Supreme Court holds that a creditor’s interest duty exists, what its content is and when it is engaged

Summary

The Supreme Court held that when directors know, or ought to know, that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable, they must consider the interests of creditors, balancing them against the interests of shareholders where they may conflict. The greater the company’s financial difficulties, the more the directors should prioritise the interests of creditors.

Background

In May 2009, the directors of AWA distributed a dividend of €135 million (the May dividend) to its only shareholder, Sequana SA (Sequana), thereby extinguishing almost the whole of a larger debt which Sequana owed to AWA. The May dividend complied with the statutory scheme regulating the payment of dividends in Part 23 of the Companies Act 2006 (the 2006 Act) and with the common law rules on the maintenance of capital.

At the time the May dividend was paid, AWA was solvent on both a balance sheet and a cash flow basis. However, it had long-term pollution-related contingent liabilities of an uncertain amount and an insurance portfolio of an uncertain value.

Subsequently, AWA went into insolvent administration in October 2018.

BTI 2014 LLC (BTI) is the assignee of AWA’s claims. BTI sought to recover the amount of the May dividend from AWA’s directors. It argued that the directors’ decision to distribute the May dividend was taken in breach of the creditor’s interest duty because the directors had not considered or acted in the interests of AWA’s creditors. BTI argued that the duty arises in circumstances where a company is solvent but there is a real but not remote risk of it becoming insolvent at some point in the future.

The Court of Appeal

The Court of Appeal had held that the creditor’s interest duty did not arise until a company was either actually insolvent, on the brink of insolvency or probably headed for insolvency. Its provisional view was that the creditor’s interest duty became paramount as soon as the company became insolvent.

The Supreme Court

The Supreme Court unanimously dismissed BTI’s appeal, holding that AWA’s directors were not at the time of the May dividend under a duty to consider, or to act in accordance with, the interests of creditors.

Issue 1: Is there a common law creditor duty at all?

Yes.  

Section 172(1) of the 2006 Act requires directors to act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. The Supreme Court held that, in certain circumstances, this duty is modified by the common law rule that the company’s interests are taken to include the interests of the company’s creditors as a whole.

• First, the duty is supported by a long line of UK case law (as well as authority from Australia and New Zealand).
• Second, the majority held that the duty is affirmed or its possible existence is preserved by section 172(3) of the 2006 Act. This makes the duty under section 172(1) “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”.
• Third, the duty has a coherent and principled justification. Creditors always have an economic interest in the company’s assets, but the relative importance of that economic interest increases where 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.

The Supreme Court noted that the creditor duty (or the rule in West Mercia) it is in truth an aspect of the director’s duty to the company, rather than a free-standing duty of its own and therefore it is not owed to creditors directly. Further, the interest of creditors are the interests of creditors as a general body. The directors are not required to consider the interests of particular creditors in a special position.

The Supreme Court further held that where the directors are under a duty to act in good faith in the interests of the creditors, shareholders cannot authorise or ratify a transaction which is in breach of that duty.

Issue 2: Can the creditor duty apply to a decision by directors to pay an otherwise lawful dividend?

Yes.

The Supreme Court held that the creditor duty can apply to a decision by directors to pay a dividend which is otherwise lawful, for two reasons:

• First, Part 23 of the 2006 Act is subject to any rule of law to the contrary. Since the creditor duty is part of the common law and is recognised by section 172(3) of the 2006 Act, it is not excluded by Part 23.
• Second, a decision to pay a dividend that is lawful under Part 23 may still be taken in breach of duty.

Issue 3: What is the content of the creditor duty?

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. The greater the company’s financial difficulties, the more the directors should prioritise the interests of creditors.

All members of the Supreme Court agree that, 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.

Issue 4: When is the creditor duty engaged? Was it engaged on the facts of this case?

The majority of the Supreme Court held that the creditor duty is engaged when the directors know, or ought to know, that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable. Lord Reed and Lady Arden left open the question of whether it is essential that the directors know or ought to know that this is the case. The duty does not apply merely because the company was at a real and not remote risk of insolvency.

The Supreme Court unanimously agreed that the creditor duty was not engaged on the facts of this case, because, at the time of the May dividend, AWA was not actually or imminently insolvent, nor was insolvency even probable.