Court of Appeal limits claims against directors

In a much anticipated and long-awaited decision, the Court of Appeal in BTI 2014 LLC v Sequana SA has cast its magnifying glass over breach of duty claims under section 172 Companies Act 2006 and limited the circumstances in which claims can be brought against directors.

The case concerned the declaration of a dividend of €131 million by a company which had ceased trading but had a contingent liability. Whilst a provision was made for the liability and the dividend was lawfully declared, the Court held that it fell foul of section 423 Insolvency Act because the evidence showed the dividend removed all the remaining assets, in case the contingent liability turned out to be bigger than the provision. The question was whether the directors were personally liable for causing the dividend to be declared and paid.

The directors argued that they could not be liable because the company was solvent when the dividend was declared, which is why the High Court  confirmed the dividend was lawful, a decision which was not challenged on appeal. The Claimant argued that the directors owed a duty to creditors because at the time the dividend was declared there was a real risk of insolvency if the contingent liability turned out to be bigger than the provision.

Section 172 says that a director of a company must act to promote the company for the benefit of its shareholders “subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors”. The Common Law Review Steering Group had recommended that codification of directors’ duties should include a duty for directors to reduce the risk to creditors when there was a “substantial probability of an insolvent liquidation”. The Government chose not to include a duty to creditors. Instead it left it to the Courts and common law to fill the gap and to develop the law.

From about 1975 there has been a growing body of Court decisions, starting with Courts in Australia and New Zealand, which suggested that directors have duties to consider the interests of creditors when a “real risk” of insolvency arises, or the company is “on the cusp” of insolvency. In recent years, Liquidators have been pushing the boundaries of section 172 claims against directors in a variety of imaginative ways, without having to prove that the company was insolvent.

The Court of Appeal reviewed the legal authorities in detail and concluded that none of the English cases supported the existence of a duty triggered by a real risk of insolvency. The Court observed that in all the English cases the duty only arose upon actual insolvency. It also noted that the list of matters, set out in section 172, to which a director must have regard when promoting the company did not include creditors’ interests.

The Court of Appeal concluded that the duty arises “when the directors know or should know that the company is or is likely to become insolvent” where the word “likely” means “probable”.

This wording is different from the trigger for wrongful trading which is where the directors “knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation” and might suggest that the duty arises before the risk of wrongful trading arises. However, the Court rejected the argument that the duty was triggered by a “real risk” of insolvency, stating that such a trigger would have a “chilling effect on entrepreneurial activity.”

The Court of Appeal decided that the duty was not triggered when the directors declared the dividend and therefore there was no claim against them. As a result, the Court did not have to consider the nature of the duty. Whilst the Court of Appeal noted without comment that a number of decisions expressed the duty in terms of the interests of creditors being “paramount”, a phrase first used in the earlier High Court decision of Colin Gwyer & Associates v London Wharf, the Supreme Court had used the phrase “proper regard” in the case of Bilta.  In the Guernsey case of Carlyle Capital v Conway, Hazel Marshall QCconsidered that “paramount” overstates the position and that under English law “there is a more fluid and fact-dependent approach”. She concluded that that the duty to act in the best interests of the company extends to embrace the interests of its creditors, and requires precedence to those interests where that is necessary, in the particular circumstances of the case, to give proper recognition to the fact that creditors will have priority of interest in the assets of the company over its shareholders if a subsequent winding up takes place.

Disclaimer: this article is not to be relied upon as legal advice. The circumstances of each case differ and legal advice specific to the individual case should always be sought.