When is a dividend unlawful?

Publication November 2016


In BTI 2014 LLC v Sequana & Ors [2016] EWHC 1686 (Ch), a case that will be of interest for company directors, the Chancery Division of the High Court addressed questions of corporate governance, the justification for capital reductions, the validity of dividend payments and the role of a company’s directors in such matters.


The company in question, Windward Prospects Limited (Windward), was responsible for indemnifying the principal claimant, B.A.T. Industries PLC (BAT), in respect of certain potential liabilities. BAT had found itself facing the prospect of a substantial US pollution liability and although it had been under the impression that Windward was sufficiently capitalised to discharge its obligations, this was no longer the case.

In December 2008 and May 2009, the directors of Windward had resolved to pay Windward’s parent company and sole shareholder, Sequana S.A. (Sequana), two dividends with a total value of approximately €580 million. These dividends were paid following a reduction in Windward’s capital carried out under section 642 of the Companies Act 2006 on the basis of solvency statements from Windward’s directors (the “CA 2006”).

All of the directors of Windward at the relevant time were named as defendants to BAT’s claim. Their decision to authorise the dividends was called into question, on grounds which included claims that they had acted in breach of their duty to promote the success of the company under section 172 of the CA 2006, and that they acted with the intention of defrauding Windward’s creditors under section 423 of the Insolvency Act 1986 (the “IA 1986”). These allegations were made even though the directors appear to have acted with the benefit of advice from respected solicitors and accountants.

If Part 23 of the CA 2006 (which deals with distributions by companies) – or, for that matter, section 423 of the IA 1986 – had been contravened, the strong likelihood is that Sequana would have been required to surrender some or all of the benefit of the considerable dividends it had received from Windward.

Although the background to this case is complex, the judgment addresses some important legal questions of corporate governance and the role and duty of company directors.

The Lower Fox River

The case had its origins in Wisconsin where, for a period of approximately twenty years until the early 1970s, paper recycling mills discharged highly toxic polychlorinated biphenyls (PCBs) into the Lower Fox River. In the 1990s, a number of companies were identified as ‘potentially responsible parties’ (PRPs) by the US Environmental Protection Agency (the “EPA”) under the Comprehensive Environmental Response Compensation and Liability Act, commonly known as “CERCLA”. As such, the companies faced strict liability on a joint and several basis for the costs of cleaning up the Lower Fox River.

Among those identified as PRPs was a company called Appleton Papers Inc (API). API was given this designation because in 1978, it acquired a paper business whose practice had been to create carbonless copy paper by coating paper with an emulsion containing PCBs. At the time of the acquisition, API was a wholly owned subsidiary of BAT,

When API acquired the paper business in 1978 it had agreed to indemnify the previous owner against any environmental liabilities; a historic liability which therefore passed to BAT. However, in 1990, BAT demerged API. At that point, BAT was itself indemnified by API and its new holding company; the entity that was later to become Windward. In 2000, that same entity was acquired by Sequana. In 2001, API was sold by Sequana, but on the basis that all liability in respect of the Lower Fox River stayed with Windward.

By 2008, Windward had ceased to be a trading company and had become a vehicle for meeting Lower Fox River pollution liabilities. There was also a large receivable on Windward’s balance sheet owed to it by Sequana.

The evolution of API/Windward’s Lower Fox River exposure

In the early and mid-2000s, there was a degree of disagreement between API, Windward and the original owner of the paper business as to the extent and scope of the indemnities which had been given and received. In short, Windward was liable to indemnify BAT against its own liability to indemnify the original seller. In order to meet that liability, Windward had however been assigned the benefit of a number of historic insurance policies purporting to provide coverage to API, and a further policy which had been specifically purchased in order to meet Lower Fox River pollution liabilities, which was referred to as the “Maris Policy”.

In the years leading up to 2008, attempts were made by the EPA and the PRPs to agree the scope and cost of the remediation works needed to restore the Lower Fox River and the level of contribution that was to be required from each PRP. By the time of the first dividend payment, API’s contribution had not been agreed.

At the start of 2008 therefore, the level of API’s contribution to the clean-up costs (and hence Windward’s) was uncertain. While it had initially been thought that the Maris Policy would be sufficient to cover Windward’s exposure, by this time Windward was carrying a provision in its accounts against future Lower Fox River liabilities with a value of around £50 million.

The 2008 and 2009 dividends

Ordinarily, it would be entirely proper for a substantial inter-company receivable between a parent company and a non-trading subsidiary to be removed. This can be effected by way of a reduction in the subsidiary’s capital (by virtue of section 642 and Part 23 of the CA 2006).

However, in the case of the Windward/Sequana receivable (which by 2005 stood at over £450 million), the position was complicated by the fact that the Lower Fox River exposure was very difficult to ascertain.

In 2008, the directors of Windward resolved to undertake the exercise of working out how much money could be taken out by way of dividend to Sequana. In consultation with various professional advisers and consultants, the directors took steps to ascertain the exposure net of the Maris Policy based on current expectations as to the various components of the exposure, arriving at a provision of approximately €60 million. On that basis, the directors resolved at a meeting in December 2008 (based on interim accounts) to reduce the company’s share capital and pay a dividend of around €440 million, leaving an outstanding inter-company debt of around €140 million.

Following the December 2008 dividend, Windward and its advisers focused on a US Supreme Court decision relating to CERCLA which was taken to suggest that API’s share of the liability could be significantly reduced. This expectation was reflected in Windward’s audited final accounts for the year ended December 2008 which reduced the provision to zero. This in turn created additional distributable reserves and, in consequence, a further dividend of approximately €130 million was paid to Sequana in May 2009. Very shortly afterwards, Windward was sold, thereby removing any exposure to the Lower Fox River from Sequana.

In these proceedings, BAT challenged the payment of the two dividends on a number of grounds, all of which involved the Court assessing what the directors knew and thought in December 2008 and May 2009. While the Court was at pains to point out that it had shielded its eyes from subsequent events in order to avoid its assessment being coloured by hindsight, it is to be presumed that Windward’s share of the Lower Fox River clean-up costs have exceeded, or will exceed, the sums available to Windward from the historic insurance policies and the Maris Policy (hence the need for these proceedings).

The ‘Could Not’ claims: did the dividends contravene Part 23 of the CA 2006?

The first ground on which BAT challenged the dividends was that they contravened Part 23 of the CA 2006 and, accordingly, that they were capable of being clawed back under section 847 of the CA 2006. This was said to be because the annual accounts used to justify the May 2009 dividend were not ‘properly prepared’ in accordance with section 837(2) of the CA 2006, and because the interim accounts on which the December 2008 dividend relied did not enable a reasonable judgment to be made as to the amounts of the items on which the justification of the dividend depended.

Three aspects of both sets of accounts were challenged. First, it was said that the capital reduction which preceded the December 2009 dividend was invalid because it did not comply with the relevant legislation. Second, it was said that the accounts made inadequate provision for the Lower Fox River liability. Third, it was also said that the accounts failed to give adequate disclosure about Windward’s contingent liabilities in a technical accounting sense.

The Court rejected all three challenges to the accounts.

  • As regards the capital reduction, the Court was required to construe the underlying provisions of the CA 2006 (sections 642 to 644) in order to determine how a company’s directors are required to go about the task of a reduction in capital which is supported by a solvency statement. Amongst other issues, it was held (importantly) that the test to be applied when determining if a director has correctly formed the opinion that there is no ground on which the company could be unable to pay its debts following the proposed capital reduction was, simply, “to look at the situation of the company at the date of the statement and, taking into account contingent or prospective liabilities, form an opinion as to whether the company is able to pay its debts” regardless of whether the opinion so formed was reasonable. In light of the facts, the capital reduction was held to be effective.
  • As regards the adequacy of the Lower Fox River provision, the question was whether the accounts gave a “true and fair view” of the state of affairs of the company for the purpose of section 226A of the CA 2006, by reference to the relevant accounting standards. This entailed a careful review of the calculations which underpinned the two sets of accounts but the particular features of the calculations (and supporting judgements) which BAT complained about were upheld.
  • As for the alleged lack of disclosure in the accounts about contingent liabilities, a key question was whether the accounts should have made some disclosure in relation to another PCB pollution site, the Kalamazoo River in Michigan. However, the Court held that there was no breach of the applicable accounting standards arising from the absence of any such disclosure and, at a more general level, that the absence of disclosure in both accounts did not result in the distributions contravening Part 23 of the CA 2006.

The ‘Should Not’ claims: did the directors breach their fiduciary duties under sections 171 to 174 of the CA 2006?

The second ground of challenge was that, in any event, the Windward directors acted in breach of their duties under the CA 2006 by declaring dividends of the distributable reserves, on the basis that the directors were aware that the estimate of Windward’s liability was surrounded by great uncertainty and there was a risk that the liability would prove much greater than the estimate.

Specifically, BAT alleged that the Windward directors’ actions were in breach of their duty under section 172 of the CA 2006 to promote the success of the company by acting in the interests of the company’s creditors, which duty had arisen by the time of the dividends.

Therefore, the question to be answered was whether the creditors’ interest duty had arisen at the time of the dividends, in the sense laid down in the authorities that Windward was “on the verge of insolvency or of doubtful insolvency, or as being in a precarious or parlous financial state”. Taking all of the factors into account, the Court decided that Windward was not.

The claim under Section 423 of the IA 1986

BAT also claimed in its own right against Sequana under Section 423 of the IA 1986, alleging that the two dividends also amounted to transactions entered into at an undervalue for the dominant purpose of putting assets beyond the reach of Windward’s main creditor, BAT.

Sequana’s first answer to this claim was that a dividend paid by a company to its shareholder was incapable of being characterised as a transaction for no consideration or at an undervalue. The Court rejected this submission, holding that the terms of section 423 were “deliberately wide”.

Next, Sequana argued that the directors of Windward did not have the section 423 purpose in relation to either dividend. However, while the Court was prepared to accept that submission as to the December 2008 dividend, it found for BAT on the May 2009 dividend. This was on the basis that the May 2009 dividend was undertaken with the intention of putting assets beyond the reach of BAT in the event that the Maris and historic insurance policies were not enough to meet the indemnity liability.

Finally, the Court rejected Sequana’s further defence that it had changed position by selling Windward and losing control of the Lower Fox River litigation.

Having found that the section 423 claim succeeded to an extent, it was agreed that the Court should not identify the remedy, as this depended on events in respect of the Lower Fox River post May 2009. However, the judge indicated that she did not simply have in mind that the May 2009 dividend would be repaid.


It is hopefully apparent, even from this brief summary, that this was a factually and legally complex case which raised a number of issues of significance for company directors and those otherwise involved in capital reductions or decisions to pay dividends.

Legally, the case is interesting because it considered a number of issues relating to the construction and application of provisions of the CA 2006 on which there was previously no authority (in connection with capital reductions in particular). It also demonstrates the difficult considerations which come into play for directors when assessing the lawfulness of a dividend, where the company making the dividend is faced with substantial contingent liabilities.
As this case shows, even where care is taken, it is difficult for directors to exercise their powers in this area appropriately. Moreover, the case shows that in this situation a creditor may still have a remedy under the IA 1986, even if the company making the dividend does not have a remedy under the CA 2006.

It is also worth noting that the proceedings against Sequana and the Windward directors appear to have been the culmination of a lengthy process. Based on published judgments, this matter first came before the Courts in BAT Industries Plc v Windward Prospects Ltd & Anor [2013] EWHC 4087 (Comm), when API applied to set aside an order permitting service of proceedings out of the jurisdiction. It appears that those proceedings concerned the scope and extent of Windward’s and API’s collective obligations to indemnify BAT, which were in issue at the time. Shortly after the hearing in that case, BAT successfully applied for a receiver to be appointed over Windward’s claims against Sequana in BAT Industries Plc v Windward Prospects Ltd [2013] EWHC 3612 (Comm) in order to commence proceedings and protect the limitation position. It seems reasonable to infer that Windward subsequently accepted its indemnity obligations as to BAT and that the receiver assigned Windward’s claims against Sequana to BAT. A lengthy campaign of litigation and related steps had therefore been required in order for BAT to get to the point at which it could attempt to claw back or ring-fence the dividends.

It is understood that an appeal is pending. If, on appeal, it is found that the dividends did contravene Part 23, we may also find out the nature and basis of the relief for a contravention of this type – an issue which it was unnecessary to decide at first instance.

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