Key takeaways for directors
A significant decision of the Supreme Court of the United Kingdom was released last week, BTI 2014 LLC v Sequana SA and others, confirming the existence of a duty owed to the company by its directors to consider the interests of the company's creditors when the company becomes insolvent or approaches insolvency.
As expressed by the Supreme Court, the so-called "creditor duty" reflects a sliding scale:
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Once a company becomes insolvent (or is approaching insolvency), the directors are required to consider creditors' interests and balance those interests against shareholders' interests where the two conflict. The greater a company's financial distress, the greater the attention that must be paid to the position of creditors.
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At the point where an insolvent liquidation is inevitable, the interests of creditors become paramount and must be prioritised by the company's directors.
New Zealand law regarding the duties of directors when facing insolvency has also been in the spotlight of late. The Court of Appeal in Mainzeal1 called for Parliament to review New Zealand's statutory insolvent trading regime, with the Supreme Court decision expected shortly2. A similar review is currently underway in Australia.
While New Zealand's company and insolvency legislation bears some similarities to the United Kingdom's and New Zealand cases recognise the need to consider the interests of creditors when approaching insolvency, there are a number of key statutory and policy setting differences that are reflected in recent New Zealand cases. Accordingly, whether, and to what extent, the Sequana decision will influence the development of directors' duties laws in New Zealand remains to be seen.
There is no "bright line" at which creditor interests become more prominent than shareholder interests, but once insolvency exists or becomes likely, New Zealand courts already consider the duty to act in the best interests of the company to include considering the interests of creditors. Directors should take care to identify the financial condition of the company and take financial and legal advice as to how best to discharge their duties when dealing with existing creditors and incurring new indebtedness.
Introduction
Last Wednesday (5 October 2022), the Supreme Court of the United Kingdom released its much-anticipated decision in BTI 2014 LLC v Sequana SA and others [2022] UKSC 25. The appeal provided the first opportunity for the United Kingdom's most senior court to consider the so-called "creditor duty" – being the duty of company directors to consider the interests of the company's creditors when the company is approaching insolvency.
The facts
In 2009, a company called AWA had paid its shareholder, Sequana, a dividend of €135 million. At the time the dividend was paid, AWA was solvent (on both a balance sheet and a cash flow basis). However, there was a real risk that AWA could become insolvent at some point in the future due to long-term pollution-related contingent liabilities and the uncertain value of an insurance portfolio asset.
Nearly ten years later, AWA went into administration. BTI 2014 LLC (BTI), having taken an assignment of AWA's claim against the directors, sought to recover the amount of the Sequana dividend payment from AWA's directors. BTI argued that the directors had breached the "creditor duty" by failing to consider or act in the best interests of AWA's creditors at the time that the dividend was made.
The key aspects of the Supreme Court's decision to dismiss BTI's appeal
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Creditor duty confirmed: The judgment confirms the existence of a duty owed to the company by its directors to consider the interests of the company's creditors when the company becomes insolvent or approaches insolvency. The Court held that the duty arose from the common law but was consistent with company and insolvency legislation and with the "modern corporate rescue culture" in the United Kingdom. The Court noted that the creditor duty was recognised in the seminal 1985 New Zealand decision in Nicholson v Permakraft (NZ) Ltd.
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A "real risk" of insolvency is insufficient to trigger the creditor duty: On the facts of this case, the creditor duty was not engaged because, at the time the Sequana dividend was paid, AWA was not actually insolvent – nor was insolvency imminent or even probable. The Court held the creditor duty does not apply merely because a company was at a "real risk" of insolvency.
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The sliding scale approach: The Court sought to address previous ambiguity regarding the "precise content" of the creditor duty by clarifying that the way in which directors discharge the creditor duty differs as the financial difficulties facing the company become more acute. Two distinct stages in what is commonly referred to as the "twilight zone" for a company can be discerned:
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Stage 1 – balancing competing interests: Once a company becomes insolvent or is bordering on insolvency, directors have a duty to consider creditors' interests, to give them appropriate weight, and to balance them against shareholders' interests where they may conflict. The balancing exercise reflects "the law's encouragement of risk-taking and commercial enterprise".
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Stage 2 – creditors' interests become paramount: Once an insolvent liquidation/administration becomes "inevitable", the creditors' interests become paramount and must be prioritised over and above the interests of shareholders. This reflects that a company's creditors are the main economic stakeholders in the company at that time.
Relevance in the New Zealand context
- To what extent is this compatible with the current New Zealand insolvent trading framework? The UK Supreme Court emphasised that the creditor duty dovetails with the wrongful trading provisions (broadly the equivalent to reckless trading in New Zealand). The New Zealand Supreme Court, or Parliament, will be equally concerned to ensure that any developments based on the Sequana creditor duty in New Zealand are consistent with our insolvent trading framework. At present, there are significant differences between the broader United Kingdom and New Zealand legislative frameworks. For example, directors in the United Kingdom have a duty to take every step that a reasonably diligent person would take to minimise potential loss to the company’s creditors once there is no reasonable prospect of avoiding an insolvency (the duty to avoid wrongful trading). Directors are permitted to continue to trade a business for a period prior to a formal insolvency process if to do so will achieve a better return for existing creditors. This approach can be seen as at odds with the Supreme Court's decision in Debut Homes.3
- Is there merit in promoting a workout culture in NZ? The Sequana creditor duty has been seen as promoting a workout culture that encourages high quality and considered risk taking (based on financial and legal advice) to bring about better returns for existing creditors without sacrificing the interests of new creditors. We would hope that the New Zealand courts (and potentially, Parliament) will reflect on whether our laws should better support or promote such a culture in New Zealand.
- There are several opportunities to consider the scope of the creditor duty. The Supreme Court decision in Mainzeal is expected to be delivered shortly. Notwithstanding the focus of Mainzeal on sections 135 and 136 of the Companies Act, the Supreme Court may take the opportunity to comment on the relevance of Sequana to that case. Further, Parliament may respond to the call of the Court of Appeal in Mainzeal for a review of New Zealand's statutory insolvent trading regime, particularly if the Supreme Court shares that view and given that a similar review is already underway in Australia.