The Year in Review: Scope of Directors’ Duties Revisited
The Supreme Court’s judgment in BTI 2014 LLC v Sequana SA and ors[1] (“Sequana”) is a key decision on the law surrounding directors’ duties.
The High Court was required to consider the Supreme Court’s Sequana judgment in Hunt v Singh (below).
What did we learn from Sequana?
In Sequana the Supreme Court confirmed that directors must consider the interests of creditors and undertake a balancing exercise with respect to the interests of shareholders when these interests are in conflict. This Creditor Duty is engaged when the directors know (or ought to know) that:
- The company is in an actual state of insolvency;
- There is a probability of the company entering insolvent liquidation or administration; or
- The company is bordering on insolvency (meaning that insolvency is both imminent and inevitable).
In such circumstances, the directors must also consider the interests of the creditors in the context of a ‘sliding scale’; the more dire the company’s financial position, the more the directors should consider the interests of creditors (based on what they actually knew or should have known).
If insolvency is inevitable, the interests of creditors should be paramount. Conversely, a real risk of insolvency is not enough to trigger the Creditor Duty alone.
The Sequana decision is largely seen as a swing of the risk pendulum towards directors. It gives them more leeway to delay engaging with the Creditor Duty. Previously directors were expected to engage with the Creditor Duty when the company was in or approaching the fairly nebulous concept of the ‘zone of insolvency’.
Hunt v Singh
In the more recent case of Hunt v Singh[2] the Court considered the Creditor Duty in the context of whether the duty arises where a company is, in fact, insolvent, but the directors wrongly believed that the liability giving rise to the insolvency had effectively been avoided.
Hunt v Singh concerned a service company, Marylebone Warwick Balfour Management Limited (the “Company”) which provided management services to its group companies. In 2002 the Company entered into a tax avoidance scheme designed to enable bonuses to be paid to the Company’s senior management without incurring liabilities to HMRC for PAYE and NIC contributions (the “Scheme”). The Company’s tax advisors advised the directors that the Scheme was “robust”, despite the growing interest and enquiries from HMRC into the operation of the Scheme. In September 2005 the Company rejected a market-wide offer put forward by HMRC to settle the liability arising under the Scheme. HMRC consequentially notified the Company of its intention to resolve the matter through litigation and in 2010 the tax tribunals held that PAYE and NIC contributions were due on the payments paid under the Scheme. The Scheme ceased in 2010 and the Company subsequently entered liquidation in 2013.
The liquidator of the Company (Mr Hunt) brought various claims against several former directors, including claims under section 212 of the Insolvency Act for breach of the Creditor Duty, for allowing payments to be made at a point where the Company was already insolvent. The claims were dismissed at first instance in the Insolvency and Companies Court and the liquidator’s appeal against Mr Singh was heard in June 2023.
What did the Court decide?
On appeal, Mr Justice Zacaroli considered the differing context of the case before him, when compared with the facts of Sequana.
In Sequana, the company was solvent at the time the relevant dividends were paid. The question in that case was whether the company’s directors ought to have realised that the company was likely to become insolvent on account of a contingent liability of an unknown amount. However, in Hunt v Singh, the Company was actually (and substantially) insolvent throughout the relevant period. The fact that the Company disputed the liability to HMRC did not change the fact that it was a liability (admittedly subject to a legal challenge that would have expunged the debt had the challenge been successful). A disputed liability was not a contingent liability.
At first instance, Judge Prentis held that the Creditor Duty was not engaged because the directors had acted reasonably in taking and acting upon advice around the merits of HMRC’s claim.
Mr Justice Zacaroli found that Judge Prentis had applied the wrong test to determine when the Creditor Duty arose.
The correct test was that where the Company’s solvency was dependent on it successfully challenging HMRC’s claim, the Creditor Duty was triggered if the directors “knew or ought to have known that there is at least a real prospect of the challenge failing”.[3]
Mr Justice Zacaroli recognised that the Supreme Court rejected this test in Sequana, but noted that, in Sequana, the Supreme Court had been examining a company that was solvent at the time the duty had allegedly arisen. In the current case, the Company was insolvent and therefore the appropriate test was one of “real risk”. As Mr Justice Zacaroli explained, the difference between the two contexts is clear when one considers the rationale for the Creditor Duty: the shift in the economic interest from shareholders to creditors. If, as in the circumstances of Hunt v Singh, it turned out that the Company was insolvent at the relevant time, then this shift in economic interest had already happened.
On the facts, the High Court in Hunt v Singh found that Mr Singh had become aware of the risk in September 2005 (when HMRC made its market-wide offer). The Creditor Duty had therefore arisen at that point and continued up to the Company’s liquidation in 2013. Mr Justice Zacaroli declined to consider whether or not Mr Singh had in fact been in breach of the Creditor Duty. Since the Sequana judgment had been handed down between the hearing of Hunt v Singh at first instance and the appeal, Zacaroli considered that further findings of fact may need to be made in line with the guidance of the Supreme Court, and accordingly remitted the case to be reconsidered.
Differences between Wrongful Trading and the Creditor Duty
The duties in respect of Wrongful Trading and the Creditors Duty are not the same. The Sequana judgment held that there was no conflict between the Creditor Duty and the wrongful trading provisions found in s.214 of the Insolvency Act. When the Creditor Duty is triggered, directors have a duty to act in the best interests of the company generally. Wrongful Trading encompasses a duty to take reasonable care to minimise the potential loss to the company’s creditors when the directors knew or ought to have concluded that there was no reasonable prospect of avoiding insolvency.
The key message for directors
The decision in Hunt v Singh should be treated with a degree of caution.
The key question as to whether the directors of a company need to know that a company is insolvent or bordering on insolvency for the duty to arise was not argued before the court.
The Court took an explicitly different approach from the Supreme Court in Sequana. It is not possible to know whether the Supreme Court would have taken the same view in this instance.
Following Hunt v Singh, once directors become aware of a disputed liability that would push their company into balance sheet insolvency, if the claim against the company were to be successful, they must consider the likelihood of the liability crystallising and the potential consequences. The test to bear in mind is whether the directors know or ought to know that there is at least a real prospect of the challenge to the liability failing. This is a low bar, and ought to be at the forefront of directors’ minds when considering liabilities and litigation of significant value.
The difficult question is when directors become aware of a potential liability. What is clear from both Hunt v Singh and Sequana is that the duty arises at the very least if a “reasonably diligent and competent director” would know that there is no reasonable prospect of avoiding insolvency proceedings. Where the line is drawn prior to that will be fact specific on the directors’ knowledge and depend on the nature of the liability in question (contingent versus disputed). A reasonably diligent and competent director ought to ensure legal advice is sought and followed on significant disputed liabilities.
Carillion - missed opportunity or a case that should never have been brought?
As a footnote to the above, it is worth noting the Insolvency Service’s disqualification proceedings against the non-executive directors (‘NEDs’) of Carillion Plc have been dropped at the eleventh hour. The discontinued proceedings were a test case in relation to the five former NEDs and was listed for a 13 week trial to run from mid-October.
The case against them was one of unfitness pursuant to s.6 of the Company Directors Disqualification Act 1986 on the basis that they did not know the true financial position of the company and allowed misstatements in the accounts to be signed off.
Had the case proceeded and the NEDs been found liable and disqualified, notwithstanding that this would be arguably inconsistent with the Companies Act, this would have had far reaching and a potentially chilling effect on UK corporate governance practices, with few NEDs being prepared to expose themselves to risk, especially regarding complex and distressed corporate structures.
In review, the year has arguably seen the scope of director’s potential risk reduced by Sequana, albeit qualified by (the distinguishable) Hunt v Singh, and in any event certainly not expanded in the way that the Insolvency Service sought in Carillion disqualification proceedings.
This article was originally published to Issue 15 of ThoughtLeaders4 FIRE Magazine.
[1] [2022] UKSC 25
[2] [2023] EWHC 1784 (Ch)
[3] [2023] EWHC 1784 (Ch) paragraph 51
