Sequana and Directors’ Duties: The Sequel

The first anniversary of the Supreme Court’s judgment in BTI 2014 LLC v. Sequana S.A. [2022] UKSC 25 has not long passed and so too therefore do we mark a year on from what was eagerly anticipated by practitioners to be clear-cut guidance as to what point on the insolvency spectrum the now commonly referred to ‘Creditor Duty’ is engaged.

We refer you back to our previous blog Sequana: Syntax, Semantics and the Sliding Scale for our commentary of the judgment when it was handed down.

The long-awaited and much discussed Supreme Court decision confirmed that there is, in effect, a sliding scale of correlation between a company’s solvency and the degree to which the Creditor Duty applies – in summary, when the risk of insolvency is too remote, so too is the Creditor Duty; and as the risk of insolvency becomes more acute, so too does the Creditor Duty.

The Supreme Court also assisted in placing the various references to a company’s financial distress/insolvency onto the helpfully curated sliding scale, with:

• a “real and not remote risk of insolvency” falling short of the trigger point;
• the duty becoming more acute as a company progresses through the following states of insolvency: “insolvency is imminent”, “borderline insolvency”, “cash flow or balance sheet insolvent”, “insolvent liquidation or administration being probable”; and
• the Creditor Duty becoming paramount when there is “no prospect of avoiding liquidation or administration”.

What the Supreme Court failed to establish (perhaps because it is just too difficult to put into a rigid “one-size-fits-all” law) is the practical or quantifiable equivalent of these stages of insolvency that would provide directors with the much needed certainty to determine whether a business continues to be viable. And so a number of questions remained post-Sequana.

We consider the impact of Sequana and look at how the Creditor Duty has since developed to see what, if any, further clarification or guidance can be gleaned.

Hunt v Singh [2023] EWHC 1784

Facts

Hunt v Singh is the most notable case post Sequana when considering the application of the Creditor Duty – particularly in the context of whether the duty arises in circumstances where the company is insolvent, but the directors wrongly believed the liability causing the company’s insolvency had been avoided or was otherwise disputed.

In brief, this case concerned a company, Marylebone Warwick Balfour Management Limited (the “Company”), that operated a “conditional share scheme” designed to enable staff to receive payments – structured as non-contractual gratuitous bonuses – without the Company incurring liabilities to HMRC by way of PAYE or NIC contributions (the “Scheme”). The Scheme was recommended to the Company by its accountants at the time. The Company entered into the Scheme in 2002 and operated it until 2010.

The Scheme was notified to HMRC in May 2003. On 4 June 2004, HMRC notified an enquiry into the Company’s return to 30 June 2002. On 20 July 2004, HMRC made further enquiries, and set out its position that if the payments under the Scheme were in reality earnings, then NIC and PAYE would be payable together with interest.

In September 2005, HMRC made a market-wide offer to participants in such schemes, including the Company. This was relayed to the Company in a letter from the Company’s accountants on 23 November 2005. The letter notified the Company that HMRC was minded to take a test case to the Special Commissioners for a formal ruling, but had decided to make an offer to all companies which, in essence, required the employing company to pay NIC contributions together with interest, with certain corporation tax relief being available. Attached to the accountant’s letter to the Company was a schedule which identified that the amount of NIC contributions for which the Company was liable (if HMRC’s challenge to the Scheme succeeded) up to that point, together with interest, was in excess of £3.65 million. The Company rejected the offer. The evidence before the court showed that by September 2005, when NIC and interest thereon payable to that date were factored in, the Company was already operating with a net deficit.

The Company’s accountants continued to advise the Company that the Scheme was “robust“, notwithstanding the actions of HMRC, such that the Scheme continued to operate until 2010 – resulting in payments to the directors and others of over £54 million.

It was not until the Court of Appeal judgment in PA Holdings Ltd v The Commissioners for Revenue & Customs [2011] (“PA Holdings”) in November 2011, where it was held that PA Holdings was, in fact, liable for both NIC and PAYE (plus interest) under a materially similar scheme, did the Company take steps to enter Creditors’ Voluntary Liquidation (“CVL”).

Proceedings brought by the liquidators

Following the Company’s entry into CVL on 14 May 2013, the liquidators brought claims against the former directors of the Company, which included claims under Section 212 of the Insolvency Act 1986 for breaching their statutory duties to the Company; specifically, the Creditor Duty.

At first instance, Insolvency and Companies Court Judge Prentis dismissed all of the claims finding that the Creditor Duty was not engaged, essentially, because the directors acted reasonably in taking advice from the Company’s accountants as to the merits of HMRC’s claim and had acted on that advice. The liquidator appealed as against Mr Singh only in respect of the claim to recover the amount received by him as a result of the breach of the Creditor Duty. Shortly after permission to appeal was granted, Mr Singh was made bankrupt on his own petition and he played no part in the appeal.

Appeal in the High Court

Hearing the appeal in the High Court, Mr Justice Zacaroli identified the principal question as:

• Following the decision of the Supreme Court in Sequana, when does a director’s duty to take into account the interests of creditors arise, in circumstances where the company is at the relevant time insolvent, but its insolvency is due to a tax liability which the directors believed at the relevant time had been avoided by a valid tax avoidance scheme entered into by the company.

A material distinction with the appeal was that in Sequana there was no doubt that at the time the relevant dividends were paid, the company was solvent, whereas in Hunt v Singh there was no doubt that the Company was in fact insolvent throughout the relevant period.

In allowing the liquidator’s appeal, Mr Justice Zacaroli held that, in cases where a liability is challenged, the Creditor Duty is in fact triggered if the directors “knew or ought to know that there was least a real prospect of the challenge failing”. The fact the Company disputed that anything was due to HMRC did not change the fact that it was insolvent: “A disputed liability is not a contingent liability”.

Notably, this threshold is different to the “real risk of insolvency” test which the Supreme Court rejected in Sequana.

Key takeaways

The appeal in Hunt v Singh has provided helpful guidance in relation to the Creditor Duty in circumstances where directors are aware of a claim which, if recognised in the company’s books, renders the company insolvent – confirming that “knowledge of a real risk that the company’s challenge to the claim may fail” triggers the Creditor Duty.

The law in this area will inevitably continue to develop as the High Court continues to interpret Sequana and apply its principles to different cases. However, for now, some of the key takeaways when considering when and if the Creditor Duty has arisen are as follows:

1. If the company is not insolvent and there is no real risk of cash-flow or balance sheet insolvency: the Creditor Duty is not engaged;
2. If the company is bordering on insolvency, but insolvency is not yet inevitable: the Creditor Duty is engaged. In these circumstances, directors should continually assess the position as creditors’ interests will have increasing importance as the prospects of actual insolvency increase;
3. If the company has a liability, which the directors challenge but, if unsuccessfully challenged, would render the company insolvent: the Creditor Duty is engaged where the directors know or ought to know that there is a real prospect of the challenge failing;
4. If the company has no prospect of avoiding administration or liquidation – the Creditor Duty is fully engaged, and directors must treat the interests of creditors as paramount and in priority to its members;
5. Finally, in Hunt v Singh, whilst Mr Singh had previously been a de jure director, he had resigned and, for the period in question (September 2005 to 2010), he was actually a de facto director: providing a stark reminder that breach of duty claims can also be pursued against de facto and shadow directors.

Our Restructuring and Insolvency team has considerable experience in advising businesses, directors and individuals facing financial distress. Should you require any assistance, please contact any one of our partners in the Restructuring & Insolvency team. We are experts in this field and are here to help.

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