The Review of the Decision number BTI 2014 LLC v Sequana SA (2022) UKSC 25 of the Supreme Court

BTI LLC v Sequana is undoubtedly amongst the most important decisions in the recent company law history. The Supreme Court addresses for the first-time directors’ duties towards creditors, the scope and content of this duty and the trigger point that activates the duty. The controversies surrounding this area of the law can be broken down into two categories. The first are those sprouting from the lack of certainty in relation to the existence and content of the duty and the second are those that target the duty from the outset and challenge with various justifications the existence of such duty. Both have been tackled by the judgement in Sequana and will be unpacked duly. The appeal in Sequana directly concerns whether directors are under a duty in respect of creditors interests, subject to its existence when it arises and how the s.171 ‘duty to act in the interests of the company’ is to be understood when a company is insolvent. In order to examine how Sequana resolves controversial issues in company law, the controversial matters antecedent to the decision must be duly addressed and whether the Sequana judgement effectively resolved these must be ascertained.

One criticism of the creditor’s duty is that creditors generally extend credit freely and voluntarily, having the ability to impose such conditions and terms as they think fit to minimise their risk. They enter a financial transaction knowing the risks involved, and if that risk materialises, they should not be afforded additional protection. Andrew Keay advocates this theory and purports that the contractarian theory ‘is opposed to the existence of such a responsibility’[1]. Lord Reed refers to this as the ‘traditional view’ on paragraph 27 of his judgement in Sequana. He exemplifies the Salomon[2] case and highlights how the speech in that case ‘emphasised that anyone giving credit to a limited company did so at their own risk’. However, he goes on to make clear that the bare fact that creditors take risks does not automatically disqualify them from legal protection. In paragraph 53 of the judgement, he remarks ‘it seems to me to be undeniable that limited liability… [is] designed to protect shareholders against claims arising from the company’s failure and accordingly expose creditors to a corresponding risk. But that does not entail that creditors should be bereft of legal protection’. Another opposition to such a duty has been summarised by Lord Briggs in his leading judgement in Sequana as ‘it would be wrong to recognise a duty owed by directors directly to, and therefore enforceable by, creditors. This would be incompatible with a fiduciary duty to the company itself, as a separate entity distinct from even its shareholders and a fortiori from its creditors’. This criticism is unfounded as no separate duty that is enforceable by creditors has been endorsed in the case law and Sequana further clarifies that the duty described is not one of that nature.  It is stated in paragraph 11 that ‘there is not a duty owed to creditors, or any duty separate from the directors’ fiduciary duty to the company… the duty remains the director’s duty to act in good faith in the interests of the company’. Lord Reed goes on to say ‘the effect of the rule is to require the directors to consider the interests of creditors along with those of members… weight to be given to their interests, insofar as they may conflict with those of the members, will increase as the company’s financial problems become increasingly serious’. Another criticism of the duty has been that, as put by Lord Briggs, ‘creditors (or at least unsecured creditors) never have a proprietary interest in the assets of a company, even when it is in insolvent liquidation, any more than do shareholders’. Sequana makes it clear that ‘neither unsecured creditors or shareholders have a proprietary interest in the assets of the company’, and that language which sparks confusion should be abandoned. Lord Hodge, in agreeing with Lord Reed, remarks ‘it is preferable not to use the language of the earlier case law which may suggest that there is a transfer of a proprietary interest in the assets of the company to its creditors when the company is bordering on insolvency. There is no such transfer’. It is evident that the Supreme Court judges paid close attention to the academic literature that prevailed in relation to creditors duty and therefore specifically targeted the ongoing concerns and criticisms to make the law clearer and more certain. The judgement, if anything, targets uncertainties and addresses controversies in a clear-cut manner rather than introducing a ground-breaking and revolutionary reform to creditor’s duties.

The controversy relating to the substance of the duty was summarised in two questions by Langford and Ramsay as ‘at what point does the duty arise?’ and ‘what does it require of directors- is it consideration of creditors’ interests, balancing the interests of creditors and shareholders, or prioritizing creditors’ interests?’[3]. The trigger point for the activation of the duty has been formulated differently across the case law and the confusion is unsurprising. Across different cases, courts have defined the activation point as ‘insolvent or bordering insolvency’[4], ‘insolvent or of doubtful solvency’[5], ‘on the verge of insolvency’[6], ‘insolvent or potentially insolvent’[7]. Though the terms broadly convey the same idea, the fact that marginal differences in interpretation can lead to important consequences for the outcomes of cases made academics uneasy and resulted in a confusion in the law. In the Court of Appeal judgement of Sequana, David Richards LJ rejected the test of insolvency and Lord Reed agreed with this rejection in his judgement. He went on to say on paragraph 87 that ‘in principle, the critical factor is whether, given where the economic interests lie, and the consequent distribution of risk, it continues to be appropriate to treat the interests of the company as equivalent to the interests of its shareholders alone’. Lord Reed elaborates on the status of the test and agrees with the view of Lord Toulson and Lord Hodge in Bilta, namely that it is sufficient if the ‘company is insolvent of bordering on insolvency’. He also calls the range of terminology used by the courts across cases ‘broadly synonymous’ in that they ‘all convey a sense of imminence’. Thereby, this judgement clarifies the uncertainty around when the duty is activated. What the duty requires of directors is also clearly defined and established in the judgement. Lord Briggs acknowledges that ‘unity of authorities about the existence of the creditor duty is not matched by any similar unanimity about its precise content’. He goes on to clarify the law and states that ‘prior to the time when liquidation becomes inevitable and section 214 becomes engaged, the creditor duty is a duty to consider creditors’ interests, to give them appropriate weight, and to balance them against shareholders’ interests where they may conflict’. He acknowledges that ‘this is likely to be a fact sensitive question’. A further controversy, before the judgement, remained the justification for the existence of such a duty. Lord Briggs identifies three existing justifications and addresses them individually. The first is the one relied upon in Nicholson v Permakraft[8], which is in Lord Briggs’s words ‘that incorporation with limited liability is a privilege which carries with it an obligation to have regard to propensity for the directors’ decision-making to damage the interests of creditors’. The second justification is that ‘the company itself owes responsibilities to its creditors once it is insolvent, so that the directors as the custodians of the conscience of the company are duty bound to the company’. The third is the proprietary justification for the existence of the duty, elaborated in the Kinsela[9] judgement. Lord contends that the first is unpersuasive and admits the third one, being the most popular one, is semantically incorrect in that neither shareholders nor creditors have a true ‘proprietary’ interest in the company. In relation to the second justification, Lord Briggs states that ‘the passage of time has given real force to [it]’. He further expresses ‘the prospect that creditors may eventually attain the status of paramount stakeholders in a statutory liquidation process… seems to me to be a very sensible justification for the existence of a common law duty’. He thereby ascertains his view on the strongest justification which concretely establishes this duty and resolves any surrounding controversy around it.

Even though the Sequana decision cleared the air in terms of legal and academic uncertainties, it can create adversarial effects for directors and those advising them. It is obvious from the current position of the law that directors’ duties may become burdensome when trying to balance the competing interests of different stakeholders. The exercise of the fiduciary duty to exercise their power bona fide for the benefit of the company as a whole[10], can become challenging if what may be beneficial for shareholders and creditors diverge. It is by now clear that decisions undertaken by directors that jeopardize the interests of creditors cannot be justified by saying it was beneficial for the ‘company’. Kinsela was about shareholder authorisation of assets being put outside the reach of the company’s creditors. Street CJ said at paragraph 732 that ‘once it is accepted…that the directors’ duty to a company extends in an insolvency context to not prejudicing the interests of creditors… the shareholders do not have the power or authority to absolve the directors from that breach’. This view was endorsed in Sequana therefore it is now clear that shareholders cannot authorise or ratify breaches of the director’s fiduciary duty towards creditors when the creditors have become the main economic stakeholders in the company. However, the consideration to be given to creditors is not as significant when the company is performing well. In paragraph 47 of Sequana, is expressly stipulated that ‘so long as the company is financially stable, the creditors’ interests do not require to be considered as a discrete aspect of the company’s interests for the purposes of the directors’ fiduciary duty to the company’. Only when the company starts performing poorly, their interest starts to gain an increasing importance. The protection offered to creditors and cemented through Sequana can become alarming for shareholders who may feel their economic interest in the company can be put in jeopardy. Paragraph 57 of the Sequana judgement illustrates such a situation, when ‘a company which is on the cusp of insolvency, and whose assets are exactly equal to its liabilities’ is considered. Lord Reed acknowledges that ‘if it ceases trading and is wound up, its creditors will be repaid in full, and its shareholders will receive nothing. If it continues trading, its shareholders will usually be no worse off whatever happens, but have a chance of being much better off, while its creditors will be no better of whatever happens, but have a chance of being much worse off’. The discrepancy in shareholders and creditors interests and the hardship involved in balancing the two in accordance with the fiduciary duty owed to the company plainly illustrates the difficulty involved in being a director faced with such a situation. Therefore, it can be admitted that how directors should handle such situations remains relatively ambivalent and highly fact-sensitive, thus somewhat controversial. The Supreme Court tries to tackle the uneasiness that such a sensitive decision-making can induce by the reassurance that rescue strategies are not ruled out and ‘the directors may well consider in good faith that such a strategy is in the interests of the company’. Yet, as acknowledged by Lord Briggs, ‘once liquidation is inevitable, the directors face personal liability under section 214 of the 1986 Act if they do not treat minimising loss to creditors as their paramount responsibility’. It remains the case that the increased protection offered to creditors can put directors in a very strenuous position and make shareholders uneasy, thus decrease investments and business initiatives in the future.

Ultimately, the Sequana judgement, being the first Supreme Court address to the issue of creditors duties, is very instructive and illuminating in relation to the duty owed by directors to creditors and when it is activated. It resolves many uncertainties in the law and addresses academic criticisms directly, thereby minimises surrounding controversies. Despite the positive nature of the clarification and illumination, directors may feel an increased sense of burden and shareholders may feel an increased hesitancy to invest in the future as a result.

[1] Andrew Keay, ‘Directors’ Duties to Creditors: Contractarian Concerns Relating to Efficiency and Over-Protection of Creditors’ [2003] 66(5)The Modern Law Review 665-699

[2] Salomon v Salomon & Co Ltd [1897] AC 22

[3] RosemaryTeele Langford and Ian Ramsay, ‘The ‘Creditors’ Interests Duty’: When Does it Arise and What Does It Require?’ [2019] 135(3) Law Quarterly Review 385-390

[4] Bilta (UK) Ltd v Nazir (No 2) [2015] UKSC 23; [2016] AC 1 para 123

[5] Colin Gwyer & Associates Ltd v London Wharf (Limehouse) Ltd [2002] EWHC 2748 (Ch); [2003] 2 BCLC 153 para 74

[6] ibid

[7] Re Loquitur Ltd [2003] EWHC 999 (Ch); [2003] 2 BCLC 442, para 240

[8] [1985] 1 NZLR 242

[9] Kinsela v Russell Kinsela Pty Ltd [1986] 4 NSWLR 722

[10] Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 616, 631