A recent decision has helped to frame the tests articulated by the Supreme Court in Sequana.

The Supreme Court’s landmark decision in Sequana[2022] UKSC 25.leaves many unanswered questions, and finding a common thread between the four quite separate judgments has proved challenging for practitioners and directors alike. The recent decision in Hunt v. Singh[2023] EWHC 1784 (Ch). required the court to interpret the subtly conflicting statements in Sequana on two critical issues:

• when the “creditor duty” arises, which obliges directors to have regard to the interests of creditors in discharging their fiduciary duties to the company; and
• the nature of the creditor duty if it has arisen.

Tax Avoidance Scheme Unravels

In Hunt v. Singh, the liquidator of the relevant company brought proceedings against a director for breach of the creditor duty. The insolvency of the company had arisen because a tax liability fell due, which the directors wrongly believed had been avoided through a valid tax avoidance scheme. The company entered into the scheme in 2002 and operated it until 2010. Under the scheme, directors and senior management were remunerated by payment of dividends by an offshore company, thereby avoiding national insurance contributions (NICs) and PAYE tax. During the period of its operation, the scheme distributed more than £54 million to directors and senior management. The company received professional advice throughout the period that the scheme was “robust”, notwithstanding that HMRC announced that from 2005 it would challenge such schemes in court when appropriate. In the same year, the company rejected a settlement offer from HMRC. Subsequently, HMRC brought a test case against an unrelated company, resulting in a Court of Appeal decision that found a similar scheme failed to avoid NICs and PAYE. Applying this decision to the company in Hunt, its liability to HMRC was in excess of £36 million. On any reading the company was insolvent, and was found to have been so since at least the initial 2005 HMRC settlement offer.

Disputed Versus Contingent Liabilities

These liabilities distinguished Hunt from Sequana, in which it was accepted that the company was not insolvent at the time the relevant dividends were paid. The focus in Sequana was whether the creditor duty arose before the company became insolvent, and it was found that it had not: the mere possibility of a future insolvency brought about by an unknown contingent liability (described in the case as the “real risk”) was insufficient. In Hunt, there was no doubt that the company was insolvent from at least September 2005. The fact that the company disputed it owed anything to HMRC for the entire period did not alter that fact — the judge distinguished a disputed liability from a contingent debt. Throughout the period in which the company had used the scheme, it had incurred an actual liability to HMRC.

However, the insolvency of the company did not automatically mean that the creditor duty had been engaged. Mr Justice Zacaroli took the view that, despite the differing obiter remarks on the point made in the Supreme Court Sequana judgments, it was necessary to establish some form of knowledge of insolvency on the part of the directors in order for the creditor duty to arise. He found that, when 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, the creditor duty arises “if the directors know or ought to know that there is at least a real prospect of the challenge failing”. That position was reflective of the economic interest having already shifted from shareholders to creditors by virtue of the company’s insolvency.

Consequences of Creditor Duty Trigger

The fact that the creditor duty may have been triggered did not necessarily mean the directors would be in breach of duty if the actions they subsequently took turned out to have damaged creditors’ interests. The content of the duty will differ from case to case and will be viewed on a sliding scale so that the more parlous the financial state of the company, the more the interests of creditor will predominate. The judge in Hunt found a clear difference between directors proposing to continue trading, notwithstanding the risks of making further losses, and directors proposing to declare dividends of all available assets leaving nothing to pay a disputed liability in the event that it becomes undisputed.

On the facts in Hunt, the judge declined to go further and decide whether the director was in breach of the creditor duty but instead remitted the case for further factual findings, noting that the director (who himself became subject to bankruptcy proceedings) was not represented.

Practical Consequences for Directors

The decision in Hunt is welcome because it translates the sometimes conflicting obiter comments of the Supreme Court justices in Sequana and applies them in a practical way to a more commonplace fact-pattern. Directors will need to exercise caution when assessing disputed liabilities — especially of the “bet the farm” variety — in their assessment of whether or not the creditor duty shift may have occurred. In Hunt, taking and following professional advice was irrelevant to determining whether the duty had arisen. The judge trod carefully around the question of whether knowledge of insolvency (actual or constructive) is required to trigger the creditor duty, concluding that on balance it was. Directors should be aware, however, that this is only a limited concession and that any actions or inactions are likely to be judged with the benefit of hindsight.

ENDNOTES

¹[2022] UKSC 25.

²[2023] EWHC 1784 (Ch).