Corporate Law Update
- The Court of Appeal has confirmed that a dividend can constitute a transaction at an undervalue and so may be susceptible to challenge under insolvency legislation
- The FCA has published Primary Market Bulletin 20, outlining new, amended and proposed technical and procedural notes and its intention to drop the UKLA name
- Another item of interest
The Court of Appeal has confirmed that a dividend paid by a company to its shareholders can constitute a transaction at an undervalue under insolvency law.
In BTI 2014 LLC v Sequana S.A. and others, a company (AWA) paid a dividend to its sole shareholder and holding company (Sequana). At the time it paid the dividend, AWA had ceased trading, but it still had contingent liabilities in respect of certain foreign claims.
AWA had the benefit of insurance to meet those liabilities, but it was possible that the insurance would not meet the full amount of the claims. To that end, AWA also relied on a historic debt owed to it by its shareholder, Sequana, to help it meet the claims if they were to arise.
At some point, Sequana decided to sell AWA so as to remove the risk of the contingent liabilities from its group. Before it could do so, it needed to eliminate or reduce the debt it owed to AWA. To achieve this, AWA recommended a dividend in favour of Sequana, which Sequana (as AWA’s shareholder) approved. AWA and Sequana agreed to set the dividend off against the debt Sequana owed AWA. This reduced the debt to a much smaller sum and allowed Sequana to sell AWA.
In due course, BTI (which had acquired certain claims against Sequana from AWA) claimed that the dividend that had been paid to Sequana was unlawful for two reasons (among others):
- The dividend fell within section 423 of the Insolvency Act 1986. Broadly, section 423 allows a court to invalidate a transaction by a company if it is at an undervalue and its purpose is either to put assets beyond the reach of creditors or to otherwise prejudice some person. Importantly, for these purposes a “transaction” includes a gift, a transaction for no consideration in return, or consideration where the company receives significantly less than the value it provides.
- AWA’s directors breached their duty to have regard to AWA’s creditors. Broadly speaking, where a company is in or close to insolvency, the company’s directors must have regard to the company’s creditors, rather than its shareholders. BTI argued that paying the dividend depleted the assets available to creditors and breached that duty.
Was the dividend invalid under section 423?
At the initial hearing, the High Court found the dividend was caught by section 423 and was therefore invalid. Importantly, it said that a dividend could constitute a transaction at an undervalue. This was an important confirmation, and the High Court has since followed this approach (for example, in Dickinson v NAL Realisations (Staffordshire) Ltd).
Sequana appealed against the High Court’s ruling. However, the Court of Appeal has now confirmed the High Court’s view. David Richards LJ has made it clear that a dividend can fall within section 423 and so can be challenged if it is intended to remove assets from the reach of creditors.
Sequana argued that, on a technical basis, dividends fall outside section 423. It said a dividend is neither a gift (rather, it is a return on a contractual investment) nor a transaction with someone (because it is a unilateral act by a company).
The court agreed that a dividend is not a gift. However, it said that a dividend can be a “transaction” for the purposes of section 423, even if it was a unilateral act. It did not need to be a transaction with someone to be caught by section 423. However, in this case, the dividend was a transaction with someone – Sequana – because Sequana had entered into a set-off arrangement with AWA.
Moreover, AWA had paid the dividend intending to put assets beyond the reach of AWA’s creditors. A key purpose of the dividend was to reduce the debt owed to AWA by Sequana. In doing so, one of AWA’s significant (and only) assets – its receivable from Sequana – was significantly reduced in value.
Did AWA’s directors breach their duty?
No. The Court of Appeal upheld the High Court’s original finding, namely that no duty to consider AWA’s creditors had arisen. Whilst AWA’s directors had made provision for the contingent liabilities in question, this did not itself mean AWA was insolvent or close to insolvency. In fact, it was not, and so the duty to consider AWA’s creditors never arose.
Although this decision simply confirms the High Court’s original decision, it emphasises the care and vigilance with which directors of a company need to act when paying dividends.
Section 423 is very wide. It is not just liquidators and administrators who can bring a claim. Anyone can challenge a transaction by a company if they are prejudiced, or capable of being prejudiced, by that transaction. This is not limited to creditors, and there is no need to wait until the company becomes formally insolvent.
As the decision shows, a dividend is one kind of transaction that can be susceptible to challenge. Company directors will need to bear in mind the potential for challenge under section 423 when paying dividends.
The decision will also be relevant to section 238 of the Insolvency Act 1986, under which a liquidator or administrator of a company can seek to “unwind” historic transactions at an undervalue.
Among other things, directors should ask themselves:
- Does the company have enough distributable profits to pay the dividend? If not, some or all of the payment will be a return of capital and need to be paid back.
- Can the company justify the dividend by reference to accounts? If the company cannot justify it by reference to its most recent annual accounts, it will need to draw up specific interim accounts.
- What is the purpose of the dividend? If all or part of the motive behind the dividend is to remove assets that could be used to satisfy claims, there is a real risk that creditors or others could challenge the dividend and seek to reverse it.
- Is the dividend consistent with the directors’ duties? If paying the dividend will leave the company unable to meet potential claims, it may be that the directors are not promoting the success of the company.
- Should the directors be thinking about the company’s creditors? If the company is insolvent or likely to become insolvent, the directors must have regard to the company’s creditors and will need to put their interests before those of any other stakeholders (including shareholders).
The Financial Conduct Authority (FCA) has published Primary Market Bulletin 20. The Bulletin sets out a few topical points of interest, confirms new guidance following previous consultations, and seeks views on new proposed changes to existing FCA guidance.
The key points for issuers are as follows:
- The FCA will be phasing out the UKLA name. Legally, the UKLA label has been defunct since 2013, when responsibility for listing securities and related matters was re-delegated directly and permanently to the FCA in its own right (rather than as the UKLA).
- The FCA reminds issuers that the related party transactions regime in Listing Rule 11 may apply where they are seeking approval to release shareholders and directors from liability in connection with unlawful dividends. It notes specifically that issuers should refer to Technical Note 204.2.
- The Bulletin provides some guidance for issuers in the extractive and logging industries on submitting information on payments to governments under DTR 4.3A. The FCA notes that there are a number of respects in which current reporting is not fully compliant.
- Following its previous consultations, the FCA has published new technical notes on quantified financial benefits statements (TN/315.1), cash flow statements in prospectuses (TN/635.1), sponsor’s duties in relation to directors’ responsibilities (TN/718.1), an issuer’s internal procedures (TN/719.1) and transactions that might have an adverse impact (TN/720.1).
- Also following previous consultations, the FCA has amended its technical notes on mix-and-match share buy-backs (TN/202.2), profit forecasts and estimates (TN/340.2), DTR 5 vote-holder notifications (TN/541.2), exemptions from preparing a prospectus (TN/602.2), and a sponsor’s duty in relation to the directors’ judgment of an issuer’s financial position (TN/708.3).
- Finally, the FCA is consulting on minor amendments to (among other things) its technical note on complying with the Listing Principles (TN/203.4); it is proposing to publish new procedural notes on implementing transactions using a scheme of arrangement (PN/913.1) and using the FCA’s Sponsor Service Enquiry Line (SSEL) (PN/912.1).
- Prospectuses. The European Securities and Markets Authority (ESMA) has published a note on the threshold in each EU member state, Iceland and Norway below which a prospectus is not required to offer securities to the public. The note also contains a summary of any rules that apply in a given state to an offer that falls below the threshold in that state.