BTI 2014 LLC v Sequana SA – Supreme Court’s Decision on Director’s duties when Company is facing financial difficulties
This case provides guidance that offers practical assistance to company directors as to the circumstances when duties to creditors are triggered and when they become paramount. Handed down by the Supreme Court in 2022, this represents an important development in English insolvency law providing directors and their advisers with clarity at a time when the UK economy is forecast to enter into a deeper recession.
The case arose because of the company directors decision to pay a dividend at a time when the company faced pollution related litigation in the US that gave rise to a contingent liability.
Whilst the Supreme Court rejected an appeal and found that the directors had not breached their duties at the time the dividend was distributed, the case importantly clarifies the framework by which company directors should make major decisions.
This case affirmed the rule that directors of a company do have a duty to consider the interests of its creditors together with those of shareholders in certain circumstances, as part of the statutory duty owed to the company, but the circumstances that trigger it and the extent of that duty has now been clarified.
Whilst the directors of a company are required to act in good faith to promote the success of the company for the benefit of its shareholders as a whole, when the company is bordering on insolvency the directors are required to consider the interests of creditors.
The critical circumstances that need to exist to trigger the ‘creditor duty’ are:
- Insolvency, imminent insolvency or the company bordering on insolvency.
- Insolvent liquidation of administration being probable.
- A transaction being under consideration that would put the Company into one of the above two circumstances. For example a decision to declare and pay a dividend.
Balancing creditors’ interests against shareholders’ interests
Once the circumstances exist to trigger the creditor duty, the directors will need to consider creditors’ interests and shareholders’ interests and perform a balancing act.
As the company’s financial position deteriorates, the interests of creditors will assume more importance whilst shareholders’ interests will become less important.
At the point that insolvent liquidation becomes inevitable, creditors’ interests will become paramount as shareholders will cease to have any valuable interest in the company. In these situations, the directors duty to act in the company’s interests means that the directors must act in the interests of its creditors as a whole.
The rights of shareholders to ratify the board’s decisions ceases at this stage because shareholders will no longer have any economic interest in the company.
When the company is bordering on insolvency or insolvent liquidation or administration is probable and the interests of shareholders and creditors conflict, the balancing act that the directors must carry out will depend upon the facts and in particular the extent of financial distress.
Directors of companies in financial difficulties will need to consider how their duties to the company require them to act before making important decisions given the framework set out in the Supreme Court’s judgment.
In a subsequent formal insolvency, the director’s past choices will be evaluated by insolvency practitioners who will have the benefit of hindsight and if a director has breached his duties by failing to consider the interests of creditors, the directors could be held personally liable to account for the losses suffered by creditors.
So the best practice for Boards to adopt is to identify the risks to directors early and put in place procedures to avoid or minimise their impact.
The interests of shareholders and creditors are often less likely to diverge if considered very early and not left too late. Furthermore, if creditors interests are considered before time, it might help the Board to become better prepared in the future when interests may no longer be aligned.
The Supreme Court decision is to be welcomed in that it did not to apply the modified duty of directors to consider creditors interests too early during the company’s financial difficulties it recognises the need to support a rescue culture and the added burden that would have been placed upon directors were the creditor duty engaged earlier.
The judgment also acknowledges that shareholders retain an economic interest in the company even when insolvent liquidation appears imminent recognising that there may still be potential for the company to recover.
Practical Tips for Directors
- A Board entering into a material transaction in these circumstances should ensure that the decision-making process is properly documented.
- Boards should take professional advice early on. This may enable the directors to rely upon the statutory relief that is available to directors who faces a claim for breach of fiduciary duties.
- Directors must stay informed and obtain up to date accounting information about the company and be warned when a company is no longer able to pay creditors when due.
- Directors must consider shareholder ratification bearing in mind that directors decisions cannot be ratified where to do so would amount to a breach of the directors duty to consider creditors interests because the shareholders cannot ratify a transaction that was entered into when the company was insolvent or that would render the company insolvent.
