In a recent case, the UK Supreme Court has clarified when directors’ obligations may shift from being owed to the company’s shareholders to its creditors. Rejecting a wider test of “real risk” of insolvency, the Supreme Court favoured a formulation in which either “imminent” insolvency (i.e. an insolvency which directors know or ought to know is just around the corner and going to happen) or the “probability” of an insolvent liquidation about which the directors know or ought to know, are sufficient triggers for the engagement of the creditor duty.

 Facts- BTI 2014 LLC v Sequana SA and others [2022] UKSC 25

  • AWA Ltd (“AWA”) paid a dividend of EUR135m to its parent company and only shareholder, Sequana SA (“Sequana”), to reduce an inter-company debt of some EUR585m owed by Sequana to AWA.
  • At the time of payment of the dividend, AWA was subject to contingent indemnity liabilities of an uncertain amount in respect of environmental pollution costs. As a result, there was a “real risk” that AWA might become insolvent in the future but it was not “imminent” or “probable”.
  • AWA went into insolvent administration in 2018.
  • BTI 2014 LLC (“BTI”), as assignee of AWA’s claims, sought to recover the amount of the dividend from AWA’s directors on the basis that they had breached their duty to creditors because they had not had regard to the interests of AWA’s creditors.
  • BTI argued that there was a “real risk” of insolvency sufficient to engage the directors’ duty to creditors.
  • The High Court rejected the claim and BTI appealed.
  • The Court of Appeal dismissed BTI’s appeal on the basis that although the duty of directors to have regard to the interests of creditors might be triggered when a company’s circumstances fell short of actual, established insolvency, the test submitted by BTI of a real, as opposed to a remote, risk of insolvency was not part of the present law as regards the creditors’ interests duty, and it would not be appropriate for the Courts to introduce such a test as a development of the common law.
  • BTI appealed to the Supreme Court.

The Supreme Court determined a number of issues including the following.

1. Whether there was a common law creditor duty

Prior to the enactment of the Companies Act 2006 (an Act of Parliament) (the “2006 Act”), it was well-established under common law that directors owe fiduciary duties to act in good faith in the interests of the company.

The common law position was subsequently codified by section 172(1) of the 2006 Act which provides that: “A director of a company must act in the way he considers, in good faith, is most likely to promote the success of the company for the benefit of its members as a whole…”.

A modification of that rule was established in West Mercia Safetywear Ltd v Dodd [1988] BCLC 250 (“West Mercia”) to the effect that the best interests of the company might include those of its creditors (the “creditor duty”). The weight to be given to creditors would increase as the company’s financial problems became increasingly serious. Where insolvent liquidation or administration was “inevitable”, the interests of the members ceased to bear any weight, and the rule consequently required the company’s interests to be treated as equivalent to the interests of its creditors as a whole.

In determining the appeal, the Supreme Court considered whether the creditor duty existed. Ultimately, it held that it did exist on the basis that:

  • a long line of authority had affirmed the existence of the duty;
  • Parliament affirmed the position at common law by enacting section 172(3) of the 2006 Act which provides that: “[t]he 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”;
  • Commercial justification, where in an insolvency scenario the interests of the company’s creditors as a whole may no longer be aligned with its shareholders.

The Supreme Court further noted that although its often referred to as the “creditor duty”, the duty is not owed to creditors separate from the directors’ fiduciary duty to the company.

2. What was the content of the creditor duty

The Supreme Court held that prior to liquidation becoming inevitable, the creditor duty was a duty to consider creditors’ interests and to balance them against shareholders’ interests where they might conflict. The weight to be given to the interests of creditors is likely to be a fact sensitive question in respect of which much would depend upon the brightness or otherwise of the light at the end of the tunnel, such as what the directors reasonably regarded as the degree of likelihood that a proposed course of action would lead the company away from threatened insolvency, or back out of actual insolvency.

3. When was the creditor duty engaged

As set out above, BTI sought to argue that a “real risk” of insolvency was sufficient to engage the creditor duty.

Disagreeing with BTI, the Supreme Court held that a “real risk” was not the appropriate trigger point on the basis that it rested upon an unsound principle. It assumed that creditors of a company were always among its stakeholders so that once the security of their stake was seen to be at “real risk”, there arose a duty of the directors to protect them. It was too remote from the event which turned a creditor’s prospective entitlement into an actual one. It was insufficient in principle to displace the ordinary general duty of directors to promote the success of their company for the benefit of its shareholders.

On the contrary, the Supreme Court preferred a formulation in which either “imminent” insolvency (i.e. an insolvency which directors know or ought to know is just around the corner and going to happen) or the “probability” of an insolvent liquidation about which the directors know or ought to know, are sufficient triggers for the engagement of the creditor duty.

Accordingly, in the case of AWA, the creditor duty had not been engaged and thus the appeal was dismissed.

Covid-19 and insolvency risk

Whilst recognising the potential limits of the pandemic as a one-off event, Lord Briggs stated that the Covid-19 pandemic provides a practical template upon which the excessive remoteness of a “real risk” trigger might be demonstrated:

“In March 2020 it must have appeared to the directors of innumerable companies in the travel and hospitality businesses that they faced a real risk of insolvency. During the two years which followed, some have no doubt become permanently insolvent (with no light at the end of the tunnel). Others have become temporarily insolvent, but kept open a realistic prospect of recovery by sensible negotiations with creditors, and may either have returned to solvency, or be confidently on the way to doing so as restrictions are lifted. Others have even avoided insolvency altogether, whether by seeking state loans, furlough payments for their employees, cutting their overheads or trying alternative types of business, such as take-away meals. Only for the companies in the first (permanently insolvent) group will their creditors have become entitled (actually or inevitably) to share in the proceeds of their winding-up or administration.” (Emphasis added)

The “creditor duty” and the Isle of Man

Whilst not codified by statute (as per the English 2006 Act), it has long been recognised by Isle of Man law that the duties of a director of an Isle of Man company are very similar to the (now codified) common law duties owed by directors of companies registered in England & Wales. This includes the duty to act in good faith in what they believe to be the best interests of the company as a whole.

The Isle of Man Courts have also recognised the modification of this rule as per West Mercia to give effect to the “creditor duty” such that the best interests of the company might include those of its creditors where a company is in financial difficulty.

We therefore expect the Isle of Man Courts will look to the Supreme Court’s judgment in Sequana as providing helpful guidance when it is next required to consider whether on the facts before it the “creditor duty” has been engaged.

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The guidance in this note is for information purposes only and is not intended to be exhaustive. It is not intended to constitute legal or other professional advice, and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances. Cains only advises on the laws of the Isle of Man and accepts no responsibility for any errors, omissions or misleading statements or for any loss which may arise from reliance on the information in this note.