Key legal and regulatory developments driving and shaping M&A
The English Court of Appeal has confirmed that:
Therefore, when directors are considering paying a dividend, it is not sufficient to consider only whether there are distributable profits available for the purpose such that the proposed dividend complies with Part 23 of the Companies Act. The board should go on to consider if the dividend is being paid for proper purposes and, if the dividend would result in the company being, or likely to become, insolvent, the interests of creditors need to be considered.
In the wake of the collapse of BHS and Carillion after having paid substantial dividends to shareholders, the reform of corporate dividends is the subject of an ongoing UK government consultation and is likely to remain high on the political agenda. In the meantime, the English courts continue to scrutinise dividends within the existing legal framework of company and insolvency law. In the recent case BTI 2014 LLC v Sequana S.A  EWCA Civ 112, the Court of Appeal provided guidance on the potential for recovery of dividend payments under section 423 of the Insolvency Act 1986 (the "Act") ("transactions defrauding creditors") and the point in time at which a duty arises on directors to consider the interests of the company's creditors.
In summary, the case concerned dividends paid by Arjo Wiggins Appleton Limited ("AWA") to its parent company, Sequana S.A. ("Sequana"), in 2008 and 2009. At the time the dividends were paid, AWA was not trading. It had one (contingent) liability, which arose under an indemnity in respect of the potential clean-up costs and damages arising out of the pollution of the Lower Fox River in the US. In accordance with the relevant statutory requirements, the directors estimated the potential liabilities under the indemnity for the purposes of making provisions in Sequana's accounts. The High Court found that the provisions were properly made and the accounts were properly prepared. Its assets included certain insurance policies and a debt (€585m) owed by Sequana, its parent company. The dividends were paid by way of set-off against that intercompany debt, reducing the value of the debt to around €3m.
It was alleged by BTI 2014 LLC ("BTI") that the dividends were: (a) unlawful in that they failed to comply with Part 23 of the Companies Act 2006 (the "could not pay" claim), (b) paid in breach of the directors' duty to have regard to the interests of creditors (the "should not pay" claim) and (c) liable to be set aside under section 423 of the Act.
At first instance, the High Court dismissed all claims in respect of the 2008 dividend. In respect of the 2009 dividend, the court dismissed the could not pay and should not pay claims but gave judgment in favour of BTI in respect of the section 423 claim and, in broad terms, ordered Sequana to repay to BTI, or meet in future (as the case may be), the environmental clean-up costs, up to the amount of the 2009 dividend (€135m).
Sequana appealed against the judgment under section 423 and BTI cross-appealed against the dismissal of the should not pay claim (but not the could not pay claim). The position on appeal, therefore, was that the dividend in question was accepted by all parties as having been compliant with Part 23 of the Companies Act 2006.
Section 423 of the Act provides a statutory cause of action where a person has entered into a transaction at an undervalue in order to try to put assets beyond the reach of creditors. The section provides that if a person enters into a transaction at an undervalue (which includes a gift) for the purpose of putting assets beyond the reach of a person who is making, or may at some time make, a claim against him or otherwise prejudicing the interests of such a person in relation to the claim which he is making or may make (the "statutory purpose") then the court can reverse the transaction and take such other measures to protect the interests of any victims as it deems fit.
Sequana's appeal rested on two submissions: first, that a dividend was not a "transaction at an undervalue" within section 423 and, secondly, that the requisite statutory purpose was not present.
Can a dividend be a "transaction at an undervalue"?
The Court answered this question in the affirmative.
First it held that a dividend is not a gift. David Richards LJ stated: "Dividends are both commercially and legally a return on the investment. It would be startling to categorise dividends as gifts made by a company to its shareholders and there is no reason to think that parliament intended the word "gift" to carry anything other than its usual meaning."
But the Court held that a dividend is a transaction for no consideration and therefore qualifies as a "transaction at an undervalue" within section 423 without the need to undertake a valuation exercise. The fact that a dividend is paid in respect of rights conferred on the shareholders by the terms of issue of the shares or the terms of a company's articles, does not alone constitute sufficient or indeed any consideration. David Richards LJ held: "In my judgment, it cannot be said that the company receives consideration for the payment of a dividend. It is not enough to say that the dividend is paid in accordance with the rights attached to the shares, where those rights are quite different from, for example, the right to receive interest payments on loan notes or the right to be considered for bonus declarations on a with-profits fund. If and when a company pays a dividend to shareholders, the terms of the dividend do not provide for the company to receive any consideration nor will it receive any consideration."
As to the meaning of the word "transaction", the Court held that whilst a "transaction" will normally include mutual dealing, the wording of section 423 is such that it can also include unilateral acts, hence gifts are expressly within the scope of section 423. In any event, the court held that it would be wrong to regard a dividend as a wholly unilateral act since it is paid pursuant to, and in accordance with, the rights of shareholders.
The Court then turned to consider the statutory purpose. This is a question of fact. A court must look at the subjective intention of the person entering into the transaction – in this case AWA (or more precisely its directors). The statutory purpose need not be the sole purpose or even the dominant purpose: it is sufficient if it is a purpose (as opposed to a mere consequence). Furthermore, it is not necessary to show that the transaction was motivated by ill will towards a third party, nor is there any requirement to show dishonesty (despite section 423 having the word "fraud" in its title).
Having reviewed evidence presented at trial, the Court of Appeal upheld the High Court's finding that the purpose of the dividend was to put the debt due from Sequana to AWA out of the reach of the creditors of AWA in the event that AWA's insurance policies proved to be inadequate to pay AWA's liability for clean-up costs. David Richards LJ held that: "The purpose was to eliminate the risk that Sequana would be responsible for AWA's liabilities if the [insurance policies] proved to be inadequate. That risk could be eliminated only if two steps were taken: elimination of the Sequana debt, thereby ending any legal obligation on the part of Sequana, and a disposal of AWA, thereby ending any moral obligation stemming from Sequana's policy of supporting its subsidiaries. The elimination of the Sequana debt removed the legal risk by removing the debt as an asset of AWA and so putting it beyond the reach of those who might make claims against AWA."
BTI appealed against the High Court's dismissal of its claim that the directors of AWA had breached their duty to AWA by authorising the 2009 dividend. BTI submitted that the directors of AWA owed a duty to consider the interests of creditors in any case where a proposal involved a real, as opposed to a remote, risk to creditors.
Having conducted a thorough review of the English and Commonwealth authorities, the Court of Appeal upheld the High Court's rejection of this submission and noted that, if correct, it would have a "chilling effect on entrepreneurial activity…" Nevertheless, the Court of Appeal held that the duty was not confined to situations where there was actual, established insolvency: it can arise at some point before that. David Richards LJ put it as follows: "The precise moment at which a company becomes insolvent is often difficult to pinpoint. Insolvency may occur suddenly but equally the descent into insolvency may be more gradual. The qualified way in which judges have expressed the trigger…reflects that the directors may often not know, nor be expected to know, that the company is actually insolvent until some time after it has occurred. For this reason, among others, a test falling short of insolvency is justified."
From the various formulations of the trigger point to be found in the authorities, the Court concluded that the duty arises "when the directors know or should know that the company is or is likely to become insolvent…" The court held that, in this context, "likely" means "probable".
The Court declined to express a view on the question of whether, from this point, the creditors interests should take priority over the interests of shareholders and other stakeholders as this question did not arise on the facts. Nevertheless, the Court expressed the view that "where the directors know or ought to know that the company is presently and actually insolvent, it is hard to see that creditors' interests could be anything but paramount."
Applying this test to the facts, the court held that at the time of the 2009 dividend the duty to consider the interests of creditors had not been triggered. The estimate of the contingent liability used for the accounts and for determining AWA's distributable profits had not been challenged by BTI and on that basis the contingent liability (with or without the dividend) could not be said to be likely to render AWA insolvent.
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