Call of duty – Supreme Court confirms company directors’ duty to consider the interests of creditors when nearing insolvency

In what was described as a “momentous decision for company law”, the Supreme Court in BTI 2014 LLC v. Sequana SA and Others [2022] UKSC 25 (“Sequana”) confirmed the existence of a duty owed by company directors to consider the interests of its creditors when nearing insolvency. 

It marks the first time the nature, scope, and content of directors’ duties to creditors when a company is nearing insolvency has been considered by the Supreme Court. 

When a company is solvent, duties are owed to a range of stakeholders but principally the shareholders. Directors are, however, increasingly caught in a grey zone when a company is facing probable insolvency or board event that leads to a director’s exit between their own interests, those of the business, and to a company’s creditors.

We have seen an increase in scenarios where, for example, following a probable insolvency event or a board reorganisation leading to a director(s) exit, the impacted directors are caught in a “grey” zone, between: 

Introduction

a) owing duties to the company and acting at all times in the company’s best interests; 

b) considering their own actions, such as setting up a newco to bid for the company’s insolvent assets or negotiating with the rest of the board to make sure they get an acceptable exit deal (whilst often also negotiating new employment terms with a possible competitor); and

c) needing to focus and act at all times in the interests of a company’s creditors. 

Duty calls

It has long been understood that where a company nears insolvency, there are situations where the board’s decision-making process ought to consider the interests of creditors, but exactly when these situations arise has not been entirely clear. 

Section 172(1) of the Companies Act 2006 requires directors to act in the way they consider would be most likely to promote the success of the company for the benefit of its members as a whole. In doing so they must consider specific factors which include:

• the interest of employees
• the impact of the company’s operations on the community and environment, and 
• the need to foster the company’s business relationships with suppliers, customers, and others. 

Creditors are notable by their absence from this list. 

In Sequana, however, the Supreme Court unanimously agreed that in certain circumstances directors are required to consider the interests of creditors and sought to spell out when such duty arises.

Background to Sequana

In May 2009, AWA sought to distribute a dividend of €135 million to its sole shareholder, Sequana. 

Although, at the time the dividend was paid, it complied with all statutory requirements and AWA was solvent, it had a contingent liability on its books in respect of clean-up costs relating to the pollution of the Lower Fox River in Wisconsin USA. The value of this liability was highly uncertain and, as such, gave rise to a real risk, although not a probability, that AWA might become insolvent at some point in the future. 

In October 2018, the risk materialised and AWA became insolvent. 

BTI 2014 LLC (“BTI“), an assignee of AWA’s claims, brought proceedings against AWA’s directors on the basis that their decision to pay the dividend was a breach of their duty to consider the interests of the company’s creditors, given that there was a real risk of the company becoming insolvent in the future.

The Supreme Court held that the directors, as part of their duty to act in good faith in the interests of the company, must also consider the interest of creditors. The judges were split, however, on precisely when the creditor duty is engaged. They all agreed that the duty can be triggered prior to actual insolvency, although a real risk of insolvency is not enough to trigger it. 

The majority view was that a 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. 

The judges also considered creditor duty. They determined that, where the company is insolvent, or bordering on insolvency but is not faced with an inevitable insolvent liquidation or administration, there is a duty to consider the interests of creditors and balance them against those of shareholders where they may conflict. They said that the greater the company’s financial difficulties, the more the directors should prioritise the interests of creditors.

What does this mean for company directors?

This decision offers helpful guidance for directors to the nature of the duties they might owe to their various stakeholders and the points at which their focus should shift. 

Where a director is also a departing director, their duty still exists. It is crucial for directors to stay up to date with the company’s affairs, with the Court’s judgment reinforcing that a prudent approach to corporate governance is essential. 

The general principle is that the more the financial difficulties of the company, the greater weight and consideration should be given to the creditors’ interest.

Best practice requires directors to:

• Make clear in what capacity you are acting. For example, if you are negotiating exit terms with the rest of the board, make clear that you are negotiating in your capacity as a departing employee. Likewise, if you submit an offer to acquire assets following the company being placed into insolvency, again make clear you are writing in your capacity as an officer/shareholder of BidCo. 
• Continue to inform themselves of the company’s financial position – both in the short term and longer term – and continue to carefully review and consider the company’s solvency.
• Seek appropriate workout/turnaround advice from lawyers early if you have any concerns, particularly if they consider there is a probability that the company could enter into insolvent liquidation or administration.
• If a director has received a director’s conduct questionnaire, seek legal advice as soon as possible (please see our article on this matter HERE).
• Deliberately and regularly consider the subjects and scope of directors’ duties and ensure accurate and up-to-date records are kept reflecting this consideration.
• Hold regular and properly documented board meetings to ensure that all appropriate matters and steps were considered.
• On a director’s personal level, keep an accurate and up to date chronology of events, document steps that the director has taken and advice that they have received. 

If you have any questions about these issues in relation to your personal capacity or own organisation, please contact Paul Taylor ptaylor@foxwilliams.com or Nik Paskevic npaskevic@foxwilliams.com speak with your usual Fox Williams contact.