BTI v Sequana ' Key UK Supreme Court Insolvency Ruling Clarifies Stance On Creditor Duties

• Published date: 25 October 2022
• Subject Matter: Corporate/Commercial Law, Litigation, Mediation & Arbitration, Insolvency/Bankruptcy/Re-structuring, Corporate and Company Law, Directors and Officers, Insolvency/Bankruptcy, Trials & Appeals & Compensation, Shareholders
• Law Firm: Herbert Smith Freehills
• Author: Mr Paul Ap'thy, John Whiteoak, Kevin Pullen, Natasha Johnson, John Chetwood, Andrew Cooke, Gareth Thomas, Alexander Aitken, Jamie Mclaren, Richard Mendoza and Leah Allen

The Supreme Court of the United Kingdom (the Supreme Court)(UK) has delivered the much anticipated decision in BTI 2014 LLC v Sequana SA [2022] UKSC 25 confirming the existence, content and timing of the duty of directors to have regard to creditors where a company is insolvent. Whilst a UK decision, it is likely to be influential in other common law jurisdictions, such as Australia, Hong Kong, Singapore and New Zealand where similar duties apply.

When directors should consider the interests of creditors is ultimately a judgment call which is only truly scrutinised in the sometimes harsh light of 20/20 hindsight in a subsequent administration or liquidation. In practice therefore, to manage the risks to directors, it will usually be better to consider creditors' interests too soon rather than too late. When boards consider the potentially different interests of creditors and shareholders early, it is also often the case that there is substantial alignment. Plus, having been through this exercise helps a board to formulate sensible and prudent contingency planning by identifying points in the future where interests may diverge.

Since March 2019, English lawyers have referred to the test used by Lord Justice David Richards in the English and Wales Court of Appeal (the Court of Appeal) in BTI 2014 LLC v Sequana SA [2019] EWCA Civ 112 that creditors' interests are engaged when it is likely (meaning probable) that a company will become insolvent. The majority in the UK Supreme Court has now:

• affirmed the existence of the duty to consider the interests of creditors;
• clarified that it is engaged where 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;
• explained that where interests of creditors are engaged and diverge from those of shareholders
  • if liquidation is inevitable, creditors' interests are paramount; and
  • prior to that, there will be a fact sensitive balancing exercise to weigh up the competing interests by reference to the degree of distress.

In this note we discuss:

• the practical implications of the Supreme Court's decision for directors of stressed companies in the UK;
• the background that gave rise to the dispute in the BTI v Sequana case and the previous first instance and Court of Appeal decisions;
• the key issues arising for decision by the Supreme Court and how those matters were decided;
• implications for other common law jurisdictions with similar approaches to directors' duties; and
• some further observations on the decision.

Practical implications for directors

Here, the decision is likely to mean little practical change for boards of stressed companies in the UK following existing best practice. There may be scenarios where there is a practical difference between the Supreme Court and Court of Appeal tests. These are however likely to be rare.

As before:

• Board decision-making around material transactions (for example, payment of dividends and mergers & acquisitions) should be properly documented even before the creditor duty is engaged (albeit taking care not to inadvertently overstate the proximity of insolvency).
• Close monitoring of the company's financial position will ensure directors are better positioned to respond to periods of turbulence and adapt to changing (and competing) stakeholder demands.
• Boards should consider engaging professional advice sooner rather than later. In the first place, the right advice may help to avert a distress scenario from ever arising (or from worsening); but failing that, since there is statutory relief for directors who have acted honestly and reasonably in the circumstances, evidence of reliance upon independent advice could make all the difference. It may also be relevant to the question of breach.
• Consider shareholder ratification- although shareholders cannot ratify director decisions once the creditor duty is engaged, it is available before that point. So in cases of uncertainty, it may be better to err on the side of caution.
• Directors should ensure appropriate insurance cover is in place and premium payments are all up to date - if all else fails, litigation can become very expensive and personal liability significant. The right directors and officers insurance policy, for example, may help to limit that potential exposure.

As discussed further below, it is accepted in a number of other common law jurisdictions, including Australia, Hong Kong, Singapore and New Zealand, that in the context of insolvency directors have a duty to consider the interests of creditors. However, in these jurisdictions the question of precisely when that duty arises has not been definitively settled. When this issue inevitably arises in common law jurisdictions, those courts are likely to find this UK Supreme Court decision instructive.

Sometimes, momentous decisions are most important for what they do not do. Directors in the UK (and potentially other common law jurisdictions) can take some comfort that the Supreme Court has declined to hold that the duty to have regard to creditors' interests is engaged where there is only a risk of insolvency - since doing so would have increased the scope for potential personal liabilities where companies encounter distress.

Background

We previously considered the background to this case here in the context of the Court of Appeal's ruling in these proceedings in early 2019. However, broadly, and as set out in the Supreme Court's judgment:

• In May 2009, the directors of a UK limited company, AWA, caused it to distribute a dividend of '135m to its only shareholder Sequana SA (Sequana). It was common ground that the dividend was lawful (in the sense of complying with the applicable statutory regime regulating the payment of dividends) and was distributed at a time when AWA was solvent.
• At the time the dividend was paid, AWA had a contingent liability on its books in respect of clean-up costs relating to the pollution of the Lower Fox River in Wisconsin. The value of...