Supreme Court on the Creditor Duty (owed by Directors to the Company’s Creditors)

The supreme court has finally handed down an important company law judgment in the case of BTI 2014 LLC v Sequana SA and others [2022] UKSC 25 (on appeal from: [2019] EWCA Civ 112). The Justices of the Supreme Court that gave the decision were: Lord Reed (President), Lord Hodge (Deputy President), Lord Briggs, Lady Arden and Lord Kitchin.

The Supreme Court considered the existence, content and engagement of the “creditor duty” ie the duty of company directors to consider the interests of the company’s creditors when the company becomes insolvent, or is likely to. The duty is known in legal circles as the “rule in West Mercia” after the case of West Mercia Safetywear v Dodd.

In May 2009, the directors of a company distributed a dividend of €135 million to its only shareholder which largely wiped out a larger debt which the shareholder owed to the company. The dividend complied with applicable regulation over the payment of dividends in Part 23 of the Companies Act 2006 and with the common law rules on maintenance of capital. Importantly, At the time the dividend was paid, the company was solvent on both a balance sheet and a commercial cash flow basis. However, the company had long-term uncertain contingent liabilities and an uncertain insurance portfolio such that there was a real risk that company might become insolvent in the future, though insolvency was not imminent, or even probable.

The company went into insolvent administration over nine years later, in October 2018. The company assigned its claims to BTI who sought recovery of the dividend of €135 million from the company’s directors.

BTI claimed there was a breach of the creditors duty owed by the company’s directors and that the directors’ decision to distribute the dividend was against the interests of the company’s creditors.

The High Court and the Court of Appeal rejected the creditor duty claim on the basis that the creditor duty did not arise until a company was either actually insolvent, on the brink of insolvency or probably headed for insolvency. The Court of Appeal’s view was that the creditor duty became paramount as soon as the company became insolvent. Since the company was not insolvent or on the brink of insolvency in May 2009, the creditor duty claim failed. Given the sum at stake, and the costs that would have been generated by this point, BTI appealed to the Supreme Court.

The Supreme Court unanimously dismissed BTI’s appeal on the basis that the directors were not at the relevant time under a duty to consider, or to act in accordance with, the interests of creditors i.e. the duty had not arisen given the solvency of the company at the relevant time.

All members of the Court agreed that the creditor duty should be affirmed as: (a) it is supported by a long line of precedent case law as well as (b) by section 172(3) of the Companies Act 2006 “to consider or act in the interests of creditors of the company and (c) the duty has a coherent and principled justification. Creditors’ economic interest in the company’s assets increases where the company is insolvent or nearing insolvency when directors should in good faith take creditors’ interests into account and avoid prejudicing them.

Directors continue to owe their duties to the company, rather than directly to shareholders or to creditors. The creditor duty is not a free-standing duty that is owed to creditors.

Yes, because Part 23 of the 2006 Act is subject to any rule of law to the contrary and the creditor duty is part of the common law and is recognised by section 172(3) of the 2006 Act. Also because a decision to pay a dividend that is lawful under Part 23 may still be taken in breach of duty. Part 23 identifies profits available for distribution on a balance sheet basis, but it cannot be the case that directors of a company which is cash flow insolvent (i.e. unable to pay its debts as they fall due) could lawfully distribute a dividend.

Where the company is insolvent, or bordering on insolvency, but is not faced with an inevitable insolvent liquidation or administration, the directors should consider the interests of creditors, balancing them against the interests of shareholders where they may conflict. The greater the company’s financial difficulties, the more the directors should prioritise the interests of creditors.

The interests of creditors are the interests of creditors as a general body. The directors are not required to consider the interests of particular creditors in a special position. The directors are also required not to harm those interests.

Where an insolvent liquidation or administration is inevitable, the creditors’ interests become paramount as the shareholders cease to retain any valuable interest in the company.

the Supreme Court held that the 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. However, it is left open as to whether it is essential that the directors know or ought to know that this is the case.

The full judgment is available here: https://www.supremecourt.uk/cases/docs/uksc-2019-0046-judgment.pdf