Supreme Court decisions on directors’ duties towards creditors – shareholders

0

The Supreme Court of the United Kingdom (“SC”) recently rendered a decision in BTI v. Sequana, concerning the powers and duties of company directors. The appeal was expected to be of significant importance.

This warning is particularly relevant to companies and directors of companies in financial distress, as well as creditors and liquidators.

The central theses

First, the court found that a director owed an obligation to the company’s creditors. The duty arises when the company becomes likely to become insolvent and takes precedence (ie supersedes the ordinary duty owed to shareholders) when insolvency is imminent. In addition, it was found that even a legitimate dividend payment to shareholders could breach this duty to creditors.

The existence of this duty to creditors means that directors of companies in financial difficulty must carefully consider the interests of creditors alongside shareholders and assess when the interests of creditors come first. Advice from insolvency experts is becoming more and more important as the financial situation worsens. However, the Supervisory Board’s apparent preference to analyze potential violations on a case-by-case basis should give directors some breathing room. If a reasonable and fact-based argument can be presented in support of the decision-making process, directors’ decisions need not be held liable. Certainly the interests of creditors will not crowd out the interests of shareholders at the first sign of financial trouble.

Summary of the case

That ruling was an appeal of a 2019 Court of Appeals decision.1 Read the Client Alert on this verdict; The wide range of issues addressed by the Court of Appeal shows that its judgment remains relevant and important reading. In contrast, the issues addressed by the SC were much narrower, focusing on the existence and content of a potential obligation to creditors owed by directors of distressed companies. A detailed explanation of the facts can also be found in the linked Client Alert.

The SC agreed with the lower court and dismissed the appeal; nonetheless, the SC provided an in-depth analysis and examination of the issues given their importance to directors and to corporate law more broadly. In addition, it is important to understand some of the differences between the reasoning of the SC and the Court of Appeals.

Is there a “creditor duty”?

In short, yes; There is a duty that a company’s directors owe to its creditors as the company approaches bankruptcy. This is not a new obligation but an amendment to the existing obligation under Section 172(1) of the Company Act 2006 (“APPROX“) to ‘promote the success of the company for the benefit of its members as a whole.’2 This means that in times of financial stability, the interests of the shareholders come first. However, as now confirmed by the SC, the interests of the creditors are becoming more and more relevant as insolvency approaches.

Of course, the clarity this creates, while important, isn’t necessarily groundbreaking. The existence of this so-called “obligation of creditors” had already been practically confirmed in cases such as West Mercia.3The SC decision thus represents the culmination of this line of common law development. However, where the court offered less certainty and intentionally left room for future developments, was in deciding the content and scope of the creditors’ duty.

What is the content of the obligation?

When do creditor interests become part of the s172 CA obligation towards the company? The SC’s decision on the matter was not unanimous, and even the majority did not seem willing to formulate the verdict as the final decision on the matter. Therefore, the following understanding of the Supervisory Committee’s decision should be read as a guide to likely court considerations and not as a definitive conclusion.

The majority of the SC considered that the duty to creditors arises in the following circumstances:

a) Where it is probably that the company becomes insolvent;

b) Where the company is in bankruptcy imminent; and

c) Where the company is located currently involved in bankruptcy proceedings such as B. Insolvency settlement or insolvency administration.

However, the content of the duty to the creditors is not the same in all these circumstances. If the company is threatened with insolvency or is involved in insolvency proceedings, the obligation to the creditors comes to the fore. Therefore, when acting in the best interests of the company, the interests of the creditors and not the interests of the shareholders must be taken into account.

In the case of a simple probability of insolvency, on the other hand, the interests of the creditors are relevant, but not decisive. Instead, their interests revolve around a sliding scale they become all the more important as a company approaches insolvency. During this time, when creditor and shareholder interests collide, they must be balanced appropriately.

In addition, the majority believed that a duty to creditors would only arise if the directors knew or should have known of the company’s insolvency situation. Lord Reed and Lady Arden disagreed with the majority on this matter, preferring to leave such a conclusion to a later decision. Directors should therefore exercise caution in pleading ignorance of their company’s insolvency for defense purposes, particularly as such knowledge may be assumed given a director’s position and responsibilities.

While the SC’s approach doesn’t necessarily seem to provide absolute clarity as to what business leaders can and cannot do when their business is experiencing financial difficulties, it can be viewed as helpful for a number of reasons. This sliding scale approach gives directors some leeway in the actions they take when a company approaches bankruptcy; even if insolvency is probable, the interests of the shareholders are not automatically subordinate to the creditors.

In addition, the court pointed out that each case should be considered according to its own circumstances. Thus, if decisions can be adequately reasoned and justified, directors should still have some room for manoeuvre.

Final remarks

The certainty of the existence of ‘creditors’ duty’ is welcome clarity for directors running companies under financial pressure. While the Board’s decision may not have been as clear or decisive as some had hoped, the flexibility of the duty should provide reassurance for directors of companies approaching bankruptcy. It is important that the obligation to the creditors does not arise if there is only an actual risk of insolvency. The higher bankruptcy standard is ‘probably’ should come as a relief.

It remains imperative that directors receive financial and legal advice in this situation and record their decisions, the information on which they rely, and their rationale at the same time. Bankruptcy professionals should be consulted to get a clear picture of a company’s financial position, bearing in mind that creditors’ interests take precedence when bankruptcy is imminent. While it may seem wise to err on the side of caution, this decision doesn’t mean it’s absolutely necessary for directors of companies approaching bankruptcy. Admittedly, balancing the often conflicting interests of shareholders and creditors can be difficult and directors may be disappointed that the SC has not prepared a checklist in this regard. For the same reason, honest and diligent directors who take advice and use their common sense should be protected from personal liability.

Significant developments in this area of ​​law are bound to continue as the SC is reluctant to make a final decision on many of the key issues. Further Client Alerts will be issued as these developments materialize – in the meantime, Morrison Foerster’s Restructuring Round-Up Blog provides in-depth analysis and insight into the areas of law most relevant to our clients.

Case: BTI 2014 LLV vs. Sequana SA [2022] UKSC 25

Kyle Howard, London Trainee Solicitor, contributed to the drafting of this warning.

footnotes

1 BTI 2014 LLC v Sequana SA [2019] EWCA Civ 112.

2 S172(1) Companies Act 2006.

3 West Mercia Safetywear Ltd v Dodd [1988] BCLC 250.

Due to the general nature of this update, the information provided herein may not be applicable in all situations and should not be relied on in certain situations without specific legal advice.

© Morrison & Foerster LLP. All rights reserved

Share.

About Author

Comments are closed.