BTI 2014 LLC V SEQUANA S.A

The facts

Arjo Wiggins Appleton Limited (AWA) paid two dividends to its parent company, Sequana S.A. (Sequana). The first, of €443m, was paid in December 2008 (the December dividend) and the second, of €135m, was paid in May 2009 (the May dividend).

The dividends were paid at a time when AWA had ceased to trade but remained subject to contingent indemnity liabilities, including in respect of cleanup costs and damages claims arising out of river pollution in Wisconsin, USA. BAT Industries plc (BAT) was liable to pay for part of that clean up and AWA was liable to indemnify BAT for part of the monies BAT had to pay out.

AWA’s assets were an investment contract with a value of up to $250m, historic insurance policies with an expected recovery, subject to litigation, of US$100m, and an inter-company debt of €585m owed by Sequana to AWA (the Sequana debt).

The dividends were paid by way of setoff against the Sequana debt.

The effect of the dividends was that Sequana could no longer, in broad terms, be called upon to repay the Sequana debt in order to assist AWA with meeting its contingent liabilities. It therefore almost eliminated Sequana’s exposure to the pollution issue. The dividends also created the possibility that AWA’s assets would be insufficient to meet the contingent liabilities to BAT.

The High Court

Both dividends were challenged, in each case on the bases that (i) they were not lawfully paid in accordance with the provisions of Part 23 of the Companies Act (CA) 2006 (ii) alternatively, they were paid in breach of the duty of the directors of AWA to have regard to the interests of its creditors under section 172(3) of the CA 2006 (the creditor duty), and (iii) in any event, the payment of the dividends fell within the scope of section 423 of the Insolvency Act (IA) 1986.

AWA assigned its claims, including those arising out of the payment of the May dividend, to BTI 2014 LLC (BTI). BTI was a corporate vehicle set up by BAT. BAT, in turn, brought the claim under section 423 in its own capacity as a potential creditor of AWA and thus, to use the statutory term, as a “victim” of the payment of the dividends.

At first instance, Rose J (as she then was) dismissed all the claims as they related to the December dividend and there was no appeal against that part of her decision. As regards the May dividend, Rose J gave judgment against Sequana under section 423, but otherwise dismissed the claims.

The Court of Appeal

With permission granted by the Judge, Sequana appealed against the judgment under section 423, and BTI appealed against the dismissal of the claim for breach of the creditor duty.

The Court of Appeal, aside from one minor issue concerning the calculation of interest, dismissed the appeal and the cross-appeal.

David Richards LJ, giving the leading judgment, determined that the creditor duty is triggered where the directors know or should know that the company is actually insolvent or likely to become insolvent (more than 50%), meaning either balance sheet or cash flow insolvent. The Court of Appeal did not, however, identify the content of the duty, other than to suggest (without deciding) that creditors’ interests must be given paramount importance (i.e., they override shareholders’ interests) in a situation of actual insolvency.

The Court of Appeal’s decision did not, therefore, resolve the uncertainty as to the content of the creditor duty, particularly in situations short of actual insolvency. It remains unclear whether creditors’ interests trump shareholder interests, or whether they only have to be considered alongside shareholder interests, but without overriding them.

The Supreme Court

BTI appealed to the Supreme Court, which heard its appeal over 2 days in May 2021. The appeal focused on the existence, trigger, and content of the creditor duty. Both sides argued that the Court of Appeal’s decision was wrong.

BTI maintained that the creditor duty is triggered where there is a real risk of insolvency. Prior to actual insolvency, the duty requires creditors’ interests to be taken into account alongside members’ interests. Once the company is actually insolvent, the creditor duty becomes paramount. This ‘two stage’ trigger, BTI argued, would provide additional protection for creditors, without causing directors to become overly cautious.

Sequana and AWA’s former directors contended, amongst other things, that the creditor duty does not exist at all, and the law has taken a wrong turn. The creditor duty, they argued, cuts across other common law and statutory rules, including the ratification principle and section 214 of the IA 1986. Alternatively, if the duty does exist, it cannot be triggered before the point of actual insolvency, because it is only at that point that creditors become prospectively entitled, through the medium of liquidation, to the company’s assets.

Awaiting the outcome

The Supreme Court has yet to deliver its decision some 16 months later. It is unlikely that the Supreme Court will do away with the creditor duty altogether. The duty has been well established in English law since the decision of the Court of Appeal in West Mercia Safetywear Ltd v Dodd [1988] BCLC 250 and serves an important function in discouraging risk-taking behaviour by directors. Moreover, the wording of section 172(3) appears to recognise the existence of such a duty.

On the other hand, if the creditor duty is triggered too early, it will, in practice, have a chilling effect on entrepreneurial activity.

This policy issue was recognised by David Richards LJ in the Court of Appeal and was a focus of argument before the Supreme Court.

As to the content of the duty, it is hoped that the Supreme Court will bring some clarity, defining if, and when, creditors’ interests become paramount.

Until the Supreme Court delivers judgment, the law remains as stated by the Court of Appeal. The creditor duty arises where the directors know or should know that the company is actually insolvent or likely to become insolvent, and in a situation of actual insolvency, creditors’ interests are probably to be regarded as paramount.

Article by Oliver Hyams – first published by ThoughtLeaders4 FIRE Magazine