In Hunt v Singh [2023] EWHC 1784 (Ch), the High Court applied the Supreme Court's decision in BTI 2014 LLC v Sequana SA [2022] UKSC 25 in the context of an uncertain liability. The issue was whether a director's duty to take into account the interests of creditors arose in circumstances where the company was at the relevant time insolvent but its insolvency was only clear with the benefit of hindsight, since it arose from a liability that the directors had believed – on advice, but wrongly – probably did not exist.
Facts
Marylebone Warwick Balfour Management Ltd (Company) had provided the services of head office staff. In 2002, it entered into a 'conditional share scheme' which was designed to allow its head office staff to receive payments – structured as non-contractual gratuitous bonuses – without the Company incurring liabilities to HMRC by way of PAYE or NIC contributions.
The scheme was operated by the Company between 2002 and 2010. During that period, HMRC notified the Company at various times that it was seeking to challenge certain elements of the scheme being utilised by the Company in test cases and made offers to the Company to compromise its potential liability in respect of the scheme. The Company rejected those offers, being advised by tax advisors throughout this period that the scheme was 'robust'.
Following a decision of the Court of Appeal in a test case, the Company was advised that it was liable to HMRC for unpaid PAYE and NIC contributions in respect of the scheme. The Company's liability totalled approximately £36 million. The Company entered into insolvent liquidation, and in due course the Company's liquidator (Liquidator) brought claims against the directors for (inter alia) breaches of their duty to consider the interests of creditors (creditor interest duty).
The decision in Sequana
The creditor interest duty has been considered recently by the Supreme Court in Sequana: see FC Case Feature 24 November 2022 and Directors' duties, Q&A here. In that case, the Supreme Court unanimously held that a director's duty to take into account the interests of creditors will not be triggered merely where there is a real risk that the company will become insolvent, as had been suggested in some of the earlier authorities. Four out of the five Justices of the Supreme Court expressed the view that the duty was only triggered where a company is actually insolvent or bordering on insolvency, or it is more likely than not that the company will go into insolvent liquidation or administration (collectively, Financial Trigger).
In addition to the objective Financial Trigger, there is a question as to what the director must know of the company's financial position (Knowledge Trigger). The Justices of the Supreme Court made comments as to this in Sequana, though there was not unanimity. Lord Briggs (with whom Lord Kitchin agreed) and Lord Hodge appeared to consider that for the duty to be triggered, in addition, either the director must know that the company is actually insolvent or bordering on insolvency or is more likely than not to go into insolvent liquidation or administration, or they ought to have known that. However, Lord Reed was "less certain" about that and both he and Lady Arden considered the question should be left open for full argument.
The decision of Zacaroli J in Hunt v Singh
At first instance, the ICC Judge rejected the Liquidator's claim. He held that the creditor interest duty had not arisen as the scheme had been put in place for genuine commercial reasons on the advice of tax advisers, who had been engaged to give advice on an ongoing basis, and the directors had been entitled to take the advice that the scheme was 'robust' at face value.
On appeal (but notably without the benefit of full argument since the respondent did not appear), Zacaroli J reversed the decision of the ICC Judge and held that the creditor interest duty had arisen. His reasoning was as set out below.
- The starting point was that there was no doubt that the Company was in fact insolvent at all relevant times. Whether appreciated or not at the time, the Company in fact had liabilities to HMRC in respect of PAYE and NIC contributions and it had no assets to meet those liabilities.
- He would proceed on the assumption (without deciding the point) that the creditor interest duty required some element of actual or constructive knowledge of the insolvency.
- Where a company is faced with a claim to establish a current liability of such a size that its solvency is dependent on successfully challenging that claim, then the creditor interest duty arises if the directors know or ought to know that there is at least a real prospect of the challenge failing.
- Applying this test, the creditor interest duty was triggered by at latest September 2005 when HMRC notified the Company that it intended to bring a test case in respect of conditional share schemes, such as that entered into by the Company, and made a market-wide offer to companies participating in such schemes.
- It is possible that the duty could have been found to have arisen even earlier, but for the purposes of the appeal the Liquidator had confined his claim to the period from September 2005.
From a legal perspective, the significant aspects of Zacaroli J's decision are in points 2 and 3 above, especially 3. It may not be controversial that a company may be found to have been actually insolvent with hindsight when the result of a dispute over a significant claim against it becomes known. However, Zacaroli J's finding that, in that situation, the creditor interest duty will be found to have been triggered at a time when: (i) the company was in fact with hindsight actually insolvent; and (ii) the directors knew or ought to have known that there was at least a real risk of the company's challenge to that liability failing (but no more than that), is more contentious. This is considered further below.
Having found the creditor interest duty to have been triggered in this case, Zacaroli J then remitted the question whether the duty had been breached by the Company's directors to the ICC Judge for determination. In doing so, he endorsed the views expressed obiter by the Supreme Court as to the content of the duty in Sequana.
In summary, the Justices of the Supreme Court all expressed the view that where the duty is triggered: (i) directors are required to consider the interests of creditors along with those of members, balancing these interests against each other where they diverge; (ii) the priority to be given to creditors' interests will depend on the company's particular financial situation and increases as a company's financial position worsens, such that there is therefore a 'sliding scale' of increasing priority for creditors' interests as a company gets more deeply insolvent and/or closer to insolvent liquidation or administration; and (iii) it is only when an insolvent liquidation or administration is inevitable (when there is no longer any "light at the end of the tunnel") that members' interests will cease to have any weight and the company's interests are to be treated as equivalent to those of creditors generally.
Analysis
Viewed in isolation, in both practice and policy terms, the decision of Zacaroli J might be welcomed as a sensible approach to the creditor interest duty. There are good policy reasons why directors of a company whose solvency depends on the uncertain outcome of a disputed claim should be subject to the creditor interest duty, since it may turn out that the company was in fact insolvent, and perhaps even inevitably heading for liquidation, such that in fact creditors had a sufficient economic stake in the company to justify their interests being taken into account by the directors. As Zacaroli J noted in his judgment, the fact that the duty is triggered does not of itself mean that the interests of creditors become paramount or that the duty has been breached. Indeed, under the Supreme Court's approach to the content of the duty, the triggering of the duty gives much discretion to the board to decide how to balance creditors' and shareholders' interests having regard to the specific facts relating to particular decisions, at least until insolvent liquidation or administration is inevitable.
The difficulty, however, with Zacaroli J's decision is in reconciling it with the views expressed by the Supreme Court in Sequana and the uncertainty and potential inconsistency that it creates. There are several, interrelated, points here.
First, in Sequana a 'real risk' trigger for the creditor interest duty was expressly rejected as a general test by the Supreme Court, undoubtedly as part of the ratio of its decision.
This was a point which Zacaroli J himself addressed: he distinguished the situation in Hunt v Singh from that in Sequana on the basis that in the former the company was undoubtedly insolvent at the relevant time, whereas in the latter the company was undoubtedly solvent at the relevant time and was merely at risk of becoming insolvent at some point in the future, such that the context for each of the two cases was therefore in his judgment different.
However, that distinction is unsatisfactory and problematic for the reasons set out below.
- On any view, it at least has the problem that it requires a relatively finely-grained analysis of the facts in Sequana, in a manner which formed no part of the Supreme Court's reasoning. The Supreme Court did not consider the precise financial position of the company at all.
- Turning to those specific facts in Sequana, the existence of the indemnity liability to which the company was subject was not disputed, but at the relevant time the ultimate quantum of that liability was very uncertain indeed (with a huge range of potential outcomes as regards quantum) and was the subject of ongoing contested litigation in the US between the relevant parties, including the indemnified party. When, several years later (and several years after the trial in Sequana), the quantum of that liability was finally settled, it rendered the company clearly insolvent (and would have done at the relevant time as well had it been quantified then).
- Indeed, further, it is not even clear that the distinction relied on by Zacaroli J (between a company undoubtedly insolvent with hindsight in Hunt v Singh and a company undoubtedly solvent at the time in Sequana) was correctly drawn in relation to Sequana, at least on the basis of the above thumbnail sketch of the position in Sequana (which is more detailed than the analysis of the facts of Sequana in Hunt v Singh). With the limited hindsight available at the time of the trial in Sequana, it might not have been clear whether or not the company was at the relevant time, or would become, insolvent. However, subsequently, when the indemnity liability was eventually quantified, it was, at least on the basis of the thumbnail sketch, arguably with hindsight insolvent at the relevant time (on the basis of the hindsight-based quantification of the liability which had existed at the time). However, as to the true position in Sequana, see further below.
- In any event, it would seem very undesirable that narrow distinctions of this sort should result in significantly different trigger tests for the creditor interest duty, yet that is what Zacaroli J's decision entails.
- In that connection, and with the practical application of the law in mind, it is important that, from the perspective of the time when the creditor interest duty potentially applies (ie without hindsight), the practical position of the company and its directors is the same in both cases: the company's real financial position is in fact unknown and unknowable, depending as it does in both situations on the outcome of a dispute which is not going to be known for some time.
- In that context, it is significant that the practical and policy reasons rightly identified by Zacaroli J as supporting his trigger test of knowledge of a real prospect of liability were also relied on in support of the appellant's contention that the trigger test should generally be a real risk of insolvency in Sequana, and the Supreme Court rejected that contention as part of the ratio of its decision.
- The above points are expanded on further below in so far as they help understand the practical difficulties created by the decision in Hunt v Singh.
Second, and most importantly, Zacaroli J adopted a narrow approach to the decision of the Supreme Court in Sequana. Adopting a rather broader approach, his reasoning is inconsistent with the reasoning of the Supreme Court.
- The majority of the Supreme Court clearly contemplated, albeit only obiter, that the Knowledge Trigger for the creditor interest duty should be sufficient knowledge of the factual situation amounting to the Financial Trigger, which, where that Financial Trigger is insolvency, means knowledge of insolvency and not something less (eg knowledge that there is a real risk of insolvency).
- Applying the dicta of the majority in Sequana to the situation before Zacaroli J, therefore, would require that the director knows or ought to know, not merely that there is a real prospect of the claim against the company succeeding, but rather either that the company is actually insolvent or that the claim against the company is more likely than not to succeed and that, therefore, it is more likely than not that the company will go into insolvent liquidation. In that situation, the directors would not have actual or constructive knowledge of the company's actual insolvency, unless the company's defence to the claim were considered unlikely to succeed or it was not bona fide. But actual or constructive knowledge that the claim is more likely than not to succeed is a much higher hurdle than knowledge of merely a real prospect that it will succeed.
Third, more generally (although related to the first point above), there is also a general argument on practical and policy grounds against Zacaroli J's approach, not depending on Sequana at all. It creates uncertainty and potentially arbitrary distinctions that make no sense from a policy perspective.
- The premise of his approach appears to be that in assessing balance sheet solvency the court can, to a certain extent, have regard to hindsight to establish that the company was in fact insolvent at the relevant date when the claim is ultimately upheld in the future.
- That is in itself not controversial, but Zacaroli J then went on to apply in that situation a bespoke trigger test as to knowledge, involving a real prospect of success only. There is no doubt that he was identifying such a test, since he said so expressly in paragraphs 48, 50 and particularly 51. It is that step which causes problems.
- That would open up some surprising distinctions between different types of claim against the relevant company, which it would be hard to justify on practical and policy grounds. Those will arise because the hindsight-based approach to the question of actual insolvency cannot apply to all types of claim.
- For example, a claim might involve the exercise of a significant element of discretion by the court, or liability might otherwise formally arise only upon the making of an order (rather than the order in effect simply declaring the existence of a liability that had existed all along since at least the relevant time, such as the statutory tax liability in Hunt v Singh). In such cases, it cannot be said that the liability always existed, and so deploying hindsight to conclude that the company was in fact insolvent at the relevant time, just because of the subsequent failure of the company's defence, is not possible.
- As it happens, the underlying liabilities in Sequana provide an example. The indemnified party in Sequana was potentially liable under 'CERCLA', a US environmental protection statute, under which the courts could allocate liability to contribute to the costs of an environmental clean-up in respect of an indivisible environmental harm amongst numerous 'potentially responsible parties' on a discretionary basis by reference to numerous relevant factors to be taken into account (including potentially by allocating no liability to particular parties). Following such allocation, long after the event, it could not be said that such liability to contribute had always existed as an actual liability, in the way that a statutory tax liability might be said always to have existed since the taxable event.
- In such a case, therefore, applying Zacaroli J's approach, the creditor interest duty would not be triggered at the relevant time even if the directors appreciated that there was a real prospect that substantial relief could be granted against the company which it would be unable to meet. However, it is hard to see why, as a matter of policy, the directors' duties should be so significantly different in those two different situations.
- The effect of the decision in Hunt v Singh is therefore potentially to create a two-tier regime. The creditor interest duty can be triggered by the directors' knowledge of claims with no more than a real prospect of success if those claims are capable of giving rise to a liability that with hindsight might be said to have existed at the relevant time and rendered the company insolvent at that time; but not by knowledge of other claims with a real prospect of success which can, even if successful, give rise only to liabilities which (for whatever reason) cannot with hindsight have that effect – for example, because such liabilities will only arise on the exercise of a discretion by the court.
- It is difficult to see the policy rationale for such distinctions. For practical purposes, the two cases will look the same to the directors, and indeed the company's creditors, at the relevant time. In both cases there is at that stage uncertainty as to the extent of the company's liability but a real risk that the company will be found to have a liability which it cannot meet. It is very hard to see why the interests of creditors should not be as deserving of the same protection in both cases.
- It is also suggested that such distinctions create unnecessary and undesirable complication, and potentially much uncertainty. Where the company faces an existentially threatening claim, the directors and those advising them will not know what test to apply in deciding whether they are subject to the creditor duty, without trying to analyse the precise juridical nature of that claim and whether, if successful, it might result in the conclusion with hindsight that in fact the company was then insolvent. It might be very difficult to work out with confidence which side of the line the claim falls.
- Directors might therefore in that situation be tempted to apply the more cautious approach of assuming that Zacaroli J's real risk test applies. However, that could potentially lead to the de facto introduction of the real risk test that the Supreme Court rejected, ultimately on policy grounds. Fundamentally, as Lord Briggs explained it in paragraphs 189-196, the court considered that a real risk of insolvency was in itself not enough to justify the intrusion of creditors' interests in directors' decision-making so as to displace the general duty under s 172 CA 2006 to promote the success of the company for the benefit of shareholders generally and to disable the normal power of ratification by shareholders.
- These practical difficulties are potentially especially acute in relation to contingent and prospective liabilities. They have to be taken into account in assessing whether a company is balance sheet insolvent, although it is notoriously difficult to formulate general rules as to how that is to be done. That creates uncertainty in itself, independently of the use of hindsight to determine insolvency at an earlier time. However, the addition of hindsight potentially compounds that uncertainty, because it is unclear how and to what extent hindsight can be used in relation to such liabilities. For example, hindsight might show that the contingency did in fact eventuate after the relevant time, but that surely cannot result in the company being found to have been retrospectively insolvent at a time before that happened. However, hindsight might instead reveal facts existing at the relevant time, unknown at the time, which made the occurrence of the contingency much more likely than had been appreciated, and that might arguably result in a hindsight-based finding of insolvency.
It therefore seems unlikely that Hunt v Singh will be the last word on these issues.
This case also highlights the wider point that Sequana has certainly not settled the law in this area and there are likely to be further decisions addressing the issues that were arguably not part of the ratio in Sequana. If the ratio of Sequana is to be construed as narrowly as it was in Hunt v Singh, then the scope for further debate is very significant indeed. The FC Case Feature on Sequana considers the views (whether part of the ratio or not) commanding at least majority support in the Supreme Court, but the approach of Zacaroli J in Hunt v Singh suggests that judges at first instance will be prepared to come to their own conclusions on matters outside their understanding of the ratio in Sequana. That may be encouraged in part by the fact that the task of discerning majority views from the Sequana judgments is not always entirely straightforward.
Helpfully, Zacaroli J's adoption of the Supreme Court's arguably obiter view as to the content of the duty appears to have been part of the ratio of his decision, since it formed part of the basis on which he refused to give judgment but instead remitted the matter to the ICC Judge.
First published on the Corporate News Service on 25 January 2024.
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