Sequana: Directors' Duties in a Distressed Landscape
The Situation: Directors in England and Wales owe duties to the companies to which they are appointed (and may face personal liability for breaching such duties). Although the Companies Act 2006 obliges directors to maximise value for a company's shareholders, case law has suggested that directors should act in the interests of a company's creditors if a company becomes distressed.
The Result: In BTI 2014 LLC v Sequana SA, the Supreme Court of the United Kingdom has confirmed that—in situations which are or could become distressed—directors should consider creditors' interests as well as those of members. The more real, immediate, and substantial the chances of an insolvency, the greater the weight which directors should place upon creditors' interests.
Looking Ahead: Significant questions remain unresolved and this judgment may lead to litigation from creditors left compromised by insolvencies against the responsible directors.
The 'duty shift' has often been justified by reference to the commercial reality. If a company becomes insolvent, the principal economic interest in the company has shifted from its members to its creditors. Following this shift, the directors should carry out their duties with the interests of creditors in mind rather than members.
This argument was one of a number made in BTI 2014 LLC v Sequana SA & Others. This caseconcerned dividends made by a subsidiary to Sequana SA. At the time of making the distribution, Sequana's subsidiary was subject to significant, contingent liabilities relating to its possible pollution of the Fox River in Wisconsin. Having made the distribution, some years later, it was found that the subsidiary was liable to clean up the Fox River and that the cost of doing so was much greater than expected. The subsidiary became insolvent as a result. Facing losses under guarantee arrangements, a guarantor of the subsidiary's clean-up liabilities sued Sequana on the grounds that the distribution was a transaction to defraud creditors. This claim succeeded in part. To make additional recoveries, claims were also brought against the directors for breach of their duties—in effect for failing to act in the best interests of the company's creditors—which claims were the subject of this supreme court case.
The central questions with which the court was engaged—for the first time—were whether directors were subject to any duty to act in the interests of a company's creditors and, if so, when that duty arose (given the distant and contingent, but material, nature of the clean-up liabilities). To determine the issue, the court had to consider the relatively long-standing rule in West Mercia and the changes made to the directors' duties regime by the Companies Act 2006. The court also considered itself obliged to consider issues of policy and equity: on the one hand, to protect creditors in circumstances where they hold the principal economic interest in a company; and on the other hand, to protect directors from owing their duties to multiple parties at the same time who may hold conflicting interests.
The court decided that directors should consider the interests of creditors if a company is distressed or if there is a risk of an insolvency. There is no independent 'creditor duty' which displaces directors' duties to act in accordance with members' interests, instead, the interests of creditors are one of a number of interests to be balanced against each other in any particular situation. The importance that directors should place upon creditors' interests will in most situations correlate with the risk of an insolvency. While this means that creditors' interests will be engaged as a relevant factor in directors' duties analyses at an early stage, creditors' interests will only become the paramount factor in directors' decision-making if an immediate insolvency becomes inevitable. Although this could in general terms be thought of as a sliding scale, directors will need to pay careful attention to the factual context of their decision-making when considering the importance of, and risks to, creditors.
On the facts of the Sequana case, the court ruled that the directors had not breached their duties (due to the remoteness of the subsidiary's insolvency) at the time of the distribution. However, having affirmed the principle that directors should consider creditors' interests in distressed situations, the court refrained from setting out general rules as to what actions directors should take and exactly when that duty is engaged, on the basis that those decisions will be better made by future courts of first instance on the basis of individual fact patterns.
This judgment has left directors, creditors and insolvency officeholders in a difficult position. Circumstances may well arise in which a company becomes insolvent due to a remote risk and the directors face the risk of subsequent criticism. To protect themselves against the risk of such litigation—always conducted with the benefit of hindsight—well-advised directors should therefore consider creditors' interests even in situations with limited insolvency risk, refresh and review their decision-making if changing circumstances impact a company's insolvency risk, and consider whether risks to creditors and the company can be mitigated. As part of their general practice, directors should take practical steps such as ensuring that minutes and records are taken and retained so that evidence exists of the factual context and underlying assumptions of their key decisions.
Finally, the judgment is also of interest for its comments regarding the different culpability thresholds required of directors for claims to be brought by insolvency officeholders (for example, for breach of duty, wrongful or fraudulent trading and misfeasance). The judgment also provides a helpful reminder of directors' obligations to consider the interests not only of shareholders and creditors, but other factors such as employee interests, environmental impacts, and the need to foster positive relationships with suppliers, customers and others.
Three Key Takeaways
- Directors should take a wide-ranging view on which of a company's stakeholders may hold relevant interests when decisions are taken on behalf of companies. Even if an insolvency appears remote, creditors' interests may be relevant to material decisions.
- The interests of creditors will become more important to directors' duties commensurate to the proximity of insolvency.
- At all times, directors should be taking practical steps to mitigate their personal liability risks. For example, ensuring that appropriate insurance arrangements are in place and keeping records of why decisions have been made (which records should detail whose interests were relevant to decisions and why).
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