In Hunt v Singh [2023] EWHC 1784, the particular question considered by the court was: when does a director’s duty to take into account the interests of creditors arise, in circumstances where the company is at the relevant time insolvent, but its insolvency is due to a tax liability which the directors (wrongly) believed at the time had been avoided by a valid tax avoidance scheme?
In answering, the Judge, Zacaroli J, took the opportunity to consider, apply and distinguish the decision of the Supreme Court in BTI 2014 LLC v Sequana (Sequana). Our discussion of that decision is available here.
Sequana in a nutshell
Much has been written about the scope of the so-called "creditor duty" owed by directors – and when it arises – following the Supreme Court’s decision in October 2022. The five Supreme Court judges gave four different (and at times, contradictory) judgments, leaving plenty of points open for debate.
What duty?
The common thread of the judgments of the Supreme Court is the confirmation of the rule that in certain circumstances where a company is financially distressed, the fiduciary duty of directors to the company to act in in good faith to promote the success of the company for the benefit of its members is modified: in such circumstances, the directors must also consider the interests of the creditors. This is often referred to as the "creditor duty" (although, confusingly, it is owed by the directors to the company, and not to the creditors).
When does it arise?
As to when the creditor duty is triggered: the judges agreed that the duty does not arise when there is a real risk of insolvency at some point in the future, but gave differing views as to when it would exactly arise, preferring the adoption of a sliding scale as opposed to a metaphorical "cliff edge". We discussed the same in our previous article.
The facts in Hunt v Singh
Marylebone Warwick Balfour Management Limited (Company) was a member of a corporate group, which was in the process of winding down its business. The Company provided staff to the group to implement this process. Between 2002 and 2010, the Company operated a complex tax avoidance scheme designed to enable bonuses to be paid to senior management without the Company incurring liabilities to HMRC for PAYE or NIC contributions. The Company paid over £54m to senior management (including the directors of the Company) via the scheme.
For the majority of the time the Company operated the scheme, it received professional tax advice that the scheme was "robust". This was despite HMRC’s increasing level of interest and enquiries into the operation of the scheme and other similar schemes from 2004. In September 2005, HMRC made a market-wide offer to participants in such schemes (including the Company) to settle the liability arising under such schemes (which the Company rejected). HMRC consequently notified the Company of its intention to resolve the matter through litigation. Eventually in 2010, the tax tribunals (including on appeal) held that PAYE and NIC contributions were due on payments made under such schemes (a decision upheld by the Court of Appeal in a test case in 2011). As a result, the Company stopped operating the scheme in 2010 and, following a financial downturn, was placed into liquidation in 2013.
HMRC claimed over £38m from the Company. In turn the liquidator of the Company (Mr. Hunt) brought claims against the former directors of the Company for breach of the creditor duty. In April 2022, the Court at first instance dismissed the liquidator’s claims in their entirety, in part based on an analysis of the law on creditor duty as it then stood (the Supreme Court having not yet given its judgment in Sequana).
By the time the appeal was heard in June 2023, only one respondent remained, Mr. Singh. The liquidator’s case was premised on the fact that the creditor duty had arisen by the time HMRC made its market-wide offer in September 2005.
The decision
On appeal, Zacaroli J took the opportunity to carefully consider the reasoning of the Supreme Court judges in Sequana, dividing this into (i) when the creditor duty arises and (ii) the content of the creditor duty.
Considering when the creditor duty arises, Zacaroli J took the view that the focus of the Supreme Court in Sequana was on the time before the company was actually insolvent. In Sequana, the company faced a contingent liability of an unknown amount. However, here the Company was actually (and substantially) insolvent throughout the relevant period. That the Company disputed anything was due to HMRC, did not change the fact that it was insolvent, because a disputed liability is not a contingent liability.
Zacaroli J noted that one of the questions left unanswered by Sequana was where the company was actually insolvent at the relevant time, is that alone sufficient to trigger the creditor duty irrespective of the directors’ knowledge as to the company’s insolvency. Because this point was not argued before him, he proceeded on the assumption that some form of knowledge of insolvency on the part of the directors must be necessary for the creditor duty to arise, even where the company was, in fact, actually insolvent.
Based on that assumption, Zacaroli J held that if a company faces a claim/liability of such magnitude that its solvency depends on the successful challenge or defence of such claim/liability, the creditor duty arises if the directors know, or ought to have known, that there is at least a "real prospect" of the challenge failing. On the facts, Zacaroli J held that in this case the creditor duty arose at the latest in September 2005, when HMRC made its market-wide offer and continued until the Company entered liquidation.
It is important to remember that when the creditor duty is triggered is only the starting point in a claim for breach of duty; it does not mean that the creditors’ interests necessarily become paramount, or that the directors would be in breach, if the actions they then take turn out to have damaged creditors’ interests. In considering the content of the creditor duty – and whether that duty was breached – Zacaroli J advocated for a nuanced approach, referencing Lord Reed’s suggested approach in Sequana which is:
“…sufficiently fact-specific to take account of differences, according to particular circumstances, in what it may be reasonable and responsible for directors to do when they find the company is in a sufficiently weak financial situation that a conflict of interest between its creditors and its shareholders appears to arise”.
Key message for directors
So in summary the key takeaway for directors is that if they become aware of a claim or other current liability (including in respect of any tax mitigation scheme) that would, if not successfully challenged or defended, result in the insolvency of the company, they must properly consider that claim or liability, including an assessment of the relative merits and chances of successfully challenging/defending it, and must keep that assessment under review. If there is at least a "real prospect" of the challenge or defence failing, the directors are likely to be under a duty to, going forward, also consider the interests of the company’s creditors when making decisions. Directors should therefore "keep their eyes and ears open", as the current test extends not just to what directors know, but what they "should" have known.
Tim Carter
Joanna Charter