Beware of your intentions when declaring dividends

The facts

Through corporate acquisitions and asset transfers, BAT Industries plc (“BAT”) (a Claimant in the proceedings) became liable to contribute to the clean-up of the sediment of the Lower Fox River in Wisconsin, U.S.A. Arjo Wiggins Appleton Limited (“AWA”), a wholly owned subsidiary of Sequana SA (“Sequana”) (a Defendant in proceedings), became liable to indemnify BAT for part of any monies paid out. Provision was duly made in AWA’s accounts to reflect a best estimate of the value of such liability.

In December 2008, the directors of AWA resolved to pay an interim dividend to Sequana by way of set-off against an equivalent amount of the intra-group receivable due to AWA from Sequana. The funds for this dividend were realised by AWA reducing its share capital using the solvency statement method based on interim accounts. AWA’s accounts were finalised in May 2009 and showed substantial group losses. The directors subsequently formed an intention to sell AWA and resolved to pay another dividend to Sequana, to be satisfied by the release by AWA of a large proportion of intra-group debt owed to AWA by Sequana.

The issues

Claims were brought by BTI 2014 plc (“BTI”) (a corporate vehicle set up by BAT for claims) and BAT to challenge the legality of both dividends on the following bases:

1. The accounts used to justify each dividend had not been properly prepared for the purposes of the Companies Act 2006 (the “2006 Act”).
2. AWA’s directors had breached their fiduciary duties in declaring the dividends due to the uncertainty of the estimate of liability and the risk that the liability would ultimately be much greater than anticipated. This was based, in part, on a claim that due to impending insolvency, the directors owed these duties to the AWA’s creditors rather than its members as a whole.
3. The dividends constituted transactions defrauding creditors (or future creditors) under section 423 of the Insolvency Act 1986 (the “1986 Act”).

What did the court decide?

1. Neither dividend contravened Part 23 of the 2006 Act as (a) the interim accounts enabled the directors to make a reasonable judgement about the items mentioned in section 836 of the 2006 Act to determine the first dividend; and (b) the final accounts gave a true and fair view of the state of AWA’s affairs and were thus properly prepared.
2. It was held impossible that every time a company has a provision on its balance sheet in respect of a long term liability which may be larger than the provision made for it in director considerations, the creditors’ interest (under section 172(3) of the 2006 Act) applies. AWA could not be described as 'on the verge of insolvency', 'of doubtful insolvency', or in a 'precarious or parlous financial state' and the creditors' interest duty had therefore not arisen at the time of either dividend and there was no actionable breach of fiduciary duty in making the payments.
3. The wording of section 423 of the 1986 Act is deliberately wide in order to protect creditors from assets being moved out of their reach and a dividend could therefore constitute a “transaction” for these purposes. The first dividend was not caught as AWA did not have the relevant section 423 purpose at that time. However, upon payment of the second dividend, the subjective intention of the directors was to prevent AWA having any legal or moral call upon its parent company to meet its creditors’ claims ie to put assets beyond the reach of its creditors. Therefore AWA had the section 423 purpose when it paid the second dividend. The court highlighted that there is no need to show dishonesty or ill will on the part of the directors.

What does this mean for practitioners?

This is the first case to hold that dividends may be liable as transactions defrauding creditors. It provides helpful clarity on how directors should view long-term liabilities on their balance sheet and when the trigger point for creditors' interests applies. The court’s decision on the section 423 point is interesting especially as Mrs Justice Rose confirmed that there is no need to show that the directors “acted in bad faith in the sense of having engaged in sharp practice or recklessness” in order to satisfy the section 423 test – we will wait to see whether this point is appealed.

It will be interesting to see how courts apply this case in the context of reorganisations and restructures especially in structures where there are long-term contingent liabilities, such as defined benefit pension schemes. However, practitioners should be aware that this case was very fact specific.