In the recent case of BTI 2014 LLC v Sequana SA & others, the Court of Appeal considered (1) whether section 423 of the Insolvency Act 1986 could apply to the payment of a dividend and (2) when a director’s duty to consider the interests of creditors arises. The Court held that a dividend is capable of being a transaction at an undervalue within the meaning of section 423(1) of the Insolvency Act 1986 and commented that a director’s duty to creditors arises when directors know or should know that the company is or is likely (i.e. probable) to become insolvent.
A UK subsidiary of BAT plc (“the Company”) was liable to indemnify BAT in respect of part of the costs of an environmental clean-up in the US and the directors of the Company had made a “best estimate” provision in the Company’s accounts for that liability. The accounts also showed that the Company was due a significant debt from its immediate parent company, Sequana (“Inter-Company Debt”). The directors decided to pay down the Inter-Company Debt by making a reduction in the Company’s capital, declaring a dividend in favour of Sequana and setting it off against the Inter-Company Debt. Consequently, on 15 December 2008 each director of the Company signed a solvency statement in accordance with the Companies Act 2006 stating that they had formed the opinion that (i) there was no ground as at 15 December 2008 on which the Company could be found to be unable to pay or otherwise discharge its debts and that (ii) the Company would be able to pay or otherwise discharge its debts as they fell due during the year immediately following 15 December 2008.
There were two key dates in implementing the above:
- 17 December 2008 – the capital in the Company was reduced and the directors resolved to pay Sequana an interim dividend of €443m which was set off again the Inter-Company Debt leaving a balance of €142m (“December Dividend”);
- 18 May 2009 – the directors resolved to pay another interim dividend to Sequana to be satisfied by setting off a further €135m of the Inter-Company Debt (“May Dividend”). Later that same day, Sequana sold the Company.
The Company brought a claim (subsequently assigned to the Claimant, BTI) against its directors and Sequana stating that:
- the dividends were unlawful as the accounts relied upon by the directors did not accord with the requirements of the Companies Act 1985, were prepared on the basis of an unlawful capital reduction effected in December 2008 and made insufficient provision for the environmental liability and the Company’s other contingent liabilities;
- the decision to pay both dividends was a breach of the directors’ fiduciary duties towards the Company.
BAT brought a separate claim against Sequana and the Company that the dividends were transactions which contravened section 423 of the Insolvency Act 1986.
First instance Judgment
The High Court:
- dismissed all the claims relating to the December Dividend;
- dismissed both the claim that the May Dividend was not lawfully paid and the claim that it was paid in breach of the duty of the directors to have regard to the interests of its creditors. The Court held that it had not been established by case law that if a company might at some point at a future date become insolvent, the duty of directors to consider or act in the interests of creditors of the company arose. To hold that the creditors’ interests duty arose in a situation where the directors made proper provision for a liability in the company’s accounts but there was a real risk the provision would turn out to be inadequate would be a significant lowering of the threshold applied in the cases. At the time of the May Dividend the Company could not be described as being on the verge of insolvency and even if there was a risk that they had not adequately provided for the environmental liability, that was a risk that faces many companies that have provisions in their accounts and that was not enough to create a situation where the directors were required to run the company in the interests of the creditors. The Court therefore held the creditors’ interests duty had not arisen at the time of the directors’ decision to pay the May Dividend;
- gave judgment against Sequana under section 423 in relation to the May Dividend, holding that a dividend was capable of being a transaction entered into at an undervalue within the meaning of section 423(1) of the Insolvency Act 1986. There was nothing in the wording of the section to exclude the payment of a dividend from the scope of section 423 (Transactions defrauding creditors) if the payment was made with the purpose of putting assets beyond the reach of a potential claimant or of otherwise prejudicing the interests of such a person in relation to a potential claim.
Sequana appealed against the decision that the May Dividend contravened section 423 of the Insolvency Act. BTI appealed against the dismissal of claim that the May Dividend was paid in breach of the duty of the directors to have regard to the interests of its creditors.
Court of Appeal Judgment
The Court of Appeal dismissed both appeals, and a summary of its reasons are below:
- Transactions defrauding creditors
- given the nature of a dividend, a dividend did not constitute a “gift” within the meaning of S423(1);
- a dividend could not be a transaction “on terms that provide for [the payee] to receive no consideration” within the meaning of section 423(1) – the nature of a dividend is payment of funds beneficially owned by a company to its shareholders and for which the company receives no consideration;
- the language of section 423(1) did not preclude its application to the payment of a dividend even if it was paid as a unilateral act by the Company. The definition of “transaction” “includes a gift, agreement or arrangement, and references to entering into a transaction shall be construed accordingly”. That definition is not exhaustive and thus a dividend was capable of coming within it;
- given the purpose and history of section 423, there was no policy reason for confining it to gifts and bilateral transactions and in any event, it was not correct that a dividend was to be regarded as a unilateral act of the company – it was too narrow to say that a dividend is a unilateral act;
- the Court did not accept that applying section 423 to payment of a dividend would cut across the statutory regime in Part 23 of the Companies Act 2006 designed for the protection of creditors;
- it followed that the payment of a dividend was within the scope of section 423(1), even if it could not be said to involve an agreement or arrangement between the company and the shareholders;
- a transaction was subject to section 423 only if the purpose requirements set out in section 423(3) were satisfied, being a question of fact in each case. Here, the trial judge had made clear findings that the purpose of the May Dividend and setting it off against the Inter-Company Debt was to eliminate the risk that Sequana could be pursued for any debt due from the Company – the effect of it was to remove the debt as an asset of the Company and put it beyond the reach of those who might make claims against the Company. That clearly fell within the purpose of section 423.
- Breach of fiduciary duty – when does it arise?
- Whilst the authorities suggest at least four possible answers to this question, it is clear that the duty may be triggered when a company’s circumstances fall short of actual, established insolvency. The Court of Appeal stated that the formulation used by Sir Andrew Morritt C and Patten LJ in Bilta v Nazir  EWHC 2163 that the duty arises when the directors know or should know that the company is or is likely to become insolvent accurately encapsulates the trigger. In this context, “likely” means probable.
- The Court of Appeal also considered whether, once the creditors’ interests duty is engaged, their interests are paramount or are to be considered without being decisive. This was not an issue that required determination on the facts of this case and as such the Court made no ruling, but indicated that where the directors know or ought to know that their company is presently and actually insolvent, it was hard to see that creditors’ interests could be anything other than paramount.
What does this mean in practice?
The Court’s conclusion that a dividend is capable of being a transaction entered into at an undervalue within the meaning of section 423(1) of the Insolvency Act 1986 will give directors pause for thought. Directors will need to consider carefully and minute the purpose for which a dividend is being paid, and whether the purpose is to put assets beyond the reach of a person who is making or may make, a claim against the company, or of otherwise prejudicing the interests of such a person in relation to a claim.
Whilst the Court of Appeal did not go so far as to define the trigger for when a director’s duty to creditors arises, the guidance that the duty arises when directors know or should know that the company is or is likely (i.e. probable) to become insolvent is a very useful indicator.
Sequana has announced that is seeking permission to appeal the decision to the Supreme Court – so watch this space.