Contentious insolvency update: section 423

The Court of Appeal has recently clarified the position on (a) whether section 423 of the Insolvency Act 1986 can apply to dividends, and (b) the circumstances in which the duty of directors to have to regard to the interests of creditors arises – BTI 2014 LLC v Sequana S.A. & Ors [2019] EWCA Civ 112.

On 6 February 2019, the Court of Appeal handed down judgment following appeals made against the decisions of Rose J in the High Court.

The facts of the case where as follows:-

a. As a result of a purchase of paper coating businesses, BAT Industries PLC (BAT) became liable for extensive pollution of the Lower Fox River in Winconsin USA, along with other parties, namely Arjo Wiggins Appleton Limited (AWA) (which was a wholly owned subsidiary of Sequana S.A. (Sequana)). BAT was indemnified by AWA for a proportion of the liability. A best estimate of the liability was placed on AWA’s accounts;

b. Sequana received two large dividend payments from AWA in 2008/2009, which effectively wiped out an intra-group debt of €585 million. These were paid despite the significant potential contingent liabilities;

c. BAT had set up a separate company for claims, namely BTI 2014 PLC (BTI). BAT and BTI challenged the dividend payments on the basis that (a) AWA’s accounts were incorrectly prepared, (b) there was a breach of fiduciary duty by AWA’s directors in making the dividends, and (c) the dividend payments were transactions defrauding creditors under section 423 Insolvency Act 1986.

The first instance decision of Rose J dismissed BTI’s claim for breach of duty, but upheld BAT’s claim under section 423. In relation to breach of duty, despite the long term liability on its balance sheet, AWA could not be described as ‘on the verge of insolvency’ or of ‘doubtful insolvency’, or as ‘being in a precarious or parlous financial state’.

The Appeal focused on two points:-

a. The first was the application of section 423 of the Insolvency Act 1986 to the payment of otherwise lawful dividends. The questions, in particular, were whether section 423 was capable as a matter of law of applying to the payment of such dividends and, if it was, whether on the facts of the case the dividend in question was paid with the requisite statutory purpose; and

b. The second issue concerned the duty of directors to have regard to the interests of creditors. In particular, when and in what circumstances did it arise, and does it ever arise when the directors are considering the payment of an otherwise lawful dividend.

The Court of Appeal dismissed the Appeal on both grounds:-

a. In relation to dividend payments under section 423, these were deemed as ‘transactions’ for the purposes of this section, such that the payment of dividends could be used for the purpose of putting assets beyond the reach of creditors. The assets were accordingly depleted by the payment of the dividend;

b. In relation to breach of duty, the duty to creditors is engaged “when the directors know or should know that the company is or is likely to become insolvent”. The Court of Appeal accordingly agreed with the High Court.

This case is of particular importance for office holders and directors as to when the duty of directors to consider the creditors interests is engaged. The case also provides clarity that dividend payments can be classed as a transaction and therefore claimable under section 423 Insolvency Act 1986. We understand, however, that there is an intention to appeal the decision to the Supreme Court.