12.10.2022

The UK’s so-called “creditor duty”: Does it exist and when is it triggered?

The recent decision of the UK Supreme Court in BTI 2014 LLC v Sequana SAV & Ors [2022] UKSC 25 has considered the nature of the so-called “creditor duty” and whether directors are required to take into account the interests of creditors when the company is “insolvent, bordering on insolvency, or that an insolvent liquidation or administration is probable.”

The Sequana decision also provides guidance about when the so-called “creditor duty” is engaged. 

Background 

In May 2009, AWA’s directors caused AWA to distribute a dividend of €135m (the May Dividend) to its only shareholder, Sequana SA.  The distribution extinguished by way of set-off almost the whole of a slightly larger debt which Sequana owed to AWA.

The May Dividend was lawful, in the sense that it complied with the statutory scheme regulating payment of dividends in Part 23 of the Companies Act 2006 (UK) (the 2006 Act) and with the common law rules about maintenance of capital.  The May Dividend was also distributed at a time when AWA was solvent.

However, AWA did have long-term pollution-related contingent liabilities of an uncertain amount.  These contingent liabilities, together with an uncertainty as to the value of one class of its assets (an insurance portfolio), gave rise to a real risk, although not a probability, that AWA might become insolvent at an uncertain but not imminent date in the future.

AWA went into insolvent administration in October 2018.  BTI 2014 LLC sought, as assignee of AWA’s claims, to recover an amount equivalent to the May Dividend from AWA’s directors.  BTI 2014 LLC alleged that the director’s decision for AWA to distribute the May dividend was a breach of  a duty owed to the company’s creditors to act in the creditors’ interests (creditor duty).

Legal issues 

The legal issues considered by the Court in Sequana included:

  • Is there a common law creditor duty?
  • What is the content of the creditor duty?
  • When is the creditor duty engaged?

Decision 

Issue 1: Is there a common law creditor duty?

The Court unanimously affirmed that a creditor duty exists at common law.  The duty can require directors to have regard to the interests of creditors in certain situations, within the directors’ overriding duty to act in the best interests of the company.  

The Court noted that:

  • The creditor duty has been supported by a long line of case law in England and in common law jurisdictions such as Australia and New Zealand (beginning as early as the 1980’s in New Zealand: Nicholson v Permakraft (NZ) Ltd [1985] 1 NZLR 242).
  • A company’s creditors have an economic interest in the company, based upon their entitlement to be paid for their debts. The importance of the economic interest of the company creditors increases when the company is insolvent or nearing insolvency.  In those circumstances, the directors should manage the company’s affairs in a way which takes creditors’ interests into account and seeks to avoid prejudicing them.
  • A creditor duty is not distinct, or in other words, not “free-standing”. The effect of the rule is that directors owe their duties to the company, rather than directly to shareholders or creditors.
  • Where the directors are under a duty to act in good faith in the interests of the creditors, the shareholders cannot authorise or ratify a transaction which is in breach of that duty.

Issue 2: What is the content of the creditor duty? 

The Court considered that:

  • Where the company is insolvent or bordering on insolvency but is not faced with an inevitable insolvent liquidation or administration, the directors should consider the interests of creditors, balancing them against the interests of shareholders where they may conflict.  However, the more parlous the state of the company is, the more the interest of the creditors will dominate.
  • 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 directors should consider the interests of creditors as a whole.

Issue 3: When is the creditor duty engaged? 

The majority of the Court held that the duty is engaged where there is “imminent insolvency (i.e. an insolvency which directors know or ought to know is just round the corner and going to happen) or the probability of an insolvent liquidation (or administration) about which the directors know or ought to know, are sufficient triggers for the engagement of the creditor duty…”

In applying this test, all members of the Court agreed that the creditor duty was not engaged on the facts.  

This is because, at the time of the May Dividend, AWA was not actually or imminently insolvent, nor was insolvency even probable.

Comments 

The Court’s decision in Sequana confirms what has already been established in New Zealand common law for some time.  That is, a director has a duty to the company to consider the interest of all creditors (not just some), particularly when the company is insolvent, or near-insolvent.  This is consistent with a director’s obligation under s 135 Companies Act 1993 not to cause or allow the business of a company to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors. 

The clear take away from Sequana and the current law in New Zealand is that when a business is in a near-insolvency position, directors must proceed with caution and consider creditors’ interests.   

The New Zealand Supreme Court decision in Mainzeal is expected shortly.  That decision is likely to further impact the New Zealand approach to the scope and extent of director’s duties. 

We will provide an update as soon as the decision is released.

If you have any questions about this case or directors’ duties more generally, please get in touch with our Insolvency and Restructuring Team or your usual contact at Hesketh Henry.

 

 

 

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Kerry
Media contact - Kerry Browne
Please contact Kerry with any media enquiries and with any questions related to marketing or sponsorships on +64 9 375 8747 or via email.

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