In “Sequana” dividends had been declared reducing the indebtedness of Sequana SA to AWA, its parent, by EUR578m. AWA potentially owed BAT a very significant sum in respect of the clean up of its operations in USA. The sums in issue were large and the players significant.

At the time the dividends were paid AWA:

• had ceased to trade;
• had only one material liability being the contingent liability for the clean-up costs and damages resulting from its activities which would fall to BAT to pay if AWA could not; and
• had, as material assets, only the investment contract and insurance policies and a large intra group receivable (of EUR585million) it was owed by its parent company, Sequana.

The dividends were supported by solvency statements from AWA’s directors. Further, each dividend was paid by the amount of the dividend being set-off against the sum due to AWA from Sequana. The effect of the dividends was to remove this asset, save for a balance for cEUR3million, and put it beyond the reach of BAT.

The action went to trial and subsequently both parties appealed the decision of the trial Judge, Rose J.

One of the issues to be determined by the Court of Appeal was when the director’s duty to creditors was engaged.

Under section 172 of the Companies Act, directors have a duty to act in a way that they consider, in good faith, would be the most likely way to promote the success of the company for the benefit of its shareholders as a whole. Section 172(3) provides in certain circumstances, that the Directors should act in the interest of creditors of the company. It was BTI’s submission that the common law duty to creditors was engaged by the time the dividend was paid in May 2009.

There was significant legal argument debating how the Court should decide when the duty to creditors became engaged. On this issue Rose J said that to set the test at the level of ‘a real as opposed to remote risk of insolvency’ would appear to be a much lower threshold than a test set at the level of being ‘on the verge of insolvency’ or of ‘doubtful’ or ‘marginal’ solvency. In her judgment, Rose J said:

‘Having reviewed the authorities, I do not accept that [BTI had established] that whenever a company is ‘at risk’ of becoming insolvent at some indefinite point in the future, then the creditors’ interest duty arises unless the risk can be described as ‘remote’. That is not what the cases say ……...’

Having considered the evidence of AWA’s financial position at the time, Rose J concluded that AWA could not be described as on the verge of insolvency or of doubtful insolvency. As such, the High Court held that the duty to creditors had not been engaged at the time that AWA’s directors resolved to pay the May 2009 dividend.

In his leading judgment for the Court of Appeal, Richards LJ undertook a thorough review of how this issue has been considered in previous reported cases. He held:

‘The precise terms in which the duty is said to arise differ but a frequently used formulation is that it arises where the company “is insolvent or of doubtful solvency or on the verge of insolvency and it is the creditors’ money which is at risk”, in which case the interests of creditors are paramount…’

Richards LJ considered BTI’s submission that the duty arises when there is a real risk of a company’s insolvency and found that that would set a lower test than one which requires asking whether the company’s solvency is ‘doubtful’ or if the company is ‘on the verge of insolvency’ or ‘likely to become insolvent’.

Richards LJ acknowledged that the precise moment at which a company becomes insolvent is often difficult to pinpoint. In some cases it may occur suddenly, whereas equally, the descent into insolvency may be more gradual. Each case will depend on the particular facts and circumstances. Further, Richards LJ observed that the adoption of any legal test to identify the point at which the duty owed to creditors is engaged involves ‘a difficult amalgam of principle, policy, precedent and pragmatism’, as stated by Richardson J in Nicholson v Permakraft (NZ) Ltd ([1985] 1 NZLR 242).

Richards LJ considered that in his view ‘for good reason’ judges have shied away from prescribing a single form of words to encapsulate the test for determining when a company’s financial position is such that the law requires that its directors owe a duty to act in interest of creditors. In considering when the point before actual insolvency arises such that the duty is engaged, Richards LJ stated:

‘Judicial statements should never be treated and construed as if they were statutes but, in my judgment, the formulation used ….. in Bilta v Nazir, and by judges in other cases, that the duty arises when the directors know or should know that the company is or is likely to become insolvent accurately encapsulates the trigger. In this context, “likely” means probable, and not some lower test…’

BTI’s appeal, based on its argument that the applicable trigger for the creditors’ interests duty was a real, as opposed to remote, risk of insolvency, was rejected by the Court of Appeal. Accordingly, BTI’s appeal as regards all claims for breach of duty by the directors of AWA in paying the May dividend was dismissed.

Commentary

This issue wasn’t the only issue appealed but this case is probably be of most interest for what the Court of Appeal said about directors’ duties and specifically what it said about the legal test is for when directors ought to be taking decisions that are in the interests of creditors rather than shareholders.

In looking at what can be taken from this case, it must first be emphasised that it arose out of exceptional circumstances. The company had ceased to trade. It had one potentially huge liability in the form of indemnity obligations linked to the outcome of litigation in the US which, if it became an actual liability, may or may not be covered by its insurance policies. It otherwise had no material liabilities or assets, aside from the EUR585 million receivable owed to it by its parent company.

The fact that the facts were exceptional does not meant that the test will not apply in more routine circumstances. This is a case with real practical consequences for directors in all business’ in financial difficulty.

What we do know in the light of this case is that:

• the creditors’ interest duty is engaged at some stage that is close to insolvency and before actual, established insolvency (either on a cash flow or balance sheet basis);
• it may not be engaged when the risk of insolvency is real as opposed to remote;
• a company being ‘on the verge of insolvency’ or ‘in financial difficulties’ or ‘approaching insolvency’ may be apt to describe particular circumstances that meet the test but none of these sets of words can be relied on to be the legal test for all situations;
• the duty arises when the directors know or should know that the company is or is likely to become insolvent (which probably means cash flow insolvent and not just balance sheet insolvent) and ‘likely’, for these purposes, means more probable and not some lower test; and
• the directors’ decision as to whether the creditors’ interest duty has arisen is best taken on an informed basis as to the practical consequences. Directors who seek and act on professional advice are likely to be in a stronger position.

For legal assistance with dealing with insolvency please contact us by email djb@winstonsolicitors.co.uk or call 0113 218 5423.

It has been settled law for many years that as a company approached insolvency there was a point when the interests of the creditors became paramount. From this point forward the directors are in danger of creating a personal liability for any additional loss suffered by the company and creditors.

Producing a test that defined the moment when creditor’s interest duty engaged has always been problematical for judges.

This issue reared its head again in the case of BTI AT Industries PLC v Sequana SA (“Sequana”) a decision of the Court of Appeal handed down on 6^th February 2019. The forum in this case was that of section 423 of the Insolvency Act 1986. This section of the Act permits the Court to review and overturn transactions designed to put assets beyond the reach of creditors.

Section 423 of Act provides a cause of action, under the heading of “Transactions defrauding creditors”.  This heading can be misleading as it is not in fact necessary to show a dishonest or fraudulent purpose in order to establish a claim under s423. 

Two requirements must be established:

1. The claimant must show that a person (a company or individual) has entered into a transaction at undervalue.  This will include an outright gift, or a transaction in which the consideration received was significantly less than that given.
2. The claimant must show that the transaction was entered into for the purpose of putting assets beyond the reach of creditors or future creditors, or otherwise prejudicing their interests.  The purpose need not be the sole purpose, or even the dominant purpose. It is sufficient to show that the purpose of avoiding creditors was at least one of the substantial purposes of the transaction.  It is not necessary that the creditors in question be in existence at the time the transaction is entered into.

The relief available to a successful claimant will be orders restoring the position to what it would have been but for the transaction.  The court’s discretion in terms of relief is wide, and can (subject to a “good faith” exception) include orders against any third party that has received a benefit as a result of the transaction. A very significant liability can result.

The Court of Appeal decided that the duty arises when the directors know or should know that the company is or is likely to become insolvent (which probably means cash flow insolvent). ‘Likely’, for these purposes, means more probable and not some lower test.

The fact that the facts were exceptional does not meant that the test will not apply in more routine circumstances. It will also apply in wrongful trading claims. This is a case with real practical consequences for directors in all companies in financial difficulty.

If you require legal assistance for dealing with insolvency please contact us by email djb@winstonsolicitors.co.uk or call 0113 218 5423.

Find out more about the basics of bankruptcy law and the functions of the trustee in bankruptcy.

What will happen to the bankrupt's home?

The bankrupt’s home is usually the most valuable asset in the bankrupt’s estate. It will automatically vest in the trustee immediately on his appointment without any conveyance, assignment or transfer.

The trustee has a duty to deal with the property for the benefit of the bankruptcy creditors. In an ideal world, the trustee’s interest is sold to a joint owner or family member. Unfortunately this is not always possible and the trustee has to apply to court for possession of the property so it can be sold.

Applying for an order for sale

When assessing whether to apply to the court for an order for sale, a trustee must consider the equity available in the bankrupt’s family home. The beneficial interest in a jointly owned property is not always split equally between the co-owners and the trustee must make enquiries as to the proportion of equity which vests on his/her appointment.

The IA 1986 limits the time in which the trustee can deal with the bankrupt’s home to a period of 3 years from the date of the insolvency order. If the trustee does not do so the property revests in the bankrupt.

The relevant section of IA 1986 is section 283A which applies only where property comprised in the bankrupt’s estate consists of an interest in a dwelling-house which at the date of the bankruptcy was the sole or principal residence of:

(a) the bankrupt,

(b) the bankrupt’s spouse, or

(c) a former spouse of the bankrupt

The trustee must take steps to deal with their interest in the bankrupt’s family home within 3 years of the bankruptcy order by:

(a) realising the interest (i.e. selling it to somebody else, often the joint owner or family member); or

(b) applying for an order for possession and sale; or

(c) applying for a charging order over the property for the value of the trustee’s interest; or

(d) entering into an agreement with the bankrupt regarding the interest.

If the trustee fails to take any steps to deal with their interest within 3 years, it falls out of the bankruptcy estate and revests in the bankrupt. This is sometimes known as the “use it or lose it” rule.

When does time begin to run?

Time will begin to run from the date of the bankruptcy order unless the trustee is not aware of the bankrupt’s interest in a property, (i.e. it was not disclosed by the bankrupt). In these circumstances the trustee will have 3 years from the date on which he/she became aware of it to deal with the interest. The 3-year period can be extended by a court order but only in exceptional circumstances.

Alternatives to an order for sale?

As an alternative to obtaining an order for sale an agreement may be reached whereby the bankrupt’s spouse, partner, a relative or a friend buys from the trustee the bankrupt’s beneficial interest in the property.

Another alternative would be for the trustee to agree to a charging order on the property; this would enable the bankrupt and his family to continue to live at the property. Any decision regarding the sale of the property ultimately rests with the trustee (and any mortgagee of the property) and not with the bankrupt. It is not unusual for a trustee to opt for a charging order in circumstances where he is not able to dispose of the bankrupt’s interest in the family home by the time he has completed the remainder of the administration of the estate.

If the trustee agrees to accept a Charging Order on the family home:

The maximum duration of a charging order is normally 12 years, but it can be renewed.

The charging order would be subject to the provisions of the Charging Orders Act 1979. Under this Act the court has discretion to impose conditions as to when the charge is to become enforceable (and whether interest will accrue).

When the property is eventually sold sometime in the future, the trustee would seize his share of the equity.

Rights of the bankrupt’s partner and children

In most bankruptcies the family home will be the main asset in the bankrupt's estate available for realisation and distribution among creditors. Since selling the home is likely to make the bankrupt and his family homeless, a conflict of interest arises between the needs of the family and the needs of the creditors. This may have which has difficult legal and financial implications.

If a Spouse/civil partner has a proprietary interest in the family home what is the position?

For example If the matrimonial home was originally conveyed into joint names of the bankrupt and his partner, only the bankrupt's interest in the property will automatically vest in the trustee. That interest will have to be identified.

The spouse/partner will retain his/her own beneficial interest in the property and will in law be known as “a trustee for sale”. If he/she refuses to sell the property, the trustee in bankruptcy must apply to the court for an Order of Sale.

If and until that order is made the partner has a legal right to occupy the property because they have a beneficial interest under a trust for sale which has not yet been determined by the court.

If an order for possession and sale is made by the court and the property is eventually sold, the trustee can only take the bankrupt's share of the proceeds of sale. The trustee could only claim the partner’s share if he/she can prove to the satisfaction of the court, that the original conveyance should be set aside as a transaction to defraud creditors.

If a Spouse/civil partner has no proprietary interest in the family home

Under section 30 of the Family Law Act 1996, a spouse who does not have any proprietary (i.e. legal) interest in the family home may be given rights of occupation, known as ‘matrimonial home rights’. These rights may be legally protected by registration.

In effect, a spouse’s matrimonial home rights are a legal charge on the estate which binds the trustee in bankruptcy. However the trustee may still obtain an order for possession and sale.

In considering an application the court must have regard to:

• the interest of the bankrupt's creditors;
• the conduct of the spouse, civil partner, former spouse or former civil partner in contributing to the bankruptcy;
• the needs and financial resources of the spouse, civil partner, former spouse or former civil partner;
• the needs of any children, and
• all the circumstances of the case other than the needs of the bankrupt.

What will happen to the bankrupt's home?

It is important to note that after one year (from the date of the bankruptcy order) the interests of the bankruptcy creditors will usually outweigh all other considerations, except in exceptional circumstances. In effect, after one year, the rights of bankruptcy creditors are considered paramount to any matrimonial home rights and the rights of occupation of the bankrupt unless the court considers the circumstances are truly “exceptional”.

According to the Insolvency Service, the court has considered certain types of family suffering as “exceptional circumstances” but generally the trend is to favour creditors’ rights without regard to ordinary family suffering.

From the perspective of the Bankrupt and his/her family it is better if these issues are planned for and dealt with as quickly as possible.

A final word of warning

• Bankruptcy and property law are complex and detailed legal advice based on the full facts of a case should be sought.  
• The information contained in this article are of a general nature and should not be taken as a substitute for proper legal advice.

If you require legal assistance for dealing with bankruptcy please email djb@winstonsolicitors.co.uk or call 0113 218 5423.

A person is insolvent if they cannot pay their debts as they fall due and/or because their liabilities are greater than their assets.

Who can petition for bankruptcy?

A petition for bankruptcy may be made by either:

• the debtor themselves; or
• by creditors who are owed more than £5,000 resulting from the debtor’s failure to comply with a court order or statutory demand.

What happens in bankruptcy?

Bankruptcy is the administration of the affairs of an insolvent individual, in the interests of their creditors. On the making of a bankruptcy order, following a bankruptcy petition or a debtor’s application (see above), the Official Receiver (OR) is appointed trustee.

The OR continues as trustee unless or until removed by the court. If there are valuable assets a private sector insolvency practitioner may be appointed trustee.

All assets that comprise the bankrupt’s estate will vest in the trustee subject to certain exceptions (e.g. tools necessary for the bankrupt’s business or domestic or personal items). The trustee’s statutory function is to get in, realise and distribute the bankrupt’s estate in accordance with the Insolvency Act 1986 (“IA 1986”).

This means realising the bankrupt’s assets and distributing the net sale proceeds to the creditors. The trustee’s professional costs are paid out of the bankrupt’s estate.

Automatic discharge from bankruptcy usually occurs after one year. Following discharge, the bankrupt is no longer liable for the balance of his/her debts.

Discharge from bankruptcy

• After discharge from bankruptcy (usually after one year) the bankrupt is released from his/her bankruptcy debts and any property they acquire after discharge is theirs to keep; the trustee cannot lay claim to it.
• However, property comprised in his/her estate at the time of the bankruptcy order remains under the control of the trustee.
• Discharge does not return ownership or control of bankruptcy assets to the bankrupt or prevent the trustee from carrying out any of his remaining functions in relation to the bankrupt’s estate.

Which assets can the trustee claim?

Once a bankruptcy order has been made by the court, the trustee is legally entitled to seize all assets in the bankrupt’s possession at the time of the bankruptcy order. His primary aim is to raise money to pay the bankrupt’s creditors.

The bankrupt’s assets are referred to as the “bankrupt’s estate”.

The bankrupt’s estate essentially consists of all the property which belongs to or is vested in the bankrupt at the start of his bankruptcy (i.e. the date on which the bankruptcy order is made). The IA 1986 defines the bankrupt’s estate as follows:

Section 283(1)

1. all property belonging to or vested in the bankrupt at the commencement of the bankruptcy; or
2. any property which is or is treated as being comprised in the estate by virtue of the provisions of the Act which relate to the insolvency of individuals.

Under insolvency legislation, the term “property” is very defined widely. It includes money, goods, things in action, and every description of property wherever situated and also obligations and every description of interest, whether present or future or vested or contingent, arising out of, or incidental to, property.

In addition to assets that are readily available, the trustee may also lay claim to “after-acquired property”, that is property acquired after the date of the bankruptcy order but before the date of discharge. (For example, the court may order that part of the bankrupt’s income from employment should be paid to the trustee.)

The trustee may also claim any “future and contingent interests” the bankrupt may hold (i.e. an interest which is uncertain, either as to the person who will enjoy it in possession or as to the event on which it will arise), provided they exist as “proprietary interests” at the date of the bankruptcy. (For example, an interest in a life policy.)

If the bankrupt has a “beneficial interest” in a property, whether freehold or leasehold (i.e. an interest in the proceeds of sale of the property) this interest will generally pass to the trustee for the benefit of the creditors. If the bankrupt jointly owns the property (perhaps with a spouse or partner) the beneficial interest is usually an equal share of the value (unless specified otherwise in the original conveyance or transfer document).  If the property has been mortgaged, the mortgage company has first claim on any proceeds of sale. Therefore, the bankrupt’s beneficial interest is calculated after deducting any loans secured against the property. In effect, the property passes to the trustee subject to the mortgagee’s interest and subject to the mortgagee’s right to take possession even after the bankruptcy and to exercise all the other rights of a mortgagee (including the right of sale)

Therefore the trustee will realise the bankrupts interest for the benefit of creditors even if the bankrupt becomes homeless as a result.

Should you require legal assistance for dealing with bankruptcy please call us on 0113 218 5423 or email at djb@winstonsolicitors.co.uk.