In BTI 2014 LLC v Sequana SA  EWHC 1686 the High Court was recently asked to consider whether:
- payment of dividends contravened Part 23 of the Companies Act 2006;
- the decision to pay the dividends was a breach by the directors of their fiduciary duties towards the company; and
- the dividends were transactions defrauding creditors under Section 423 of the Insolvency Act 1986.
The case lasted over 30 days at trial and the factual matrix was complex.
Arjo Wiggins Appleton Limited (AWAL) was a wholly owned subsidiary of Sequana SA (SSA). Through a series of acquisitions, the claimant in BAT Industries PLC (BAT) became responsible for part of the costs of an environmental clean-up operation in the United States. AWAL was liable to indemnify BAT for part of that liability and provision was made in AWAL's accounts to reflect the directors' best estimate of the amount of that liability.
In December 2008 the directors of AWAL each signed a solvency statement under Section 643 of the Companies Act stating that they had formed the opinion that:
- there were no grounds on which the company could be found to be unable to pay or otherwise discharge its debts; and
- the company would be able to pay or otherwise discharge its debts as they fell due during the following year.
AWAL's directors resolved to reduce the company's capital and pay an interim dividend to SSA.
In May 2009 it was resolved that AWAL would be sold to a third party and its directors resolved to pay a further interim dividend to SSA.
AWAL brought a claim (subsequently assigned to BTI LLC, a corporate vehicle of BAT) against its directors and SSA on the following grounds:
- The dividends contravened Part 23 of the Companies Act because the accounts by reference to which the directors justified the distributions either were not properly prepared or, as they were interim accounts, did not enable the directors to make a reasonable judgement as to the financial status of the company in order to determine the value of the dividend; and
- The decision to pay both dividends was a breach by the directors of their fiduciary duties towards the company.
BAT subsequently brought a separate claim against AWAL and SSA asserting that the dividends declared by AWAL were transactions defrauding creditors in contravention of Section 423 of the Insolvency Act.
In response, SSA asserted that it had changed its position as a result of the dividend payments and that this constituted a defence under Section 425(2) of the Insolvency Act.
The court dismissed the claims originally brought by AWAL under the Companies Act regarding payment of dividends and in respect of the directors' fiduciary duties towards the company, but allowed BAT's claim under Section 423 of the Insolvency Act in part.
Payment of dividends
In making a solvency statement under the Companies Act, the court held that the directors must have formed the opinion (required by Section 643(1)) that there were no grounds on which the company could be found to be unable to pay its debts.
The test was not a technical one, but a straightforward one applying the words of the statute. The directors had to examine the situation of the company at the date of the statement and, taking into account contingent or prospective liabilities, form an opinion as to whether the company could pay its debts. The absence of reasonable grounds for such an opinion did not render the solvency statement or the reduction of capital invalid.
Accordingly, the December dividend did not contravene Part 23 of the Companies Act, as the interim accounts for that month were sufficient to enable the directors to make a reasonable judgement as to the financial status of the company in order to determine the value of the dividend.
In addition, the 2008 final accounts had been properly prepared insofar as was relevant for determining whether the May dividend would contravene Part 23, since they gave a true and fair view of the state of AWAL's affairs.
Directors' fiduciary duties
The law states that directors must act in the way that they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole (Section 172(1) of the Companies Act).
At common law, where a company is insolvent, the directors must consider the interests of the creditors as paramount and take those interests into account when carrying out their duties to the company (Liquidator of West Mercia Safetywear Ltd v Dodd (1988) 4 BCC 30).
The question here was whether the duty to act in what the directors believed to be the best interests of the creditors had arisen at the time of the dividend.
The court emphasised that the authorities do not establish that whenever a company is at risk of becoming insolvent at some indefinite point in the future, the directors' duty to act in the best interests of the creditors arises. Instead, the essence of the test is that the directors ought to be anticipating the insolvency, because when that occurs the creditors have a greater claim to the assets of the company than the shareholders.
In this case, it did not follow that just because AWAL had on its balance sheet a provision in respect of a long-term liability which might turn out to be larger than the provision made, the 'creditors' interests' duty applied for the whole period for which there was a risk that the company's assets would be insufficient to meet the liability. That would result in the directors having to take account of creditors' rather than shareholders' interests when running the business over an extended period. In fact, AWAL's balance sheet showed no deficit of liabilities over assets and there were no unpaid creditors. Therefore, the creditors' interests duty had not arisen at the time of the decision to pay either the December dividend or the May dividend and there was no breach of fiduciary duty.
Transactions defrauding creditors
Section 423 of the Insolvency Act allows claims to be brought where a company or individual disposes of property at an undervalue for the purpose of putting that asset beyond the reach of a potential claimant or otherwise prejudicing the interests of such person in relation to a potential claim. The claim need not be brought by an insolvency office holder (and the offending company or individual need not be subject to a formal insolvency process), and can be brought by a victim of the transaction.
The first question for the court was whether payment of the dividends by AWAL was a 'transaction' for the purpose of Section 423 of the Insolvency Act. The court held that nothing in the wording of Section 423 excludes the payment of a dividend from the scope of that provision if the payment was made with the purpose, set out in Section 423(3), of putting assets beyond the reach of a potential claimant or otherwise prejudicing the interests of such a person.
The second question was whether, in respect of each of the December dividend and the May dividend, the purpose of Section 423 was met. The court held that there was no evidence that the directors had had such a purpose in mind when declaring the December dividend. However, there was evidence to show that their intention when declaring the May dividend was to remove from SSA the risk that the indemnity liability to BAT might turn out to be greater than the amount available to meet it. BAT was also prejudiced by payment of the May dividend and it therefore satisfied the purpose of Section 423.
The third question for the court to consider was SSA's change of position defence – that, having received the second dividend and sold AWAL, it had lost control of the management of AWAL's exposure to environmental liabilities and had the May dividend not been paid, then AWAL would not have been sold. The judge held that while SSA's change of position was relevant to the granting of appropriate relief, it did not provide a complete defence to a Section 423 offence. In any event, the judge maintained that SSA knew of and shared the purpose of Section 423 and was a beneficiary of the overall transaction. There was therefore no significant detriment on which SSA could rely to engage the defence.
BTI v Sequana focuses on a number of interrelated legal and commercial issues.
On the payment of dividends and solvency declaration, the decision provides useful guidance on the requirement that directors take into account the contingent and prospective liabilities of the company when forming their opinions on its solvency. From a practical perspective, the decision would seem to encourage activist creditors to check the filed accounts and filing history of debtor companies to consider whether certain activities in the company's history might be challenged (through insolvency measures), and might highlight the actions of directors.
On the duties of directors, the key takeaway appears to be that in conducting the company's business, directors ought to be anticipating the insolvency of the company, because once that occurs, the creditors have a greater claim to the assets of the company than the shareholders.
Although this appears a sensible approach, the principal practical disadvantage of determining the trigger point by reference to closeness of insolvency may be that it results in the duty coming into effect too late to be of assistance to creditors – once a company is close to insolvency, the creditors' chances of being paid are sometimes minimal or non-existent. Although cases involving possible breach of the failure to consider creditors' interests (which are fairly rare) tend to arise in relation to insolvent companies which are then liquidated, a definitive ruling is still required to deal with those cases where the company is not insolvent, but creditors' interests may still not have been given sufficient consideration.
Finally, on transactions defrauding creditors, BTI v Sequana is the first English case to hold that dividends may be liable to challenge as a transaction defrauding creditors. It will be interesting to see where a change of position defence is available to a person entering into such a transaction, as the court seems to have accepted in principle that, depending on the factual matrix, such a defence may be available.
For further information on this topic please contact Paul Durban at Brown Rudnick LLP by telephone (+44 20 7851 6000) or email ([email protected]). The Brown Rudnick LLP website can be accessed at www.brownrudnick.com.