A long awaited Supreme Court judgment was handed down last month which confirmed the position on creditors’ interests on insolvency.
In May 2009, Arjo Wiggins Appleton Limited (AWA) distributed a dividend of €135 million to its parent company, Sequana. AWA appeared solvent on both a cash flow and balance sheet basis making the payment a legal dividend distribution. At the time, AWA was exposed to contingent liabilities relating to clean-up costs from polluted related activities of the business. The creditor whom AWA owed this liability to was the appellant, BTI.
When a company is solvent, the directors of owe a fiduciary duty to act in the best interests of the shareholders of that company (the ‘shareholder duty’). However, Companies Act 2006 implies that on insolvency, this duty switches so that directors must act in the best interests of the creditors (the ‘creditor duty’).
BTI argued that the significant liabilities owed to them from AWA posed a real risk of AWA becoming insolvent at some point in the future, and therefore the dividend paid to Sequana should be redistributed to the creditors on the basis that the directors were under a duty to act in the best interests of the creditors rather than the shareholders.
The Court rejected this argument on the basis that a risk of becoming insolvent at some point in the future was too remote as a company could easily recover from a temporary period of financial instability. As the dividend was paid when AWA was solvent, it cannot be said that the duty was owed to the creditors.
So when does the duty to consider creditors’ interests kick in?
This answer remains ambiguous. The Court confirmed that for the duty to apply to creditors, the company must be insolvent or bordering on insolvency. Therefore, the engagement of the duty widely varies on a case by case basis and requires a degree of factual analysis depending on the circumstances of the company in question.
Despite this ambiguous element of the ruling, in general it cleared up significant confusion around creditor interests on insolvency, namely, that the creditor duty was not a stand alone duty. Instead it is a modification of the shareholder duty which kicks in when the company is ‘insolvent or bordering on insolvency’. The ruling also confirmed that the shareholder duty does not suddenly switch to the creditor duty. The transition of the shareholder duty to the creditor duty varies on the proximity to insolvency. For example, if the company is in financial difficulty, the directors should still consider the interests of the shareholders predominantly. However, the closer the company edges to insolvency and the shareholders’ value in the company reduces, the greater thought should be given to the interests, of the creditors. This balancing act differs from previous judgments which suggested the creditors interests were paramount to other interests on insolvency.
Therefore, Sequana has afforded greater insight and clarity to the creditor duty, however the question remains over when exactly the duty is engaged. It’s clear that this answer varies on a fact specific basis. The decision reinforces the necessity of seeking professional advice prior to distributing dividends where the company has contingent liabilities, whether this poses a risk of insolvency or not.
If you would like to discuss any of the issues raised in this article, Megan Bingley, Trainee Solicitor or Henry Maples, Partner in Business, would be delighted to hear from you. You can reach Megan or Henry on 01872 226990 or you can email megan.bingley@murrellassociates.co.uk.
The information provided in this article is a summary for general information purposes only and does not constitute legal or other professional advice and cannot be relied on as such. Any law quoted in this article is correct as at 11 November 2022. Appropriate legal and financial advice should be sought for specific circumstances before any action is taken.
