Dividends – compliant but challengeable?

In the recent English High Court decision of BTI 2014 LLC v Sequana SA; BAT Industries plc v Sequana SA [2016] EWHC 1686 (Ch), several aspects of company and insolvency law were most admirably considered and ruled upon by Mrs Justice Rose in her 528 paragraph judgment.

A fiendishly complex set of facts were examined in detail, resulting in consideration of part 23 of the Companies Act 2006 in relation to declaration and payment of dividends to members, reduction of capital in terms of s 642 of the Act and matters to be considered when signing the relevant solvency statement(s), director duties (in particular the “creditors' interests duty” in terms of s 172 (3) of the 2006 Act), and finally s 423 of the Insolvency Act 1986 in relation to “Transactions defrauding creditors”. This article will consider only the last of these, insofar as it gives guidance in relation to the potential that dividends declared and paid in accordance and consistent with the relevant provisions of the 2006 Act may nevertheless fall foul of s 423, with relevant consequences.

Steps to remove a financial risk

The facts of the case were extremely complex but can be summarised for our present purposes as follows:

(a) a company called Arjo Wiggins Appleton Ltd (“AWA”) was a wholly-owned subsidiary of Sequana SA (“Sequana”);

(b) the directors of AWA reduced its capital in order to create distributable reserves, and resolved in December 2008 to pay an interim dividend to Sequana (“the December dividend”). They also resolved that payment of the December dividend should be effected by way of set off against an intra-group receivable due to AWA from Sequana;

(c) in May 2009 the directors resolved to pay a further interim dividend to Sequana, again by way of release by AWA of a further element of Sequana's intra-group debt owed to AWA (“the May dividend”);

(d) through a series of historic corporate acquisitions and asset transfer transactions, AWA was liable to indemnify BAT Industries plc for a proportion of its liability to pay for part of the environmental clean-up of the Lower Fox River in Wisconsin, USA pursuant to the Comprehensive Environmental Response Compensation and Liability Act 1980 (“the Fox River issue”);

(e) AWA was sold by Sequana to TMW Investments (Luxembourg) SARL immediately after the May dividend (“the sale”). It was apparent from evidence that Sequana was not prepared to sell AWA to TMW with a substantial amount of inter-company receivable still payable to AWA, and TMW did not have the means to make payment for that right to remain in AWA. The outstanding inter-company receivable therefore had to be eliminated in order to allow a sale of AWA to proceed – and the May dividend achieved that end;

(f) from evidence, it was clear that Sequana's policy was to “stand behind its subsidiaries”. For so long as AWA remained a subsidiary of Sequana, Sequana would have injected whatever cash was needed into AWA to enable it to meet its obligations, even if it had no legal obligation to do so;

(g) from evidence, it was clear that a significant part of the sale documentation was drafted to ensure that Sequana would have absolutely no post-sale liabilities in relation to indemnity liabilities, the Fox River issue and other environmental exposure of AWA; and

(h) Mrs Justice Rose determined that the removal of the risk of exposure to liability appearing in Sequana's balance sheet associated with its subsidiary AWA could only be achieved if the May dividend could be paid by offsetting it against the remaining inter-company receivable so that AWA could then be sold to TMW (a company outwith the Sequana group).

Section 423 issues

Section 423 relates to any transaction entered into at an undervalue where the court is satisfied that it was entered into for the purpose:

(a) of putting assets beyond the reach of a person who is making, or may at some time make, a claim against the transferor, or

(b) of otherwise prejudicing the interests of such a person in relation to the claim which he is making or may make

– “the 423 purpose”. It will be noted that there is no requirement that the company be insolvent at the time that the transaction is entered into.

The relevant legal issues arising can be summarised as follows:

1. Can payment of a dividend be a transaction for the purposes of s 423?
2. Was the 423 purpose present in relation to the December dividend or the May dividend?

Mrs Justice Rose determined that there is no reason in the wording of s 423 to exclude the payment of a dividend from its scope if the payment is made with the 423 purpose. Section 423 may therefore apply in relation to the payment of dividends by a company to its shareholder(s).

She further determined that, given that as at the date of declaring the December dividend there was no settled intention of selling AWA to someone outside the Sequana group (and thus presumably Sequana avoiding liability to support its subsidiary as referred to above), AWA did not have the 423 purpose at that point.

However, Mrs Justice Rose went on to find that the payment of the May dividend was entered into with the purpose of eliminating the receivable due by Sequana to AWA, which then cleared the way to AWA being sold and to Sequana removing any risk of having to fund AWA to meet its indemnity liability to BAT if the funds left in AWA proved to be inadequate.

The judge, after some hesitation, agreed with BAT's stated position that this case was distinguished from other cases where directors declare dividends for their shareholders for the usual reasons for which dividends are paid, without turning their minds to whether this leaves enough money for potential creditors. In the present case, BAT claimed that there was no doubt that the subjective intention of the directors at the time of the May dividend and the sale was to prevent AWA having any legal or moral call upon its parent company to meet its creditors' claims. After the declaration of the May dividend and the sale to TMW, the creditors of AWA were prejudiced because the assets of AWA had been depleted and BAT no longer had any call on Sequana to that extent. In that regard, Mrs Justice Rose found that BAT's claim under s 423 was well founded as regards payment of the May dividend, in that AWA had the intention, in paying that dividend, of putting the dividend monies beyond the reach of BAT or of otherwise prejudicing BAT's interests, BAT being a victim of the transaction within the meaning of s 423(5).

Scottish companies' potential exposure

As a result of the BAT decision, it is now clear that the declaration and payment of dividends by a company may, notwithstanding that such dividends comply entirely with the requirements of the 2006 Act, still be challenged if the 423 purpose can be shown to be present in connection therewith. Section 423 should not prevent the declaration and payment of dividends to shareholders in the ordinary course (as referred to in the case), but if factors are in play which could subsequently be interpreted as satisfying the 423 purpose, directors would be well advised to take specific advice from appropriate insolvency professionals before declaring and paying dividends to shareholders.

Not only does the court have power to restore the position to what it would have been if the transaction had not been entered into and protect the interests of persons who are victims of the transaction, but the extent of a director's responsibility for the company entering into any transaction liable to be set aside under s 423 is included among the matters to which the court must have regard in determining whether their conduct makes them unfit for the purposes of the Company Directors Disqualification Act 1986.

It must also be remembered that s 423 applies to England & Wales only. As such, companies registered in Scotland are not subject to its provisions. However, Scottish registered companies may, of course, remain exposed to the potential consequences of s 423 should they hold shares in any England & Wales registered companies – and expect to receive dividends from them.