United States: Defrauding Creditors Through Dividends, And The Shift Of Directors' Duties

Last Updated: March 14 2019
Article by Howard Morris, Sonya Van De Graaff and Edward Downer


The Court of Appeal of England and Wales ("CA") made a significant ruling on two matters affecting the powers and duties of directors of English companies.

First, the declaration and payment of a dividend by a company has been unwound as it was found to be a transaction that had as its purpose the defrauding of a company's creditors. This is the first time the payment of a dividend has been unwound for this reason. This decision is especially significant as the company that paid the dividend was not subject to an insolvency proceeding until almost ten years later.

Secondly, the CA confirmed existing case law that stated the shift in focus of a director's duties from a company's members to its creditors can take place even before a company is insolvent.

This alert is especially relevant to companies in financial stress as well as directors, companies, creditors and insolvency practitioners.


On dividends: Directors of companies should be mindful of their purpose when declaring and paying dividends. And creditors aggrieved by such actions should consider their rights.

On directors' duties: Directors should have regard to the interests of a company's creditors whenever a company is likely to become insolvent, and take financial advice to ensure they have a proper understanding of its solvency.

Insolvency practitioners are further armed to restore value to creditors.


Since the Statute of 13 Elizabeth, an Act of the English Parliament made in 1571, transfers of property intended to "delay, hinder or defraud creditors" have been susceptible to challenge. Provisions of this statute survive in the UK under section 423 of the Insolvency Act 1986 ("Section 423") and exist in most jurisdictions around the world.1

Section 423 gives an administrator, liquidator or other "victim" the right to bring a claim to unwind a transaction that has as its purpose the placing of assets beyond the reach of, or prejudicing the interests of, creditors. Insolvency of the company is not a condition to bringing a claim under Section 423. Any actual or potential creditor can bring a claim at any time as a "victim" of such a transaction.2 A payment of a dividend has never before been held to fall within the scope of Section 423.


The relevant company, Arjo Wiggins Appleton Limited ("AWA"), declared and paid two dividends to its sole shareholder, Sequana SA ("Sequana"), amounting to approx. €578 million: a December 2008 dividend for €443m (the "December Dividend") and a May 2009 dividend for €135 million (the "May Dividend"). The dividends were offset against an intragroup loan owed by Sequana to AWA, repaying it for all but about €3 million. The dividends were paid in compliance with Part 23 of the Companies Act 2006, specifically, section 830 because AWA had distributable profits, and section 836 as the distributable profits were determined by reference to the company's relevant accounts.

At the time the dividends were declared and paid, AWA had ceased to trade, and its "only significant obligations were its contingent indemnity liabilities."3 This contingent indemnity was linked to the outcome of litigation in the United States. AWA had an investment contract and historic insurance policies, which would pay out in an amount possibly less than that required by the indemnity. The May Dividend was declared and paid in contemplation of a sale of AWA by Sequana to AWA's management. Before the sale was approved, the transaction was described in a memo by a director of Sequana and AWA as a good deal for Sequana since it would enable Sequana to get rid of a "hairy issue under favourable terms, while greatly limiting its future exposure". Sequana's board minutes reflected this sentiment. Sequana sold AWA to eliminate the risk that potential insurance proceeds would not be enough to satisfy the contingent indemnity.

British American Tobacco Industries plc ("BAT") was a creditor of AWA. BAT had acquired environmental liabilities through a number of acquisitions that took place, in respect of which BAT claimed to have an indemnity from AWA. BAT brought the claim under Section 423 as a "victim" of the transaction against AWA through its subsidiary, BTI 2014 LLC ("BTI"). BTI asserted that a claim under Section 423 did not require proof of whether AWA was actually required to indemnify BAT. The fact that BAT was a potential creditor was sufficient. BTI challenged the dividend payment on the following grounds:

  1. The accounts the AWA directors relied on were not properly prepared and therefore the dividends were not lawful;
  2. The directors owed a duty to have regard to the interests of AWA's creditors as a consequence of AWA's financial situation; and
  3. The dividends were transactions that were authorised with the intention of defrauding creditors.


While instinctively challenging, the CA held that there was "no conceptual difficulty" in a dividend being paid for the purpose of putting assets beyond the reach of creditors. The CA stated that a dividend payment was the same as any other transaction that aimed to prejudice creditors. For that reason, the payment of a dividend that was lawful under the Companies Act, nevertheless, fell within Section 423.

The CA stated that determining whether the purpose of a transaction is to put assets beyond the reach of a creditor or prejudice its interest is a question of fact. A transaction need not have either of the above purposes as their only purpose, or even their dominant purpose, but as long as it was either positively anticipated or not simply consequential, this element of a claim under Section 423 would be satisfied.

The CA held that the judge at first instance made clear findings that:

  1. the payment of the May Dividend was not made in cash but was set-off against the intercompany debt, so as to allow AWA to be sold; and
  2. AWA was being sold with the purpose of removing a "hairy issue" from Sequana's balance sheet, in particular, the risk that insurance proceeds would not meet the indemnity in favour of BAT and as a result Sequana would be responsible for AWA's liabilities.

These findings differentiated the payment of the May Dividend from a normal scenario in which directors would declare dividends for their shareholders. The creditors of AWA were prejudiced as the assets of the company had been "depleted and [the creditors] no longer had any call". Accordingly, the purpose of declaring and paying the dividends fell within Section 423.


Company accounts were prepared on the basis that the insurance proceeds would satisfy the amount likely to be required under the indemnity. The company's auditors gave an unqualified certificate that the accounts gave a true and fair view of the company's affairs. The balance sheet of AWA which revealed net assets of approximately €3 million did not take into account the potential recoveries under the insurance policies. The auditor's report contained an emphasis of matter that stated the amount required under the indemnity was uncertain and not in the control of the company.

By way of reminder, section 172 of the Companies Act 2006 ("Section 172") requires directors to act in a way likely to promote the success of the company for the benefit of its members; this duty is subject to any rule of law requiring directors to have regard to creditors' interests. BTI asserted that the duty to act in the interests of the creditors had been engaged when the May Dividend was paid due to the financial situation of the company.

The CA examined case law in relation to when the duty shifts and stated authorities suggest there are at least "four possible answers":

  1. When a company is either cash-flow or balance sheet insolvent4
  2. When a company is on the "verge of", "nearing" or "approaching" insolvency
  3. When a company is or is likely to become insolvent
  4. Where there is a "real, as opposed to remote, risk of insolvency"5

The CA held that tests 2-4 were "different ways of saying the same thing". It also stated that the fourth test was not a part of current law.

The CA avoided describing the precise moment when the directors of a company must shift the focus of the duties from a company's members to its creditors. It is likely that the moment that this duty must shift will vary in each case, depending on the facts and circumstances. Any legal test for determining whether a director's duty has shifted would require "a difficult amalgam of principle, policy, precedent and pragmatism".6 The CA did however confirm that a company need not be insolvent for the duty to be engaged. The CA said that the shift arises when directors "know or should know that the company is or is likely to become insolvent"; 7 and further that the word "likely" means "probable".


In this case, the duty to creditors was not engaged. The first instance judge rejected BTI's argument that there was a real, as opposed to remote, risk of insolvency that should have triggered the directors to run the company in the interests of the creditors. The CA affirmed this decision. Although there were "great uncertainties about the extent of [AWA's] indemnity liability", as demonstrated by the auditor's emphasis of matter, this did not amount to a finding that AWA was or was likely to become insolvent. Accordingly, there could be no breach of duty.

Sequana has announced its intention to appeal the decision to the UK Supreme Court and has 28 days from the date of the judgment to do so.

Case: BTI 2014 LLC v Sequana SA [2019] EWCA Civ 112 (6 February 2019)

Jai Mudhar, London Trainee Solicitor, contributed to the drafting of this alert.


1 See, e.g., Chapter 11 USC § 548 of the U.S. Bankruptcy Code.

2 BTI 2014 LLC v Sequana SA [2019] EWCA Civ 112 at [29].

3 BTI 2014 LLC v Sequana SA [2019] EWCA Civ 112 at [14].

4 West Mercia Safetywear Ltd v Dodd [1988] BCLC 250.

5 Kalls Enterprises Pty Ltd v Baloglow [2007] NSWCA 191.

6 Nicholson v Permakraft (NZ)[1985] 1 NZLR 242.

7BTI 2014 LLC v Sequana SA [2019] EWCA Civ 112 at [222].

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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