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 6th 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:
- 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.
- 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.