UK Supreme Court Clarifies Directors’ Duties to Consider Creditors’ Interests Where Risk of Insolvency is Imminent

In this alert, we review an important UK Supreme Court decision, which confirms that the fiduciary duties of directors to act in good faith in the interests of the company should, where insolvency[1] is imminent or insolvent liquidation or administration is probable, be interpreted as including the interests of its creditors.

The decision of the UK Supreme Court in BTI 2014 LLC v Sequana SA and others[2] provides helpful clarification on the weight to be assigned to the interests of a company’s creditors in the directors’ exercise of their fiduciary duty to act in a company’s best interests. The case confirms that, while the duty for directors to consider creditors’ interests exists, it is only triggered by imminent insolvency, i.e. where the company is “bordering on insolvency”, or if insolvent liquidation or administration are probable (not merely if there is a risk of insolvency at some point in the future).

Prior to this judgment, although it has been previously recognised in English law that directors of companies owe fiduciary duties to the company, which must in certain circumstances involve consideration of the interests of the company’s creditors,[3] there had been no express decision on whether that duty arises prior to insolvency. This judgment addressed this issue (and the point at which this duty arises in obiter comments) and clarified that as a matter of English law, the relevant test or “trigger point” for directors to balance the interests of creditors against those of members is one of imminent insolvency or probable insolvent liquidation or administration. This highlights the importance of both engaging advisors at the earliest opportunity if a company is distressed and the need for directors to stay informed of the scope of their fiduciary duties.

By way of recap, under English law, company directors owe fiduciary duties to the company, one of which is to act in the way they each consider, in good faith, will be most likely to promote the success of the company “for the benefit of its members as a whole”. This is a statutory, fiduciary duty owed by directors to the company, but whose primary beneficiaries are the members; that is, the company’s interests are taken to be equivalent to the interests of its shareholders as a whole. In fulfilling this duty under section 172(1), the Companies Act 2006 (the “CA”) also requires directors to have regard to the interests of other stakeholders (or secondary beneficiaries), including employees and suppliers, among others.

However, the English courts (since West Mercia) have recognised that there exists a “modifying rule” under common law which requires directors to balance the interests of creditors against those of members in circumstances in which a company is insolvent, is bordering on insolvency, or is more likely than not to enter insolvent liquidation or administration.

Moreover, section 172(3) CA subjects the original duty to promote the success of the company (which is commonly associated with the benefit of the members) “to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company”.

Given the competing interests of shareholders and creditors in insolvency scenarios, how should directors act to reconcile these duties? In this case, the Supreme Court has given significant guidance for directors of English companies.

The appeal related to litigation in relation to a company, AWA, which in May 2009 lawfully declared a dividend to its sole shareholder, Sequana SA. This dividend complied with the statutory scheme regulating dividend payments in Part 23 of the CA and it extinguished the majority of a debt which Sequana owed to AWA, by way of set-off. AWA was solvent on both a cash-flow and balance-sheet basis (i.e. its assets exceeded its liabilities and it could pay debts as they fell due) when the dividend was paid. However, AWA had long-term pollution-related contingent liabilities of an uncertain amount that meant there was a real risk AWA could become insolvent at some point in the future. In October 2018, nine years after the dividend was paid, the company became insolvent because of these liabilities.

The Appellant, BTI 2014 LLC, was an assignee of AWA’s claims against Sequana and sought to recover the dividend payment, asking the Supreme Court to consider the extent to which AWA’s directors owed a duty to its creditors at the time of approving the May 2009 dividend.

The BTI 2014 LLC judgment has settled the question of how directors should approach their fiduciary duties to the company by establishing two important points:

• Directors are not subject to a separate duty to act in the best interests of creditors. Instead, in certain circumstances (outlined below), the interests of the company, which directors are under a fiduciary duty to act consistently with, are taken to include the interests of its creditors as a whole (i.e. all creditors as a class, as opposed to current creditors alone); and
• The requirement for directors to balance the interests of creditors against those of members is not triggered even if there is a real risk of insolvency in the future, unless the company is at risk of imminent insolvency (“bordering on insolvency”) or probable insolvent liquidation or administration.

The court considered that the rationale for this shift in the directors’ consideration of shareholders’ and creditors’ interests is based on the creditors’ economic interests in the company: i.e., the entitlement to be paid debts owed to them, which is ultimately enforceable against the proceeds of realisation of the company’s assets if the company does become insolvent. As insolvency becomes more likely, the economic interests in the company begin to shift from the shareholders to the creditors.

The Supreme Court held that, at the point of “imminent” insolvency or “probable” insolvent liquidation or administration, the interests of creditors need to be taken into consideration by the directors; and at the later point where insolvent liquidation or administration is unavoidable, the interests of creditors take priority over those of shareholders (they become “paramount”), as that is the point at which the shares they hold become worthless.

This judgment has provided helpful clarification for directors, members and creditors of distressed companies and should reassure directors by giving some guidance as to duties they have to balance creditors’ and members’ interests, and the point in time at which those considerations shift.

In particular, the Judges each gave separate (and in places contrary) judgments that provided commentary on issues including whether these duties conflicted with duties under the CA and the Insolvency Act 1986 and the impact on shareholders’ rights once the duties have arisen. These issues were not part of the ratio of the decision and therefore may lead to further litigation, especially in areas where there was disagreement between the Judges.

The Supreme Court was careful to pitch the modified fiduciary duty of directors at a point in a distressed company’s cycle where it promotes a “rescue culture”; to encourage directors to take measures to save struggling companies, including securing co-operation from creditors, but not to endorse “insolvency-deepening” activities in relation to financially distressed companies which have slim chances of avoiding irreversible insolvency.

If you have any questions concerning the material discussed in this client alert, please contact the members of our Commercial Disputes and Corporate practices.