It has long been established that a director owes a duty to act in the best interests of the company. Section 172(1) of the Companies Act 2006 states that a director must act in the way ‘he considers, 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 handing down its judgement in BTI (2014) LLC V Sequana confirmed that this duty to the company and its shareholders extends to its creditors and went further to explain when this duty is triggered, and what the duty entails.
The facts of the case
In May 2009 the directors of AWA approved payment of a dividend of €135million to its sole shareholder Sequana SA to offset an intercompany loan (May Dividend).
At the time the dividend was paid, AWA was solvent; its assets were in excess of its liabilities, and it was able to cover debts as they arose. AWA had been obligated to indemnify another company (BTI) for a portion of costs incurred in the clean-up of the polluted Lower Fox River in Wisconsin. The extent of these costs and likelihood of this contingent liability becoming realised were unknown. The directors considered the likely future costs of the clean-up of the polluted river and decided to go ahead with payment of the May Dividend. It was recognised at the time that there was a real risk to AWA that these liability costs may result in insolvency in the future, but this was considered unlikely.
It later transpired that the clean-up costs were significantly higher than had been expected. Almost 10 years after the payment of the May Dividend, AWA found itself facing insolvent liquidation. BTI sought to pursue the directors of AWA for the costs, arguing that the directors had owed a duty to consider the interests of the company creditors and that payment of the dividend to Sequana had breached this duty.
BTI failed in its claim against the directors of AWA at the court of first instance and subsequently, at the Court of Appeal. Both courts resolved that as AWA was not facing ‘imminent’ or ‘probable’ insolvency at the time the dividend was agreed, the creditor duty had not been trigged. BTI was granted permission to appeal this decision to the Supreme Court.
Affirming the earlier Court of Appeal decision in the case of West Mercia Safetywear Ltd v Dodd (the rule in ‘West Mercia’), the Supreme Court confirmed that the creditor duty does exist.
The court was very clear that this creditor duty is not a separate duty but is a modifying rule which falls under the section 172 CA 2006 duty. In short, once triggered, the duty to consider creditor interests forms part of the director duty to consider the interests of the company as a whole. The extent of the duty owed to creditors is based on a sliding scale and balanced against the interests of shareholders, with the priority of creditor interests increasing with the seriousness of the company’s financial situation. Once insolvency becomes inevitable, the interests of the company’s creditors will become paramount.
Helpfully, the court went on to consider when the creditor duty is triggered. Lord Reed stated that a duty to consider creditor interests is not triggered ‘merely because the company is at a real and not remote risk of insolvency at some point in the future’. It was held by the majority of the Supreme Court that the creditor duty will be triggered when directors know or ought to know that the company is either facing imminent insolvency or that insolvent liquidation or administration is probable.
The supreme court held that in this case the directors of AWA had not breached their duty to creditors as the dividend was legally made when insolvency was not imminent or probable at the time payment was made.
What does this mean for directors?
In light of the Sequana judgement it is clear that any company decisions, such as payment of dividends, which are taken by directors must take into account the financial position of the company. To do this effectively, directors will need to keep themselves well informed of the state of the company’s financial health.
It is also important that directors are able to show evidence to support decisions so it is worth making sure that all reasoning and considerations are well documented.
Directors will need to understand fully their duties to shareholders and creditors, when these duties are triggered and how to navigate them. The best way to ensure compliance is by engaging the services of professionals who can explain financial and legal obligations. This has the additional benefit of securing that all important evidence which can be used to support decisions.
If you would like to discuss how our Corporate Solicitors can help you understand your duties as a director or would like to discuss how we can assist your business, you can contact our Corporate Team here.