That Creditors’ Duty is a modification of the statutory duty to act in good faith and promote the success of the company under section 172 of the Companies Act 2006. It exists at common law and is distinct from directors’ liabilities in relation to wrongful trading and unlawful preferences under the Insolvency Act 1986.
• The Creditors’ Duty is not owed to creditors direct (nor is the duty to act in the company’s interests owed to members direct) and it is a duty to consider creditors’ interests as a whole.
• As soon as the duty arises, directors should have regard to creditors’ interests but creditors’ interests do not become paramount until insolvency is inevitable.
• Until such time as insolvency is inevitable, directors must balance the interests of members and creditors. This will mean giving more weight to creditors’ interests the closer to insolvency the company becomes.
• The balancing exercise (between members’ and creditors’ interests) is a sliding scale and not a cliff edge, as had been proposed by the Court of Appeal. Once engaged, the duty is not owed exclusively to either group, at least until insolvency is inevitable.
• Members cannot ratify a breach of the Creditors’ Duty. This is because shareholders cannot authorise or ratify a transaction which would jeopardise the company’s solvency or cause loss to its creditors.
• The Creditors’ Duty can apply to directors resolving to pay a dividend that would otherwise be lawful. In other words, the Creditors’ Duty is an additional obligation so that even if a company is solvent and there are distributable reserves for the purposes of Part 23 of the Companies Act 2006, a dividend could still constitute a breach of the directors’ duties. The remedy in that case would be equitable and at the court’s discretion.

What should directors do if a company is facing insolvency?

There are many practical steps that directors should consider taking. In her judgment, Lady Arden emphasises the importance of directors staying informed, maintaining up-to-date accounting information, and ensuring they are alerted if cash/asset reserves deplete so that creditors risk not being paid.

Directors should always take careful notes of decisions taken and the reasons for them. It is always prudent to seek professional advice promptly. Directors’ duties – and the risk of potential liabilities – is an evolving, complex area of law. Engaging advisers at the earliest opportunity provides the best opportunity of rescuing the company and of directors avoiding liability. Any member of our financial restructuring and insolvency team would be happy to discuss this further.

Case: BTI 2014 LLC v Sequana SA and others [2022] UKSC 25