On 4 and 5 May 2021, the Supreme Court heard an appeal in BTI 2104 LLC v Sequana SA and others  UKSC 25 and this week it gave its judgment. The length of the time taken to issue the judgment reflects both the complexity of the issues involved and the importance of the questions raised for company law in the UK.
The central question considered by the court relates to the existence, content and engagement of the "creditor duty" - i.e. the supposed duty of a company's directors to act in accordance with the interests of a company's creditors where it has either become insolvent, is verging on insolvency or there is otherwise a real risk of insolvency.
The facts of BTI are very straightforward. In May 2009, the directors of a company called AWA caused it to distribute a dividend of €135 million to its only shareholder, Sequana SA. This extinguished almost all of a larger debt which was owed to AWA by Sequana. The dividend was issued lawfully in compliance with Part 23 of the Companies Act 2006 and with common law rules on the maintenance of capital. Further, as was accepted by all parties before the Supreme Court, there was no question that AWA was solvent at the relevant time, regardless of whether solvency was looked at on a balance sheet or cash flow basis. The issue was that AWA had long-term contingent environmental liabilities which were of an uncertain sum and an insurance portfolio, the value of which was also uncertain. The result of these liabilities was that, while the insolvency of AWA could not be said to be in existence nor even imminent or probable, there was certainly a real risk that AWA may become insolvent at an indeterminate point in future.
As it happened, AWA went into insolvent administration in October 2018 and BTI 2014 LLC (the claimants in the action) were the assignee's of AWA's claims. BTI sought to recover the amount of the dividend from AWA's directors arguing that the decision to distribute the dividend in 2009 was in breach of the creditor duty because the directors had failed to consider the impact of the lawful distribution on AWA's creditors, despite that distribution having been made almost 10 years earlier. The issue raised in BTI was unique in the UK. As Lord Reed explained in his judgment, it was the first case in this jurisdiction in which the question of the "creditor duty" has been raised in relation to a company which was unquestionably solvent at the material time.
On appeal to the Supreme Court, counsel for the respondents attacked the very existence of the creditor duty, going, as Lord Briggs observed in his judgment, "well beyond what they needed to do in order to shield their clients from liability". They argued that the attempted justifications for its existence were contrary to settled principles of law relying on academic criticism of the duty (see Dawson F, Acting in the Best Interests of the Company - For whom are the Directors' Trustees (1984) NZULR 68; Sarah Worthington, Directors' Duties, Creditors' Rights and Shareholder Intervention (1991) 18 MULR 121; Justice Hayne AC, Directors' Duties and a Company's Creditors (2014) 38 MULR 795) and on novel arguments made at appeal. The criticisms in academia outlined by Lord Briggs in his judgment were as follows. First, a duty to creditors, enforceable by them, was contrary to and incompatible with the fiduciary duty owed by directors to the company itself. Secondly, limited liability did not come "with strings attached" (i.e. duties of care to creditors) but rather was essential to commercial business. Thirdly, creditors deal with companies at arms-length and so are in a very different position from shareholders. Their relationship with the company is contractual and it's up to them to decide whether to extend the company credit or not. Fourthly, creditors had no proprietary right to a company's assets but simply had a statutory right to share in the net proceeds of a liquidation process.
Added to that, counsel for the respondents argued that it was wrong to suggest that insolvency meant that the directors' duty in some way shifted from being a duty to the company to a duty to its creditors. There was no such shift in duty. The true basis of the directors' duty to act to the benefit of shareholders was that they were to be identified with the company, had bestowed powers on the directors and could choose, appoint and remove them. That conclusion was bolstered by the ratification principle and any cases which suggested that the ratification principle was, in some way, disapplied by insolvency were wrong. The directors' duty to shareholders could never be disapplied simply because the company was insolvent. The shareholders' interests always took precedence over those of the creditors, even on insolvency. They argued that the leading English case of West Mercia Safetywear Ltd v Dodd  BCLC 250 which established the rule in the UK was wrongly decided, and contrary to binding authority of the Court of Appeal in Wincham Shipbuilding, Boiler and Slat Co (1878) 9 Ch 322.
Is there a common law creditor duty at all?
The court rejected the respondents' submission that there was no such duty. The starting point in answering that question for the court (all members of the court) was that directors owed their fiduciary duties to the company. The suggestion, raised in some authorities, that there was a "creditor duty" as distinct from the directors' fiduciary duty to act in the interests of the company, was wrong. However, a creditor duty was part of a directors' fiduciary duties to the company. The position in that regard (which was essentially accepted by all members of the court) is perhaps best put by Lord Reed (at para 11) "As it seems to me, there is a risk of confusion if this is described as a creditor duty, as the parties described it, as there is not a duty owed to creditors, or any duty separate from the directors' fiduciary duty to the company. Rather, there is a rule which modifies the ordinary rule whereby, for the purposes of the directors' fiduciary duty to act in good faith in the interests of the company, the company's interests are taken to be equivalent to the interests of its members as a whole…Where the modifying rule applies [i.e. the rule in West Mercia] - the company's interests are taken to include the interests of its creditors as a whole. The duty remains the director's duty to act in good faith in the interests of the company. The effect of the rule is to require the directors to consider the interests of creditors along with those of members. The weight to be given to their interests, insofar as they may conflict with those of the members, will increase as the company's financial problems become increasingly serious. Where insolvent liquidation or administration is inevitable, the interests of the members cease to bear any weight, and the rule consequently requires the company's interests to be treated as equivalent to the interests of its creditors as a whole"
So the duty to act in the interests of creditors on insolvency is an aspect of the directors' fiduciary duties owed to the company and the court affirmed the existence of such a creditor duty for several additional reasons.
First, there is a line of authority in England and in Australia and New Zealand which affirms the duty as settled law. The Supreme Court has also (albeit in obiter remarks) confirmed the existence of the duty in two recent cases: Stone & Rolls Ltd v Moore Stephens  AC 1391 and Bilta (UK) v Nazir (No 2)  AC 1 where Lord Toulson and Lord Hodge held that "It is well established that the fiduciary duties of a director of a company which is insolvent or bordering on insolvency differ from the duties of a [director of a] company which is able to meet its liabilities, because in the case of the former the director's duty towards the company requires him to have proper regard for the interest of its creditors and prospective creditors", a passage which was repeated by the court in MacDonald v Carnbroe Estates Ltd  UKSC 57. Perhaps unsurprisingly, Lord Hodge, who gave the judgment of the court in each of these cases was unpersuaded that his recent remarks about the existence of a creditor duty were wrong.
Secondly, the court had regard to section 172 of the 2006 Act which obliges directors to "promote the success of the company for the benefit of its members as a whole". There was a significant discussion about the impact of section 172 on the creditor duty. Section 172 reflects the common law approach of shareholder primacy. The beneficiaries of the duty in that section are the shareholders, not the company. While section 172 obliges the directors to have regard to various other factors including the interests of employees, suppliers and customers (which, as Lord Reed explained, will often include creditors) the primary statutory duty under section 172 is to the shareholders. However, section 172(1) is qualified by section 172(3) which 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". Lord Briggs and Lord Hodge considered that this sub-section affirmed the existence of the creditor duty which was outlined in West Mercia. Lord Reed and Lady Arden stopped short of agreeing that the point of the sub-section was to affirm such a rule, considering instead that the section 172(3) "preserved" the common law rule in West Mercia and that the absence of an express duty was partly because Parliament was aware of the existence of the duty at common law and, therefore, it had been unnecessary to legislate in respect of it. Nonetheless, the court was in agreement that the terms of section 172 read as a whole were supportive of the common law creditor duty.
Thirdly, there was an obvious principled justification for the rule. While creditors do not have a proprietary interest in the assets of the company, they do have, as Lord Briggs put it "an economic stake in the liquidation process which may be triggered by insolvency" (para 147). The very fact that creditors may eventually obtain the status of paramount stakeholders in a statutory liquidation process and the availability of remedies fixing directors with personal liability for failure to minimise their loss (such as wrongful trading rules under section 214 of the Insolvency Act 1986) was, in the court's view, a convincing justification for the existence of a common law duty to the company to, at least, consider creditors' interests at an earlier stage. As Lord Hodge put it at paragraph 246 of his judgment in agreement with Lord Reed "A company’s creditors always have an economic interest in its continued solvency so that it can pay its debts to them. The relative importance of that economic interest or stakeholding as against the economic interest or stakeholding of the company’s shareholders increases when a company is bordering on insolvency. It is this shift in relative economic interest or, in Lord Briggs' non-technical words, "skin in the game", that gives rise to the fiduciary duty to the company to give separate and proper consideration to the interests of a company's creditors".
In relation to the respondent's other arguments, the court saw no reason why the creditor duty could not apply to a decision of directors to pay an otherwise lawful dividend. First, as the creditor duty was part of the common law, it was not supplanted in any way by Part 23 of the 2006 Act. Moreover, as David Richards LJ had pointed out in the Court of Appeal, a company may well have a balance sheet surplus and, therefore, profits available for distribution under Part 23 but may also be cash flow insolvent and unable to pay its debts as they fall due. Such a company should clearly not pay a dividend as it would be a "foolhardy risk as to the long-term success of the company" (Lord Briggs at para 161). Finally, the existence of the common law ratification principle was not considered an obstacle to the existence of the creditor duty. The ratification principle simply did not apply to decisions by shareholders made at a time when the company was insolvent or the implementation of which would render it insolvent (Bowthorpe Holdings Ltd v Hills  1 BCLC 226) and the respondents' argument to the contrary was rejected.
Accordingly, the creditor duty which most company lawyers will have, at one time or another, cited glibly to company directors over the years, was upheld. From a practical point of view, there are obviously sound public policy reasons to ensure that such a duty is maintained. As Lord Hodge outlined in his judgment, the existence of such a duty assists professional advisers of company directors to encourage them to act responsibly when their company is bordering on insolvency (para 233). Yes, there is a risk that the principle leads to uncertainty in that directors can never be absolutely sure if they are on the correct side of the duty or not. But that uncertainty itself may persuade directors to be more careful with their decision-making than they otherwise would have been. There would be a lack of clarity and coherence in the law if, on insolvency, directors remained, as the respondents suggested, under an unqualified duty under section 172(1) to promote the success of the company for the benefit of its shareholders. If that were so, directors would, as Lord Hodge explained at paragraph 230, be in a conflict of interest because their duty to shareholders under that section would conflict with their interest to avoid personal liability under section 214 of the Insolvency Act 1986 for wrongful trading.
What is the content of the creditor duty?
The Supreme Court noted that the "impressive unity of the authorities about the existence of the creditor duty is not matched by any similar unanimity about its precise content" (Lord Briggs at para 163). There are different lines of thought as to the content of the duty and some commentators consider that once the company is balance sheet insolvent (i.e. any surplus of the company's net assets are exhausted) the paramount duty to serve the shareholders is automatically replaced by a duty to serve the creditors (see Goode on Principles of Corporate Insolvency Law, 5th edition (2018) paras 14-21). There are ample authorities to vouch that thinking (Brady v Brady  BCLC 20; Colin Gwyer & Associates Ltd v London Wharf (Limehouse) Ltd  EWHC 2748). However, as Lord Briggs explained at paragraph 169 of his judgment, there are also authorities to the opposite effect - i.e. that creditors interests are not paramount but merely need to be taken into account (in particular, Westpac Banking Corporation v Bell Group Ltd (in liquidation) (No 3)  WASCA 157). The court was of the view that these authorities better explained the content of the duty and that the balancing of competing interests was consistent with a director's fiduciary duties. Essentially, there may come a time prior to the time when liquidation is inevitable that the directors are obliged to "consider creditors' interests, to give them appropriate weight, and to balance them against the shareholders' interests where they may conflict. Circumstances may require the directors to treat shareholders' interests as subordinate to those of the creditors" (Lord Briggs at para 176).
Accordingly, the approach that directors take in any case will be fact-sensitive and as the court explained, much will depend on whether there is "light at the end of tunnel" or not for the company. There is no bright line rule for directors to follow in all cases. It will be up to the particular directors to carefully consider the whole circumstances and make nuanced judgements which will undoubtedly mean that they also need to be sure to be taking advice from the experienced professionals advising them and their business.
When is the creditor duty engaged?
Having established that there was a creditor duty, the Supreme Court then had to turn its attention to whether the duty was actually engaged in the present case. So, when was it engaged? Was it sufficient that insolvency was "probable" or a "real risk" in the medium/long-term, as the Court of Appeal had held (i.e. that it was likely to become insolvent at some point in the future)? Or was it only engaged when insolvency was actual or imminent? In the Court of Appeal, David Richards LJ (now Lord Richards) had explained that there was no helpful guidance on that question in any of the authorities. Counsel for the appellant had argued that the "real risk" test was best because it could track the development of a real risk of prejudice to creditors arising from the changing fortunes of the company better than any other formulation. But Lord Briggs and the majority of the court rejected that test, favoured by the Court of Appeal, as being wrong. The problem with it was that it assumed that creditors were always among the stakeholders of a company. While that was an assumption which underlined some of the authorities, such an assumption was false. They are only stakeholders when the company actually goes into insolvent liquidation - "It is that prospective entitlement which entitles them to have their interests considered, although not necessarily given paramountcy, when the onset of insolvency makes that prospect both much more likely and one which may be beyond the ability of the company to control, in the sense that insolvency immediately exposes a company to being wound up at the behest of any unpaid creditor". A real risk of insolvency is, therefore, just too remote. As Lord Briggs went on to explain, "When real risk is distinguished from probability (as it must be for present purposes) insolvency itself is by definition unlikely, and insolvent liquidation may only be a remote possibility". Such remoteness was an insufficient trigger for the creditor duty to kick in.
When considering whether there was any "trigger" absent actual insolvency the majority of the court held that the preferable formulation was the directors had to know, or ought to know, that the company was insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable. Lord Reed and Lady Arden agreed that the duty applied when the company was insolvent or bordering on insolvency, or when an insolvent liquidation or administration was probable. Indeed, Lord Reed pointed out that that was essentially the view expressed by Lord Toulson and Lord Hodge in Bilta. Lord Reed expressly disagreed with David Richards LJ's view that it was sufficient that the company was likely to become insolvent at some point in the future saying that "such a likelihood may objectively exist before the interests of shareholders and creditors are in practice liable to diverge, so as to require the interests of the latter to receive separate consideration". He continued, saying that "I also have a related concern that such a test, applied with the benefit of hindsight might impose an impracticable burden upon directors". Lord Reed and Lady Arden diverged from the majority of the court in relation to whether it was essential that the directors "know or ought to know" that the company was insolvent or bordering on it. They indicated that, that point not having been argued, they preferred to reserve their position on it, Lord Reed simply indicating that "It should be borne in mind that directors are under a duty to inform themselves about the company’s affairs….and the rule in West Mercia will itself incentivise directors to keep the solvency of the company under careful review".
Accordingly, in the judgment of all members of the court, the duty was not triggered in the present case. At the time of the dividend in May 2009 insolvency was not even probable and such a remote risk of insolvency at an indeterminate point in the future was insufficient to fix directors with the creditor duty. Insolvency had to be imminent or the probability of insolvent liquidation, about which the directors know or ought to know, had to exist in order to trigger the creditor duty.
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