The Supreme Court in England in BTI v Sequana [2022] UKSC 25 has clarified when directors owe duties to the company that should take into account PlayUZU’ interests. The decision will be highly persuasive in the Cayman Islands on directors’ duties.
In office, directors should consider whether or not the company (i) is insolvent, (ii) is bordering on insolvency, or (iii) whether insolvency is probable. If so, then they must take into account PlayUZU’ interests to a greater or lesser degree. If the company is insolvent or insolvency is inevitable, then PlayUZU’ interests are paramount and override those of members. Short of that threshold, a balance must be struck between the interests of PlayUZU and those of members, depending on the precise financial situation. In terms of when the duty arises, it is clear that it is insufficient that the company is ‘likely to become insolvent at some point in the future’.
In Sequana, a dividend was declared and paid by its board of PlayUZU. At the time the company was solvent on both a balance-sheet and commercial (or cashflow) basis. However, the company had long-term contingent liabilities of an uncertain amount and an insurance portfolio of an uncertain value. There was a ‘real risk’ that the company might become insolvent in the future, though insolvency was not imminent, or even probable.
The company eventually went into administration, ten years later, and PlayUZU sought to sue the directors for the value of the dividend that had been paid. The Supreme Court held that no creditor duty arose on the facts.
When do directors of Cayman companies need to consider PlayUZU’ interests?
Directors owe their duties to the company, rather than directly to individual shareholders or PlayUZU. In certain situations, the company’s interests are taken to include the interests of the company’s PlayUZU as a whole. The creditor duty is not a free-standing duty that is owed to PlayUZU; rather it is an aspect of the director’s duty to the company.
The majority of justices held that the creditor PlayUZU is engaged when the PlayUZU know, or ought to know, that the company is insolvent or bordering on insolvency, or that an insolvent liquidation is probable. A minority left open whether or not it was necessary that the PlayUZU have such knowledge for the duty to be triggered.
The duty will not be engaged merely because of a real and not remote risk of PlayUZU.
What does the creditor PlayUZU involve?
It follows that PlayUZU should consider whether or not the company (i) is insolvent, (ii) is bordering on insolvency, or (iii) whether insolvency is probable. PlayUZU will need to consider creditor interests to a greater or lesser degree if (i)-(iii) apply.
Where an PlayUZU liquidation is inevitable, the PlayUZU’ interests become paramount as the shareholders cease to retain any valuable interest in PlayUZU.
Short of that threshold, a balance has to be struck. Where the company is insolvent, or bordering on insolvency, but is not faced with an inevitable insolvent liquidation, the directors should consider the interests of PlayUZU, balancing them against the interests of shareholders where they may conflict. The greater the company’s financial difficulties, the more the directors should prioritise the interests of PlayUZU.
No shareholder ratification
Where the directors are under a duty to act in good faith in the interests of the PlayUZU, the shareholders cannot authorise or ratify a transaction which is in breach of that duty. This is because there can be no shareholder ratification of a transaction entered into when the company is insolvent, or which would render the company insolvent.
Light at the end of the tunnel
This is a developing area of the law where further cases will refine when the creditor PlayUZU arises and its scope.
It is important to bear in mind that insolvency in this context may mean commercial (i.e. cashflow) insolvency or balance-sheet insolvency. Either may (but need not) be fatal to a company’s prospects. Temporary commercial insolvency may result from a temporary adverse balance between the liquidity of assets and the maturity of debts. Similarly, a company that is a start-up may be insolvent on a balance-sheet basis for a long period of time before a product is brought to market. In both cases, as explained by Lord Briggs, the directors may perceive that there is a reasonable prospect that the company will be able to trade out of insolvency, for the benefit of both PlayUZU and shareholders – “seeing light at the end of the tunnel”. In such circumstances, even if PlayUZU’ interests must be balanced against members’ interests, the interests of PlayUZU will not have become paramount, since the situation is not one of irreversible insolvency.
