Momentous decision of UK Supreme Court confirming directors’ duty to consider interests of creditors
The Supreme Court of the United Kingdom handed down a "momentous" judgment addressing directors' duties and the extent to which they must act in the interests of creditors.
The decision is significant in that it is the first instance that the Supreme Court has considered the common law concept of the “creditor duty”: whether there are circumstances in which directors must act in, or at least consider, interests of the company’s creditors. The Court addresses fundamental concepts of whether the duty exists, the nature of its content, to whom it is owed and when it arises. The decision provides practical guidance as to how the courts will approach actions of directors when dealing with companies that are approaching, or entering into insolvency.
The judgment is of particular interest in jurisdictions such as the Cayman Islands, BVI and Bermuda and will inevitably be the subject of judicial scrutiny in these courts in the near future.
In May 2009, the directors of a paper company called Arjo Wiggins Appleton (AWA) caused it to distribute a dividend of €135 million to its only shareholder, Sequana SA (Sequana) extinguishing a significant proportion of a debt owed by Sequana to AWA by way of set-off. AWA was solvent at the time of the distribution. Further, the payment of the dividend complied with the relevant statutory requirements and the common law rules of maintenance of capital. However, AWA had a long term contingent liability and there was a real risk that the company might become insolvent in the future. Ten years later, AWA entered insolvent administration. BTI 2014 LLC (BTI), as assignee of AWA’s claims, sought to recover the dividend on the basis that the directors acted in breach of a duty to consider the interests of creditors at the time the distribution was made.
BTI’s claim was dismissed at first instance, as was its subsequent appeal to the Court of Appeal. The Supreme Court similarly dismissed BTI’s appeal and unanimously held that the directors of AWA were not under a duty to consider the interests of the company’s creditors at the time they issued the dividend to Sequana.
The Supreme Court confirmed the existence of the creditor duty, having never considered it before. The Court confirmed that the creditor duty, as articulated in West Mercia Safetywear Ltd v Dodd  BCLC 250, was supported by a long line of United Kingdom and Commonwealth authority and was preserved by section 172(3) of the Companies Act 2006. Further, the Court noted that there is a coherent and principled justification for the duty: creditors always have an economic interest in a company’s assets, the relative importance of which increases as the company nears insolvency. The Court clarified that directors owe duties to the company. Accordingly, the obligation to consider a creditor’s interests is not a free-standing duty that is owed to creditors.
The duty is, in effect, a sliding scale. At one end of the scale, the Court reiterated the long-established fiduciary duty of directors to act in good faith in the interests of the company, that is, the interests of its shareholders. However, the closer a company is to insolvency, the greater the responsibility for directors to take into consideration creditors’ interests. When a company’s financial troubles are dire such that insolvency is inevitable, creditors’ interests become paramount as the company’s shareholders no longer have a valuable interest in the company’s assets.
The judgment identifies a wide range of factors and considerations which provide helpful guidance to directors in considering when they must have regard to the interests of creditors, and also to others when assessing whether or not a director has acted in breach of the creditor duty. Critically, the Court held that the duty may exist even in circumstances where the relevant transaction was otherwise lawful, as was the dividend payment in this case.
With respect to when the duty arises, the Court held that the duty is engaged when the directors know or ought to know that the company is insolvent or bordering on insolvency or that insolvent liquidation or administration is probable. The mere existence of a “real risk” of insolvency is not sufficient to give rise to the duty. Overall, the decision provides practical guidance which will be welcomed by directors, creditors, liquidators and insolvency lawyers.