Overview

In a recent landmark case, the United Kingdom Supreme Court held in BTI 2014 LLC v. Sequana SA & Ors, [2022] UKSC 25 that directors of a corporation owe a fiduciary duty to creditors when a corporation is at or near insolvency. Sequana SA is inconsistent with the decisions of the Supreme Court of Canada in Trustee of People’s Department Stores Inc. v. Wise, 2004 SCC 68 and BCE Inc. v. 1976 Debentureholders, 2008 SCC 69. In those cases, the Supreme Court of Canada held that directors do not owe a fiduciary duty to creditors when a corporation is in the “vicinity of insolvency.” It remains to be seen whether the reasoning in Sequana SA may lead the Supreme Court of Canada to reconsider Peoples and BCE.

Facts

In 2009, the directors of AWA caused AWA to distribute a dividend of €135 million to its only shareholder. The dividend was lawful.[1] It was also distributed when the company was solvent. But, when the dividend was made, there was some concern that AWA would become insolvent in the future. Certain liabilities “gave rise to a real risk, although not a probability, that AWA might become insolvent at an uncertain but not imminent date in the future.”[2]

Almost 10 years later, AWA entered insolvent administration. BTI sought, as assignee of AWA’s claims, to recover an amount equal to the 2009 dividend. It argued that the directors breached their duty to AWA’s creditors by issuing the dividend in 2009 because the company had a real risk of insolvency in the future.[3]

The trial judge and Court of Appeal rejected this argument. The lower courts held that the directors had no duty to consider the creditors’ interests in 2009. At that point, the company was not insolvent, nor was a future insolvency imminent or probable.[4]

On further appeal to the UK Supreme Court, the appellant argued that directors have a duty to consider creditors’ interests when there is a real risk of insolvency — the situation facing AWA in 2009.[5]

UK Supreme Court Decision

The UK Supreme Court unanimously dismissed the appeal: the directors did not owe a duty to creditors in this case.[6] However, in reaching this conclusion, the court outlined four important principles regarding the duties directors owe to creditors:

1. Directors must consider and act in the best interests of creditors in certain circumstances.[7] This is not a free standing “creditor-duty”; rather, it is an aspect of the directors’ fiduciary duty to act in the best interests of the corporation.[8]
2. This duty is triggered when the corporation is insolvent or bordering on insolvency.[9]
3. Directors do not need to consider or act in the interests of creditors merely because the company is at a real risk of insolvency,[10] or becomes temporarily insolvent.[11]
4. The weight given to creditor interests depends on the company’s financial situation. If the company is bordering on insolvency, the directors must consider and balance[12] the interests of shareholders and creditors.[13] But where insolvency is inevitable, directors must act solely in the best interests of the creditors as a whole.[14]

The UK Supreme Court held that this duty was needed to protect creditor interests. When the company is financially stable, creditors are protected by the directors’ general duty to act in the best interests of the corporation as a whole — which typically aligns with the best interests of its shareholders.[15] Failing to pay debts may, for example, harm shareholders by making debt financing more difficult in the future.[16]

According to the UK Supreme Court, this dynamic changes when the company is insolvent or bordering on insolvency. At that point, shareholders typically have nothing to lose because shares are at risk of becoming worthless.

Shareholders therefore have every incentive to pursue risky ventures when the company is near insolvency, even if that plan (1) will likely fail and (2) reduce the assets that the company could pay to creditors. In economic terms, this creates a situation of “risk externalization”[17] — the profits, if any, are kept by the risk takers (the shareholders) but the losses are realized on innocent third parties (the creditors). An example provided by Lord Hodge illustrates this issue:

[238] By way of example, suppose (i) a company has been unsuccessful and the capital of the shareholders has been lost through balance sheet insolvency; (ii) the company’s directors know or ought to be aware in the exercise of their duty of skill and care that a formal insolvency process is more likely than not; (iii) there is a prospect of avoiding the formal insolvency if the company were to undertake a particularly risky transaction; but (iv) the company’s assets that remain and which would be put at risk by the transaction would be lost to its creditors if the gamble were to fail. The shareholders, whether present or future, would probably have nothing to lose from the adoption of the very risky transaction as a last roll of the die because the likely alternative would be a formal insolvency from which they would receive nothing. A requirement that the directors consider and, if the facts of the particular case require it, give priority to the interests of the company’s creditors in their decision-making in such circumstances appears to be a necessary constraint on the directors…To my mind the law would be open to justifiable criticism if it were to provide no remedy in respect of the interests of such creditors where such a course of action was proposed or had been adopted in the exclusive interest of the shareholders and to the probable detriment of the company’s creditors without a proper consideration of the interests of the latter.

Requiring directors to consider the interests of creditors when the corporation is near insolvency ensures that creditors are not taken advantage of in those situations.

Implications for Canadian Corporations and Directors

Sequana SA is inconsistent with Canada’s approach to the fiduciary duties owed by directors and officers of corporations incorporated federally or provincially in Canada.

In Trustee of Peoples Department Stores Inc. v. Wise 2004 SCC 68, the Supreme Court of Canada held that directors owe a fiduciary duty solely to the corporation, not to any individual corporate stakeholder like a shareholder or a creditor. This duty does not change when the corporation is at or near insolvency:

[43] The various shifts in interests that naturally occur as a corporation’s fortunes rise and fall do not, however, affect the content of the fiduciary duty under section 122(1)(a) of the CBCA. At all times, directors and officers owe their fiduciary obligation to the corporation. The interests of the corporation are not to be confused with the interests of the creditors or those of any other stakeholders. […]

[46] The directors’ fiduciary duty does not change when a corporation is in the nebulous ‘vicinity of insolvency’. That phrase has not been defined; moreover, it is incapable of definition and has no legal meaning. What it is obviously intended to convey is a deterioration in the corporation’s financial stability. In assessing the actions of directors it is evident that any honest and good faith attempt to redress the corporation’s financial problems will, if successful, both retain value for shareholders and improve the position of creditors. If unsuccessful, it will not qualify as a breach of the statutory fiduciary duty.”

[Emphasis added.]

Peoples was affirmed in BCE Inc. v. 1976 Debentureholders, 2008 SCC 69.

It remains to be seen whether the Supreme Court of Canada will revisit Peoples and BCE. Supporters of Peoples will likely argue that there is no need to impose a fiduciary duty on directors to act in the best interests of creditors because other remedies, like the statutory oppression remedy, adequately protect creditors. In Lord Hodge’s hypothetical discussed above, for example, Canadian creditors could argue that the directors’ actions were oppressive if they were made without any consideration of the creditors’ interests. Still, others might argue that the oppression remedy does not adequately protect creditors, particularly because it requires establishing the creditors’ “reasonable expectation” that the directors would consider and weigh their interests over the interests of other stakeholders in a certain way when the circumstances require it. Absent some representation made by the corporation or a well-establish commercial practise, it may be difficult for a creditor to establish the reasonableness of any expectation.

Case Information

BTI 2014 LLC v. Sequana SA & Ors, [2022] UKSC 25

Date of Decision: October 5, 2022

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[1] Para. 115.

[2] Para. 115.

[3] Para. 115.

[4] Para. 116.

[5] Para. 117

[6] Para. 10.

[7] Paras. 148, 153, 156, 207, 227.

[8] Paras. 11, 205.

[9] Paras. 88, 138, 165, 203, 207, 247.

[10] Paras. 14, 83, 199.

[11] Paras. 172-176, 191-193.

[12] See para. 177.

[13] Paras. 81, 96.

[14] Paras. 11, 76-77, 148.

[15] Paras. 65, 113, 135, 139.

[16] Paras. 47, 66-67, 83, 229.

[17] Para. 59.