Court of Appeal Clarifies When Directors Should Have Regard to the Interest of Creditors
Summary
The outcome of this case shows that directors must run the company for the benefit of the creditors, rather than the members where the company is ‘likely’ to become insolvent (likely meaning ‘probable’), rather than actually insolvent. This should make claims for breach of fiduciary duties easier to prove.
A review of the recent decision in BTI 2014 LLC v Sequana SA & Others outlines the outcome in more detail.
The Facts
The Case considers the application of section 423 of the Insolvency Act 1986 (IA 1986), in relation to the payment of (otherwise lawful) dividends between companies.
Arjo Wiggins Appleton Limited (AWA) was a wholly owned subsidiary of Sequana S.A. (SSA). AWA was liable to indemnify BAT Industries plc (BAT), for costs associated with the clean-up of the sediment of the Lower Fox River in Wisconsin (a provision was subsequently made in AWA’s accounts to reflect this potential contingent liability).
In December 2008 AWA resolved to pay an interim dividend of £443m and set it off against an intercompany debt due to it from SSA. The funds for the dividend were realised by AWA reducing its share capital.
By May 2009 AWA’s accounts had been finalised and showed substantial group losses. The directors had also formed an intention to sell AWA. A further dividend of €135m was declared thereafter, further reducing the intercompany debt due from SSA to AWA.
AWA has placed into administration and assigned its claim in respect of the recovery of the dividends to BTI 2014 LLC (BTI), a company specifically incorporated by BAT to acquire the claims.
BTI and BAT subsequently brought claims:
(a) To challenge the legality of the dividends pursuant to s.423 IA 1986, on the basis that AWA’s purpose was to place assets outside of the reach of creditors or otherwise prejudice the interests of creditors; and
(b) against the directors of AWA pursuant to section 172(1) of the Companies Act 2006 (CA 2006) for failing to have regard to the interest of creditors in declaring the dividends.
First Instance Decision
At first instance Mrs Justice Rose found in favour of BTI pursuant to s.423, holding that dividends are transactions and can therefore be set aside pursuant to section 423 IA 1986. She further held that there is no need to show that directors acted in bad faith to satisfy the test for s.423.
She rejected however the claim pursuant to s.172(1) CA 2006, finding that the dividends were validly declared and that AWA’s duty to have regard to the interests of creditors was not activated, as AWA could not be described as ‘on the verge of insolvency’, ‘of doubtless insolvency’ or in a ‘precarious or parlous financial state’.
Both parties appealed aspects of the decision to the Court of Appeal.
The Court of Appeal Decision
The Court of Appeal upheld the decision of Mrs Justice Rose in respect of s.423 above finding in favour of BTI.
The Court of Appeal further considered however the authorities in respect of ‘insolvency’ and found that the duty to have regard to the interest of creditors could be triggered when a company’s circumstances fall short of actual established insolvency and where it was ‘likely’ to become insolvent (likely meaning ‘probable’).
Notwithstanding their revised consideration of the authorities the Court of Appeal nevertheless found that the duty was not triggered in this case and, accordingly, the claims pursuant to s.172 IA 1986 failed.
Comment
Directors should seek advice when paying dividends or entering into large transactions where:
- It may put the company into questionable solvency and or at a real risk of entering insolvency; and/or
- It will reduce the assets which would otherwise be available to creditors, especially where they seek to apply set-off to reduce or otherwise extinguish an intragroup liabilities.
It’ll be interesting to see how the Court applies this decision going forward in large scale restructurings, where a group has long-term contingent liabilities.
SSA has indicated it intends to seek permission to appeal to the Supreme Court.
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