Introduction
On 5 October 2022, the UK Supreme Court delivered its long-awaited judgment in BTI 2014 LLC v. Sequana SA and others [2022] UKSC 25 ("Sequana Case") which concerns the question of the trigger point when directors must have regard to the interests of creditors ("Creditor Duty"). This case raised questions of considerable importance for Malaysian company law.
The UK Supreme Court in the Sequana Case considered for the very first time, the existence, content, and engagement of the Creditor Duty. The Supreme Court effectively confirmed the existence of the Creditor Duty in the arena of insolvency and held that the Creditor Duty is engaged when the directors know, or ought to know, that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable.
In this Update, we summarise the legal issues and decision of the UK Supreme Court and discuss the possible impact of the Sequana Case for Malaysian companies.
Brief Facts
In May 2009, the directors of a company known as Arjo Wiggins Appleton Limited ("AWA") caused AWA to distribute a dividend of €135 million ("May Dividend") to its only shareholder, Sequana SA ("Sequana"), which extinguished by way of set-off almost the whole of a slightly larger debt which Sequana owed to AWA.
The May Dividend was distributed when AWA was solvent on both balance sheet and cash flow basis. However, it had long-term pollution-related contingent liabilities of an uncertain amount and an insurance portfolio of an uncertain value.
Almost ten years later, AWA went into insolvent administration sometime in October 2018.
BTI 2014 LLC ("BTI"), as assignee of AWA's claims, sought to recover the May Dividend from AWA's directors on the basis that their decision that AWA distributes the May Dividend was a breach of the Creditor Duty because the directors had not considered or acted in the interests of AWA's creditors.
Decision
This claim was rejected by the High Court and the Court of Appeal. The Court of Appeal ([2019] EWCA Civ 112) held that the Creditor Duty may be triggered in circumstances short of actual insolvency namely, the said duty arises when the directors know or should know that the company is or is likely to become insolvent.
The Supreme Court unanimously dismissed BTI's appeal and confirmed that the Creditor Duty arises under certain circumstances, namely (i) when the directors know or ought to know the company is insolvent or bordering on insolvency; (ii) where an insolvent liquidation or administration is probable; or (iii) where the transaction in question would place the company in either of the foregoing two situations. On the facts of the Sequana Case, the Creditor Duty was not triggered as the company was not actually or imminently insolvent nor was insolvency probable at the time.
Summary of the Salient Legal Issues
1) Whether there is a common law Creditor Duty at all?
Section 172(1) of the UK Companies Act 2006 requires directors to act in the way 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. Under common law, directors are in a fiduciary position to act in good faith in the interests of the company and exercise their powers bona fide for the benefit of the company as a whole. In West Mercia Safetywear Ltd v Dodd [1988] BCLC 250 ("West Mercia"), the English Court of Appeal modified the ordinary rule by including the interests of the creditors as a whole under the company's interests. The rationale for this is that a company's creditors have an economic interest in the company based on their entitlement to be paid their debts. The importance of the economic interest of the company's creditors increases when the company is insolvent or nearing insolvency. As such, directors are required to manage the company's affairs in a way which takes creditors' interests into account.
The Supreme Court agreed that the common law does establish that under certain circumstances, directors are required to take into account the interests of creditors. The Court also held that the Creditor Duty is not a free-standing duty on its own - instead it is part of the directors' fiduciary duty to the company.
2) What is the content of the Creditor Duty?
Where the company is insolvent, or bordering on insolvency, but is not faced with an inevitable insolvent liquidation or administration, the duty of the directors includes taking into account the interests of creditors as well as the interests of the general body of shareholders, and to act accordingly. Where their interests are in conflict, a balancing exercise will be necessary. The interests of creditors are essentially the interests of creditors as a general body and directors are not required to consider the interests of particular creditors. It was acknowledged by the Supreme Court that any course of action to be taken by directors of companies faced with potential insolvency is a fact sensitive question which requires a weighing of interests and exercise of judgment.
The Supreme Court further recognised that where an insolvent liquidation or administration is inevitable, the creditors' interests become paramount.
3) When is the Creditor Duty engaged?
On the facts of the Sequana Case, the Creditor Duty was not engaged, as at the time of the May Dividend, AWA was not actually or imminently insolvent, nor was insolvency even probable.
The majority of the Supreme Court held that the Creditor Duty is engaged when directors know, or ought to know, that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable.
How will this impact the Malaysian position on Directors' Duties Towards Creditors?
1) The Position in Malaysia
In Malaysia, a director's duty to the company is provided under the Companies Act 2016 ("CA 2016"). Section 213 of the CA 2016 provides that: -
"(1) A director of a company shall at all times exercise his powers in accordance with [the CA 2016], for a proper purpose and in good faith in the best interest of the company
(2) A director of a company shall exercise reasonable care, skill and diligence with –
- the knowledge, skill and experience which may reasonably be expected of a director having the same responsibilities; and
- any additional knowledge, skill and experience which the director in fact has."
Malaysian Courts have followed the common law position in West Mercia, as seen in the High Court case of Tradelift Indopalm Industries Sdn Bhd v Waris Selesa Sdn Bhd [2017] 1 LNS 2074, where the High Court dealt with the interest of creditors of an insolvent company. The High Court concluded on the facts of the case that where the plaintiff company was considered insolvent, the interests of the creditors of the plaintiff company displaced that of its members.
Similarly, the High Court in Dan-Bunkering (Singapore) Pte Ltd v The Owners of the Ship or Vessel "PDZ Mewah" & Anor [2020] 1 LNS 1966 acknowledged the principle that when a company is insolvent, directors must have regard to the interests of creditors. Both of these cases effectively acknowledged the common law position laid down in West Mercia.
Notwithstanding that Section 213 of the CA 2016 does not deal with directors' duties vis-à-vis the interests of creditors, the Malaysian Courts have accordingly acknowledged the common law position that directors must have regard to the interests of creditors when a company is insolvent.
It is necessary to note that CA 2016 also contains provisions that touch on protecting the interests of creditors. This, inter alia, includes Sections 131 and 132 of the CA 2016 which deal with distribution of profits to the shareholders by way of issuance of dividends and Sections 539(3) and 540 of the CA 2016 which deal with the liability for wrongful and fraudulent trading, respectively.
2) Impact on Malaysian Landscape
There is limited guidance on the Creditor Duty in respect of companies that are nearing insolvency as opposed to when companies are already insolvent. Therefore, the exact scope/limit of the Creditor Duty and when it arises have not been fully considered and examined by the Malaysian Courts.
The decision in the Sequana Case is likely to be highly persuasive and may have a significant bearing on the development of the law in this area in Malaysia. However, for directors trying to understand the practical implications of when a company's insolvency is "imminent", or where its insolvent liquidation or administration becomes probable, the timing of when the Creditor Duty is engaged (i.e. triggered) remains fact specific and is subject to future case law development.
Steps Directors Should Take When Company is in Financial Distress
Given the current economic and business conditions, where a company is in financial distress and potentially facing the threat of imminent/probable insolvency, directors should consider taking the following steps:
- staying fully informed and mindful of the financial health of the company. Directors ought to have full access to all information that is necessary to make informed decision(s) as this will have a significant impact on the weight to be accorded to creditors' interests;
- taking professional legal advice to support the board of directors' understanding and exercise of its duties;
- seeking appropriate specialist financial advice on the assessment of the company's financial position in relation to refinancing, restructuring or insolvency options; and
- holding frequent board meetings to assess the financial position of the company and whether the company should continue to trade and documenting in the board minutes the reasons for decisions taken.
Conclusion
The Sequana Case is an important development, especially since the Sequana Case has recognised that the Creditor Duty is part of the common law. Such a recognition provides Malaysian Courts with a basis to import the Creditor Duty since developments in the common law can be considered and adopted in Malaysia. Any adoption of the decision in the Sequana Case may be viewed as a welcome development by creditors in Malaysia, although this does result in a widening of the fiduciary duties of directors of companies.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
