Richard Gray: UK Supreme Court sets new precedent on creditor duty
Richard Gray, partner and head of corporate at Belfast-based Carson McDowell, welcomes new clarity on creditor duty.
The UK Supreme Court considered the existence, content, and engagement of ‘creditor duty’ for the first time ever in the matter of BTI 2014 LLC (Appellant) v Sequana SA and others (Respondents)  UKSC 25. The key question as to when directors must consider the interest of creditors where a company is at risk of insolvency has finally been answered.
A dividend of €135 million was distributed to the company’s only shareholder. At the time the dividend was paid, the company was solvent on both balance sheet and a commercial (or cash flow) basis. There was however a risk the company might become insolvent in the future due to long-term pollution related liabilities of an uncertain amount and insurance portfolio of an uncertain value.
The company eventually went into insolvent administration and the appellant, BTI, as the assignee of the company’s claim, sought to recover the amount of the dividend from the shareholder directors. It was argued that the decision to distribute the dividend was in breach of the creditor duty as the directors had not considered or acted in the interest of the company’s creditors.
This claim was rejected by the High Court and the Court of Appeal, with the Court of Appeal stating that creditor duty did not arise until the company was insolvent or headed for insolvency. Since at the time of the dividend AWA was solvent, the creditor duty claim failed.
The Supreme Court dismissed BTI’s appeal, agreeing that AWA’s directors were not at the relevant time under a duty to consider, or act, in accordance with the interests of the creditors. The following position was established regarding creditors duty:
The director’s duty 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, 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 creditor duty.
Creditor duty should be affirmed as it is supported by a long line of UK case law, it is affirmed or preserved by section 172(3) of the Companies Act 2006 and it has a coherent and principled justification. Creditors have an economic interest in the company assets, the importance of which increases where the company is insolvent or nearing insolvency.
Creditors duty is engaged when the directors know, or ought to know, that the company is insolvent or bordering on insolvency.
The director’s duty is owed to the company, and not to creditors. The creditor duty is an aspect of the directors’ duty to the company, rather than a separate duty.
The shareholder authorisation or ratification principle does not prevent the recognition of the creditor duty. Where directors are under a duty to act in good faith in interest of creditors, the shareholders cannot authorise or ratify a transaction which is in breach of that duty.
Creditor duty can apply to a decision by directors to pay a dividend which is otherwise lawful.
Where the company is insolvent or bordering insolvency, but is not faced with inevitable liquidation or administration, the directors should consider the interests of creditors. Creditor interest should be prioritised as the company’s financial difficulties develop.
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 interests of creditors are an interest as a general body. The directors are not required to consider the interests of particular creditors.
The judgement sets a new precedent regarding creditor duty and represents a significant development for company law. As a company begins to face greater financial difficulties, it is very important for the directors to consider creditors’ interests. On the facts of Sequana, the creditor duty was not engaged as at the time the company was not at risk of insolvency.
Whilst the creditor duty test is confirmed for now, not every question considering creditors duty has been considered, such as consequences of breach of duty or relief available. Further developments on the creditor duty are surely likely to follow.