The Court of Appeal, in the recent case of BTI 2014 LLC v Sequana SA (“Sequana”), has determined the trigger point at which a director’s duty switches from the duty to promote the success of the company for the benefit of its members as a whole to the duty to consider, and act in, the interests of the creditors of the company.

Background

Under section 172 of the Companies Act 2006, a director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, subject to any rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.

The Court of Appeal in Sequana was tasked with ruling on one of the circumstances in which the caveat to the duty to promote the success of the company would be activated. This circumstance was the exact point at which the caveat would be triggered in relation to a company that is solvent but has the potential to become insolvent at some future point.

This is a much-debated area of English law and, while there is much academic discussion and obiter dicta commentary on the topic, Sequana is the first time that the Court of Appeal has been required to rule on the subject.

Ruling

The court identified four potential points in time at which a director may need to consider the interests of the company’s creditors over its shareholders in relation to insolvency. These were:

1. when the company is in actual insolvency;
2. when the company is at least on the verge of insolvency, or is nearing or approaching insolvency;
3. when the company is or is likely to become insolvent; or
4. where the company faced a real, as opposed to a remote, risk of insolvency.

The court rejected timing 1 because the moment at which a company actually becomes insolvent was not ascertainable with certainty and on the basis that it was settled legal precedent that the trigger point of the shift in duty was short of actual insolvency (albeit that the exact timing was still uncertain).

Timing 2 was rejected by the court as the judges determined that it was not a temporal test, i.e. the proximity of insolvency was not relevant. A temporal test would not capture the situation in which a company, although able to pay its debts as they fall due for an indeterminate amount of time, is likely to become insolvent in the future.

The court rejected timing 4 as it was not part of the present law and it would not be appropriate for the courts to introduce such a test, not least as it is a less demanding test than that at timing 3 above. And, as such, would have a chilling effect on entrepreneurial activity.

The court came down on the side of timing 3: a director’s duty to consider the company’s creditors arises when the director knows, or should know, that the company is or is likely to become insolvent.

Comment

This is a welcome judgment and provides clarity, where before there was general uncertainty, as to the trigger point for when directors need to consider the interests of the company’s creditors over those of its shareholders.

However, the court was reluctant to go beyond the initial question relating to the trigger point to look at the content of the duty itself. Accordingly, ambiguity remains as to the extent to which directors need to take creditors’ interests into account once the trigger point has been reached: are creditors’ interests to be considered paramount or should they be weighed-up alongside those of shareholders and should the type of decision being made alter the extent of the duty? These are questions for another court and until they are determined we remain only halfway to a clear approach to how directors should consider creditors’ interests in the context of insolvency.

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