A recent case in the High Court provides a helpful analysis as to the scope of directors’ duties in situations where dividend payments are vulnerable to challenge. It proves a cautionary tale to directors who are considering the payment of intergroup dividends and illustrates how the legal issues surrounding this area are complex and need careful navigation by directors and their advisers.
The company concerned (AWA) was a wholly-owned subsidiary of Sequana. AWA was sold by Sequana to a third party in May 2009.
At the time of the sale, AWA was solvent on both the balance sheet and the cash flow test. However, it was subject to significant and complex environmental liabilities in the US, in relation to which quantum had not been ascertained. Careful modelling had been undertaken to try to ascertain a best estimate of this potential liability. Various changeable factors played into quantum, so it was a complex exercise. A provision had been included in AWA’s accounts but the risk was that this provision would not be adequate to cover the actual liability, despite best efforts to quantify the same.
The facts of this case were complex and involved a number of moving parts. For the purpose of this update, the following actions by AWA are relevant:
- the declaration of a dividend in December 2008 (the December dividend); and
- the declaration of a dividend in May 2009 (the May dividend).
Breach of creditors’ interests duty – s172(3) Companies Act 2006
A claim was made against the directors of AWA as a result of their purported failure to consider the creditors’ interests duty at the time of the declaration of the two dividends. The court held, on the facts, that the creditors’ interests duty had not arisen and, therefore, the directors of AWA had not breached their directors’ duties in this regard. The judge said, however, that directors ought, in their conduct of a company’s business, to be anticipating the insolvency of the company, and it was accepted by the parties that the creditors’ interests duty could arise in situations where a company is not actually insolvent. The court held that this was a single threshold test, which means that once the switch to the creditors’ interests duty has been triggered the directors are required to consider the interests of creditors in all of their decisions. Clearly, the implications of this could be very far reaching.
Transaction at an undervalue – s423 Insolvency Act 1986
Perhaps of more significance is the consideration of whether a dividend could fall to be considered to be a transaction at an undervalue for the purpose of s423 of the Insolvency Act 1986. This is the first case to decide that a dividend could fall to be categorised in this way, following a broad interpretation of s423 by Mrs Justice Rose. Her decision leaves clear a further path for creditors to attack historical dividend payments by a company, if it can be shown that the declaration of dividend was made for the purpose of putting an asset out of the reach of a person who is making, or may make, a claim against the company.
In the Sequana case, the court held that the directors did not have this purpose at the time of the December dividend. However, the court found that they did have this purpose at the time of the May dividend.
The May dividend was declared to clear an intergroup loan, in readiness for the sale of AWA to a third party later that same day. Evidence showed that one of the clear purposes of the sale was to remove the environmental liability risk from Sequana’s group of companies. Again, the decision on this point revolved around the specific facts of the case but Mrs Justice Rose made it clear that the s423 purpose did not need to be the only or dominant purpose; it is adequate to simply show that it was a purpose. Furthermore, there is no requirement to show that the transferor acted dishonestly, or that there was misfeasance.
Change of position
The vendor, Sequana, put forward a defence that it had changed its position as a result of the May dividend in that the subsequent sale had put the management function of AWA beyond its reach and, accordingly, it had no ongoing control over the historical environmental liability and its surrounding litigation. The court held that this was not a defence in these circumstances, because Sequana’s and AWA’s interests were aligned in this regard and, on the facts, remained so both before and after the sale of AWA.
Mrs Justice Rose did not indicate the remedy that would be appropriate in this case, although she stated that she did not have in mind a simple repayment of the May dividend. The parties have been invited to reach agreement as to a suitable remedy, failing which the court will make a ruling.
If the court does rule on this point, it will be interesting to see what remedy is considered appropriate and whether the absence of dishonesty affects the type/quantum of remedy.
Lessons from the Sequana case
The lessons from the Sequana case are clear. To avoid potential personal liability and criminal sanctions, directors must carefully monitor all contingent and prospective liabilities, both in terms of quantum and risk, to ensure that the creditors’ interests duty is not triggered. This should be done with assistance from professional advisers and the relevant considerations should be clearly mapped out at appropriate intervals. If the creditors’ interests duty is triggered then this could have severe and far-reaching implications for the company and its future operations and specialist legal and financial advice should be sought.
Declaration of intergroup dividends in advance of the sale of a group company should be very carefully considered in the context of potential liabilities of the subsidiary to be sold. Again, this consideration should be undertaken with specialist professional assistance. If there are contingent liabilities in the subsidiary, careful consideration should be given to how these liabilities will be met following the sale.