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Illuminating the Twilight Zone: UK Supreme Court Sequana judgment

  • United Kingdom
  • Banking and finance
  • Distressed - Restructuring and Insolvency
  • Restructuring and insolvency

06-10-2022

Consideration by the Supreme Court of issues relating to the existence, content and engagement of a duty of company directors to consider the interests of creditors.

In a long-awaited judgment handed down on Wednesday 5 October 2022, the UK Supreme Court has considered the duties of company directors and whether, and if so when, directors are required to consider the interests of creditors ahead of the interests of shareholders.  

The factual background

These long-running proceedings arose out of a claim brought against Sequana S.A. (“Sequana”) (and others) on the basis that certain dividends paid to it by a subsidiary it ought not to have been paid.  The argument was that the payment of the dividends left insufficient funds in the subsidiary to satisfy a contingent liability arising from an indemnity for clean-up costs in respect of pollution, thereby prejudicing the interests of a creditor (the beneficiary of the indemnity).

The legal background

There were a number of issues considered by the Supreme Court, but most keenly-awaited (by Restructuring lawyers at least) was whether there is a point at which directors of a company should consider the interests of creditors, and if so, when that point arises.  The duties of directors in the “twilight zone” (that is, a time when financial difficulties are being encountered and insolvency is a possibility albeit not yet inevitable) have long been challenging for directors to navigate, not least in the context of the previously-understood legal position being that at some point - which has been notoriously difficult to identify - the directors must consider the interests of creditors above all others.

Directors’ duties are codified in sections 171 to 177 of the Companies Act 2006 (“CA 2006”).  Section 172(1) sets out the general duty to promote the success of the company for the benefit of its members; this duty is expressly subject to the following qualification contained in section 172(3):

The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company”.   

It is this qualification, and the point at which it arises, that was the key issue in the hearing before the Supreme Court, and on which we will focus.

Judgment

The Supreme Court noted that the Court of Appeal had concluded in 2019 that the trigger point for the duty arising can be accurately described as being the point at which the directors know or should know that the company is or is likely to become insolvent, with, in this context, likely meaning probable.   

The important points arising out of the Supreme Court’s judgment are:

  • The duty in section 172(1) CA 2006 states that directors must act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole.  The judgment holds that in certain circumstances, this duty is modified by the common law rule that the company’s interests are taken to include the interests of the company’s creditors as a whole.
  • This conclusion is supported by a long line of case law, as well as section 172(3) CA 2006 which makes the section 172(1) duty expressly subject to the qualification that:

The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company”.

  • However, this does not give rise to a free-standing duty owed to creditors; rather, it is an adjustment to “the long-established fiduciary duty to act in good faith in the interests of the company.  Where the rule applies, the way in which the company’s interests are understood, for the purposes of that duty, is extended so as to encompass the interests of the general body of creditors as well as the interests of the general body of shareholders” (Lord Reed, at paragraph 77 of the judgment).
  • The content of the duty, as modified, is therefore to “require the directors to consider the interests of creditors along with those of members. The weight to be given to their interests, insofar as they may conflict with those of the members, will increase as the company’s financial problems become increasingly serious.  Where insolvent liquidation or administration is inevitable, the interests of the members cease to bear any weight, and the rule consequently requires the company’s interests to be treated as equivalent to the interests of its creditors as a whole” (Lord Reed, at paragraph 11 of the judgment).
  • Different opinions were expressed by the members of the Court as to the point at which the modifying rule is engaged.  However, the majority held that it 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 Court members were unanimous that the rule was not engaged on the facts surrounding the payments to Sequana.

In respect of terminology, it is worth noting that certain members of the Supreme Court were content to use the label “creditor duty”, while others preferred the term “the rule in West Mercia” (a reference to the case of West Mercia Safetywear Ltd (in liquidation) v Dodd [1988] BCLC 250), albeit these labels refer to the same thing, which is the “modifying rule” – that is, the qualification to section 172(1) CA 2006 which is set out in section 172(3) CA 2006.

Implications

The Supreme Court decision provides clarity on the duties of directors of a company confronted with circumstances of financial difficulty.  It will go some way to assisting directors, acting alongside their professional advisers, in navigating the challenges presented in such circumstances.  It will also prove instructive to insolvency office-holders who are considering pursuing a claim against directors for breach of duty. Directors, and their advisers, will however still be left with the thorny issue of identifying when the modifying rule is engaged, which will always be fact-specific.

The case is BTI 2014 LLC v Sequana SA and others, and the judgment is available at BTI 2014 LLC (Appellant) v Sequana SA and others (Respondents) (supremecourt.uk).

How Eversheds Sutherland can assist

Should you require advice on directors’ duties or any other restructuring and insolvency matters, Eversheds Sutherland can leverage its market-leading strength and depth of experience in these areas to assist. 

For more information or guidance, please get in touch with your usual Eversheds Sutherland contact, or one of the individuals below.