Dividend Payments and the Shifting Focus of Directors’ Duties

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Dividend Payments and the Shifting Focus of Directors’ Duties

The Court of Appeal recently made a significant ruling on two matters relating to dividends and the shifting focus of directors’ duties.

Firstly, it upset a dividend declared and paid by a company as a ‘transaction defrauding creditors’ under S423 of the Insolvency Act 1986. This case is significant for two reasons – not only is it the first time the court has upset a dividend under S423, but also the dividend was declared ten years before the company went into liquidation.

Secondly, the court confirmed the long established principle in earlier case law that a major shift happens in the focus of directors’ duties – from being owed to the company shareholders to the company creditors – before companies become ‘insolvent’.

If you’d like to read the decision itself, click here. And if you would like to read more about the shift of duties, click here.

What is a transaction defrauding creditors?

S423 of the Insolvency Act 1986 gives an administrator, liquidator or the victim the ability to upset any transaction whose purpose is putting company assets beyond the reach of actual or potential creditors, or which prejudices the interests of creditors.   Note that the company does not have to be insolvent at the time of the transaction for it to be upset.


The facts of the case are?

An English company, Arjo Wiggins Appleton Ltd, declared and ‘paid’ two dividends totalling  £0.5 billion to its parent company, Sequana SA – £400m in late 2008 and £100m in Spring 2009. The dividends were set off against a debt Arjo owed to Sequana, almost cancelling out the entire debt. The dividends were not illegal, Arjo had sufficient distributable profits to pay them as confirmed by the appropriate accounts.

But at the time when the time the dividends were declared and paid, Arjo had ceased trading, its only other liabilities being ‘contingent’ – potential uninsured losses depended on the outcome of litigation in the USA.

The 2009 dividend was declared and paid in anticipation of AWA being sold to its management.  In the lead up to the sale, one of Sequana’s directors said in an internal memo that the sale would be a good deal for Sequana as it would enable it to rid itself of the ‘hairy issue under favourable terms, while greatly limiting its future exposure’.  Sequana’s board minutes then went on to agree with this statement. That is to say Sequana sold Arjo in order to try to avoid potential uninsured losses.

British American Tobacco was a creditor of Arjo and started action under S423 as a victim. BAT challenged the dividends on the following grounds:

(a) The accounts Arjo’s directors relied on to declare the dividends were not properly prepared, so the dividends were illegal;

(b) Because of Arjo’s circumstances, its directors owed a duty to act in the interests of Arjo’s creditors and not its parent; and

(c) The sole purpose of declaring and paying the dividends was to defraud potential creditors.


The court held that:

  1. A payment of the dividend was no different to any other transaction, it could prejudice creditors.
  2. While the dividend was indeed legal under the Companies Act, it could still be upset under S423.
  3. Determining whether the purpose of a transaction is to put assets beyond the reach of creditors or prejudice their interests is simply a question of fact. A transaction need not have either of these purposes as their sole or even their main purpose, as long as it was either positively anticipated or not simply consequential, then Section 423 would be satisfied.
  4. The creditors of Arjo had been prejudiced as its assets had been reduced by the off set of the dividend and creditors could no longer call on the assets. Therefore, the purpose of declaring and paying the dividends fell within Section 423.
  5. The second, 2009, dividend, should be upset, because it was made in contemplation of the sale of the company, but the court was not convinced the 2008 dividend should be upset. As a consequence tshe court ordered Sequana to repay over £100m.

How does this fit with the director’s duties?

Accounts were prepared showing that the insurance proceeds would be enough to satisfy the debt. The auditors gave an unqualified report in the accounts.

S172 of the Companies Act 2006 requires directors to promote the success of the company for the benefit of its shareholders, but this duty is surpassed in those instances where the directors should have regard to creditors’ interests. BAT claimed that the duty to act in the interests of the creditors applied on the declaring of the 2009 dividend due to the company’s circumstances at that time.

The court considered earlier case law as to the timing of when the duty shifts:

  1. When a company is insolvent on either a cash-flow or balance sheet basis
  2. When a company is on the verge of 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’.

The courts said that tests 2 to 4 were just different ways of saying the same thing and that test 4 was not part of current law.

Somewhat unhelpfully the court avoided defining the precise moment when directors must shift their focus from the shareholders to the creditors – when this happens will depend on the court’s interpretation of the facts and circumstances, which obviously vary from case to case.   The court did say that the test for determining when the directors’ duty shifts requires ‘a difficult amalgam of principle, policy, precedent and pragmatism’. The court did say that a company does not have to be insolvent for the duty to have shifted but that the shift definitely happens when directors know, or should know, that the company is insolvent or is probably going to become insolvent.

Did the directors breach their duties?

The court said, in this case, the directors had not breached their duties as there was, at the time of the declaration and payment of the dividends, only a remote risk of insolvency therefore there had been no trigger changing the shift of focus from shareholders to creditors.

Sequana said at the time of the judgement that it might appeal.



This case has shown that dividends paid many years prior to any liquidation of a company can, if the circumstances fit, be upset as a transaction defrauding creditors – but the chances of those circumstances being right, and there being sufficient documentary evidence to support a S423 argument, are probably for most companies pretty slim.  But never say never!

The case also shows that creditors with deep pockets and an appetite for litigation can, under S423, take action, it doesn’t have to be the liquidator or administrator who takes action.

Update 19 May 2019, Sequana has announced that it will be going into liquidation as it cannot pay the £100m claim – see this article.

By |2019-05-19T08:47:55+01:00March 19th, 2019|Administration, Liquidation|0 Comments

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Licensed Insolvency Practitioner, fellow of the ICAEW, Black Country bloke

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