In a recent case, the High Court has had one of its first opportunities to consider BTI v Sequana [2022] UKSC 25 (see our previous update here), in which the Supreme Court gave important guidance on the existence and scope of the duty of company directors to have regard to the interests of creditors (the so-called “creditor duty”, which arises in an insolvency scenario).
In Stephen John Hunt v Jagtar Singh [2023] EWHC 1784 (Ch), the court applied the Sequana guidance in the context of a liquidator’s claim against a director of a company which was said to be insolvent at the relevant time on the basis of a substantial (disputed) tax liability. The court acknowledged that one of the unresolved questions following Sequana is whether it is necessary to establish some form of knowledge (actual or constructive) of insolvency on the part of the directors for the so-called creditor duty to arise even where the company was, at the relevant time, actually insolvent or whether the fact of insolvency is sufficient to trigger the duty.
Proceeding on the assumption that some knowledge component is required, the judge held that where a company is faced with a claim to a current liability of such a size that its solvency is dependent on successfully challenging that claim, then the creditor duty arises:
“if the directors know or ought to know that there is at least a real prospect of the challenge failing”.
Accordingly, while uncertainty remains around the precise scope of the creditor duty, the judgment raises important considerations for directors in assessing their company’s solvency position, particularly those faced with so-called “bet-the-company” litigation or other potentially substantial liabilities.
Background
Marylebone Warwick Balfour Management Limited (“MWB”) implemented a conditional share scheme (the “Scheme”) on the understanding that the Scheme would allow it to make payments to its staff without MWB incurring tax liabilities. The facts were broadly as follows:
- The Scheme was operational from 2002 to August 2010, during which period HMRC sought to challenge the legitimacy of the tax treatment of schemes of this nature.
- In September 2005, HMRC made a market-wide offer to participants of such schemes, allowing them to make the tax payments in lieu of HMRC seeking to litigate the matter.
- MWB rejected that offer and continued to operate its Scheme. At that point, the quantum of the purported tax liability alone would have exceeded MWB’s assets, thereby calling into question MWB’s solvency. HMRC subsequently commenced proceedings against a number of companies, including MWB.
- In one of those cases, the first-tier tribunal found in favour of HMRC (which ruling was later upheld by the Court of Appeal: HMRC v PA Holdings Ltd [2011] EWCA Civ 1414). In view of this decision, MWB was advised by Counsel that it seemed overwhelmingly likely that its own defence would similarly fail.
- MWB was placed into voluntary liquidation with HMRC claiming overdue tax payments in the sum of £38,701,750. MWB’s liquidator brought claims against the former directors of MWB, including Mr Singh, alleging (amongst other things) breach of fiduciary duty, specifically the creditor duty.
ICC Judge Prentis, in the Insolvency and Companies List, dismissed the claim for breach of the creditor duty on the basis that the duty was not engaged. In the judge’s view, on the facts, the directors had acted reasonably in taking and acting on accountancy advice as to the treatment of HMRC’s claim and as to what provision, if any, should be made in MWB’s accounts for the accruing liabilities.
The liquidator appealed the decision as against Mr Singh alone to recover amounts he had received as a result of his alleged breach of the creditor duty. The appeal was limited to the period from September 2005 to 2010 (following HMRC’s market-wide offer until the Scheme ceased to be operational). One other relevant director had already settled the claim and another’s tenure fell outside the period covered by the appeal.
Shortly before the appeal hearing, Mr Singh was made bankrupt and told the court that, for a number of reasons, he was unable to attend, albeit that he was content for the appeal to proceed in his absence.
Decision
Zacaroli J allowed the liquidator’s appeal, finding that ICC Judge Prentis had erred in suggesting the creditor duty was not engaged. He remitted the case to be reconsidered, resisting an invitation by the liquidator to make subsequent findings as to breach.
Zacaroli J noted that the original hearing before ICC Judge Prentis had taken place prior to the seminal judgment in BTI v Sequana, in which the Supreme Court provided crucial guidance on the existence and scope of the creditor duty.
The Supreme Court in Sequana
In that case, there had been no dispute that the company in question had been solvent at the time the creditor duty was said to have arisen. However, the appellant had argued that a “real risk” of insolvency was sufficient to engage the duty.
There was no doubt among the majority in the Supreme Court as to the existence of the duty to have regard to the interests of creditors in certain circumstances. However, the Court was satisfied that those circumstances do not include where there is merely a real risk of insolvency. Rather, as Lord Briggs put it, the creditor duty is engaged where the directors know or ought to know that the company is insolvent or bordering on insolvency, or that an insolvent liquidation is probable. Although Lord Reed and Lady Arden agreed with the majority’s characterisation of the relevant threshold, they were prepared to leave open the question of whether knowledge on the part of the directors is an essential element of the test.
Returning to the instant case, therefore, Zacaroli J explained that the principal question raised in the appeal was:
“when, following the decision of the Supreme Court in [Sequana], 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 (wrongly, as it later turned out) believed at the relevant time had been avoided by a valid tax avoidance scheme…”
MWB’s solvency
As Zacaroli J observed, the focus in Sequana had been on the time before the company was actually insolvent. In contrast, he said, this case concerned a situation where there was “now no doubt that the Company was in fact insolvent… throughout the relevant period.” Indeed, the judge rejected the view that the tax liability in question, by virtue of being disputed, should be characterised as contingent: “The fact that the Company disputed that anything was due to HMRC does not change the fact that it was insolvent. A disputed liability is not a contingent liability”.
The judge drew on previous authority in this regard, namely Integral Memory PLC v Haines Watts [2012] EWHC 342 (Ch) where it was said, by Richard Sheldon QC sitting as a deputy High Court judge, that “a contingent liability is a liability which, by reason of something done by the person bound, may or may not arise depending on the happening of a future event.” Where an alleged tax liability has come before the courts, Mr Sheldon QC held, its existence is not contingent on HMRC succeeding or failing; rather “all the tribunal or court is deciding is whether or not there is an actual liability.”
The relevance of knowledge
Having determined that MWB had been actually insolvent at the relevant time, the judge went on to consider whether that is sufficient in itself to trigger the creditor duty, irrespective of a director’s state of knowledge as to the company’s insolvency. He observed that this had remained an open question following Sequana (notwithstanding the comments of Lord Briggs and others).
The judge acknowledged that, because Mr Singh did not take part in the appeal, he had heard no arguments contrary to those advanced on behalf of the liquidator. However, while he appeared to stop short of determining the point, he was nevertheless prepared to assume that some form of knowledge is required.
In Zacaroli J’s view, “where a company is faced with a claim to a current liability of such a size that its solvency is dependent on successfully challenging that claim, then the creditor duty arises if the directors know or ought to know that there is at least a real prospect of the challenge failing.”
In support of this conclusion, the judge drew on the reasoning in Sequana as to the existence of the creditor duty: where the company is insolvent there is a shift in economic interests from shareholders to creditors (either alongside or to the exclusion of shareholders depending on how much “light there is at the end of the tunnel” as it was put in the Supreme Court). If it turns out, the judge said, that the company was in fact insolvent at the relevant time, then this shift has already occurred. Accordingly, if directors are wrong in their assessment of the risk of the company actually being insolvent then, he said, their actions and decisions were in fact impacting the company’s creditors at that time. Knowledge of a real risk that the company’s challenge to the claim may fail therefore “equates to knowledge that it is the creditors that are potentially currently affected by the directors’ actions and decisions.”
Comment
The full impact of this judgment remains to be seen, particularly as given Mr Singh’s bankruptcy, it is not certain whether the remaining issues in this case will be further considered.
On the question of MWB’s insolvency, the High Court in this case was inevitably only focussed on the nature of the specific liability in question – here a tax liability – as to which the relevant principles are well-trodden. The judge’s analysis of whether the liability should be characterised as actual or contingent was understandably limited for that reason (and also, as noted, unchallenged). The judge’s comments should not necessarily be read as reflecting a point of universal application to all disputed claims, of whatever nature. Each claim will need to be considered on its own merits to determine the nature of the underlying liability.
It also seems that whether knowledge forms a key component of creditor duty, where a company is actually insolvent, remains a question for another day. However, with Zacaroli J being at least prepared to assume that it does, the High Court has provided further guidance to add to this developing area of law. A further issue which is then likely to arise depends on the nature of any knowledge test – if a real risk of the company’s defence failing is in fact the correct test, as Zacaroli J suggests, this would seem to set a relatively low bar.
Indeed, on one view, any claim passing the summary judgment test of being arguable necessarily results in the defence being at real risk of failing. If a company’s defence is more likely than not to succeed but there nevertheless remains a real risk of it failing, this case leaves unanswered how its directors must take the liability into account for the purposes of determining whether the creditor duty is owed. That analysis may also differ from the accountancy analysis as to whether the liability must be provided for. There is doubt also as to the position of a director that does not seek any advice so does not appreciate that there is a real risk of the company’s defence failing.
For further information, please contact:
Andrew Cooke, Partner, Herbert Smith Freehills
andrew.cooke@hsf.com
