Momentous Supreme Court judgment on the creditor duty – Tom Snelling and Olivier Swain

The Supreme Court found that a creditor duty does exist, as part of the duty to act in good faith in the interests of a company, but it is not triggered when insolvency is neither probable nor imminent.  The judgment gives guidance on when the duty might arise, and the extent of the duty in various circumstances.  That guidance will offer important practical assistance to directors of companies in this jurisdiction.

The judgment relates to a dividend paid in May 2009 by an English company named AWA.

AWA was solvent at that time, and the dividend was lawful under Part 23 of the Companies Act 2006 (as well as the common law rules governing maintenance of capital).  However, AWA had a contingent liability relating to pollution-related litigation in the USA.  That contingent liability gave rise to a “real risk, although not a probability, that AWA might become insolvent at an uncertain but not imminent date in the future”.  AWA did go into insolvent administration, nearly ten years after the dividend was paid, in October 2018.

BTI (the assignee of AWA’s claims) brought proceedings to recover the dividend amount from AWA’s directors.  BTI argued that the directors’ decision to distribute the dividend breached the creditor duty.  The High Court and the Court of Appeal rejected BTI’s claim.  The Court of Appeal held that the creditor duty does not arise until a company is insolvent, on the brink of insolvency, or probably headed for insolvency.  None of those circumstances applied to AWA in May 2009.  BTI appealed to the Supreme Court.

The Supreme Court dismissed BTI’s appeal.  It found that AWA’s directors were not under a duty to consider or act in accordance with creditors’ interests in AWA’s circumstances at the relevant time (when the dividend was distributed).

The Supreme Court found that the creditor duty does exist, but, crucially, it is not triggered “merely because the company is at a real and not remote risk of insolvency at some point in the future”.  The creditor duty adjusts the well-established duty for directors to act in good faith in the interests of the company.  It is not a separate duty.  Rather, in certain circumstances, the company’s interests are taken to include the interests of its creditors.

Where a company is insolvent or bordering on insolvency, the directors should balance creditors’ interests against those of shareholders where they conflict.  The greater the company’s financial problems, the more priority should be given to creditors’ interests.   Where insolvent liquidation is inevitable, the creditors’ interests will predominate (since shareholders cease to retain any valuable interest in the company).  In those circumstances, the duty to act in the company’s interests “requires the company’s interests to be treated as equivalent to the interests of its creditors as a whole”.

In obiter comments, the Supreme Court provided guidance about the circumstances in which the creditor duty might apply prior to insolvency, and the extent of the duty if it does apply.  The creditor duty would be engaged if a company’s directors know, or ought to know, that it is insolvent or bordering on insolvency, or that insolvent liquidation or administration is probable.  Where the interests of shareholders and creditors conflict, a balance must be struck between them, “reflecting their respective weight in the light of the gravity of the company’s financial difficulties”.