There are limits on the ability of shareholders to ratify dubious acts of the directors – it cannot be effective if the interests of existing creditors have become paramount (so as to subordinate the duties owed to shareholders) and are prejudiced. This is particularly relevant to upstream guarantees. On 6th February, the Court of Appeal gave its 51-page judgment in BTI 2014 LLC v Sequana S.A which is relevant to exactly this point.

Arjo Wiggins Appleton Limited was an English paper producing business. In 2008 it had stopped trading, and it had two assets on its balance sheet and one, contingent, liability. The liability was under an indemnity given to BAT Industries PLC which related to the alleged pollution (along with several other paper producers) of the Lower Fox River in Wisconsin over many years, going back to the 1950s. The assets were (a) a right to receive repayment of an €585m loan owed to it by its parent company (Sequana) and (b) the benefit of an insurance policy giving it up to US$100 million of cover against any liability under the indemnity. So, if the relevant environmental protection litigation in the USA went the wrong way, and the award was for more than US$100 million, the loan to Sequana would have to be called in. They declared a dividend roughly equal to the amount of the loan, which was then offset against the loan. This was to the potential prejudice of BAT of course and so it brought proceedings, arguing that the payment of the dividend was in breach of section 423 IA 1986 (“Transactions defrauding creditors)” and was contrary to the directors’ duties to the creditors (meaning BAT). Rose J held that:

  • the directors were free to declare the dividend and the interests of the creditors had not become overriding (section 172 CA 2006 spells out the “duty to promote the success of the company” (a.k.a. obtain corporate benefit) but this is subject to “any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company”, which preserves the common law rule that makes the interests of creditors paramount when a company is or is close to insolvent; in which case a shareholders’ ratification is ineffective); but
  • section 423 caught it and so it would be set aside.

The CA upheld her decision on both counts:

  • having reviewed all the authorities (including some New South Wales and New Zealand cases – testament yet again to the 21st century’s remarkable common law consensus) at length, the test was that the common law limitation only kicked in “when the directors know that the company is or is likely to become insolvent… In this context, ‘likely’ means probable, not some lower test”. Here, it was not probable.
  • as regards whether section 423 applied or not (a) a dividend was not a “gift” but it was a “transaction” for no consideration, and so fell within the section. This sounds right – as a matter of language, a “transaction” is literally an “doing across” and as a matter of construction, a gift is expressly a transaction within the meaning of section 423, and (b) the dividend was declared to insulate Sequana and so the motive of the directors was within section 423.

Sequana has apparently already applied to appeal but meanwhile this is clear judgment that identifies the point beyond which the interests of the creditors arise and section 172(3) kicks in, and so the point beyond which a shareholders’ ratification is ineffective.