Court guidance as to the solvency statement on a reduction of capital

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A Ltd, a UK company, was a wholly owned subsidiary of S SA.  By reason of a series of corporate acquisitions BAT plc became liable to pay for an environmental clean-up operation in the United States and A Ltd was liable to indemnify it for part of that liability.  A provision was included in A Ltd’s accounts to reflect its directors’ best estimate of that liability.

A Ltd’s accounts also showed a large debt owing from its parent company. The directors wished to reduce the company’s share capital, declare a dividend in favour of the parent company and set off that dividend against the inter-company debt.

In support of the capital reduction each of the directors signed a statutory solvency statement confirming that in their opinion (i) there was no ground, as at the date of the declaration, on which A Ltd could be found to be unable to pay or otherwise discharge its debts; and (ii) A Ltd would be able to pay or otherwise discharge its debts as they fell due during the following 12 months.  The capital reduction proceeded and A Ltd paid an interim dividend to S SA by way of set off against the intra-group receivable and, subsequently, it paid a second dividend against release of the balance of the intra-group receivable.

A Ltd later brought a claim against its directors and S SA on the following grounds:

  • the accounts by reference to which the dividends were paid contravened the requirements of the Companies Act 2006. (A distribution must be justified by reference to “relevant accounts”, the requirements for which are set out in sections 836 to 839 of the Companies Act).  In so far as the relevant accounts were A Ltd’s last annual accounts (in respect of the second dividend), they contravened the requirement (in section 837(2)) that they be “properly prepared” or, to the extent that they were interim accounts (in respect of the first dividend), they did not enable a “reasonable judgment” to be made (section 838(1)).  This was because:
    • the accounts had been drawn up on the basis that the capital reduction had taken place and was effective to create sufficient distributable reserves to pay the dividend, whereas A Ltd argued, the capital reduction was vitiated by a defective solvency statement
    • the accounts made inadequate provision for the environmental liability
    • the accounts failed to make adequate disclosure of A Ltd’s contingent liabilities
  • the decision to pay the dividends was in breach of the directors’ fiduciary duties

BAT plc also brought a claim against S SA and A Ltd on the grounds that the dividends contravened section 423 of the Insolvency Act 1986, as transactions defrauding creditors.

The High Court [1] gave judgment in part in favour of BAT plc on the section 423 claim but dismissed all other claims.

Statement of capital

The statement of capital that the company had filed contained an error, with the figure stated for the reduced paid up share capital being incorrectly stated by a factor of 100 as the statement of capital had conflated the figures for the issued and authorised share capital.  This was not, however, sufficient to render the resolution invalid.  The Court cited prior authority (in relation to a declaration of solvency) [2] where the judge had stated “I do not think that I ought to impute to Parliament an intention to require perfection in a provision which contains no words to indicate this super-human standard”.  The same reasoning, the Court held, applied to a statement of capital made pursuant to a capital reduction.

Requirements of the solvency statement

Much of the Court’s judgment comprised an analysis of the requirements of the solvency statement in support of a capital reduction. The Court made the following points:

  • section 643(1) required the directors to have taken certain things into account to demonstrate that they had actually formed the opinions set out in the solvency statement.  It was not enough for the directors to say that they had formed those opinions if in fact they had not done so, for example, if they had misunderstood what was the correct test.  The Court must be satisfied that the directors had formed the opinions required and therefore applied the correct test in coming to those opinions
  • the test for establishing whether the company was unable to pay its debts was not a technical one. The directors needed to consider the contingent and prospective liabilities of the company in coming to their conclusion with consideration being given to the nature of the contingent and prospective liabilities, the assets available to meet them and what provision (in the non-technical sense) had been made to meet them
  • a solvency statement was not invalid simply because the directors did not have reasonable grounds for making the statement. The requirement for “reasonable grounds” was a necessary ingredient of the criminal offence in section 643(4) but it did not impact the validity of the solvency statement (and therefore the reduction of capital itself)
  • the directors were entitled to take into account the likely receipts under an insurance policy to meet the company’s prospective and contingent liabilities
  • the directors had formed the necessary opinion for the purposes of section 643. It followed that the two sets of accounts were not defective by reason of showing that the capital reduction had taken place.

The disclosure in the accounts regarding contingent liabilities

Under Accounting Standard FRS 12, where a liability is a contingent liability, no provision needs to be made, although there must be disclosure of the contingent liability.  Any defects in the disclosure made in the accounts were not relevant to the question whether the accounts gave a true and fair view or enabled a reasonable judgement to be made for the purpose of paying the dividend.  Section 836(1) provided that the lawfulness of a distribution was to be determined “by reference to the following items as stated in the relevant accounts”, namely profits, losses, assets and liabilities; provisions relating to depreciation or diminution in the value of assets or any amount retained as reasonably necessary for the purposes of providing for any liability the nature of which requires provision for accounting purposes.  The focus was on amounts rather than narrative, something reinforced by the wording of section 837(2) (in respect of the last annual accounts) which states: “The accounts must have been prepared in accordance with this Act, or have been prepared subject only to matters that are not material for determining (by reference to the items mentioned in section 836(1)) whether the distribution would contravene this Part”.  Further, the ability of directors to rely on interim accounts to determine the lawfulness of a distribution was another indication that disclosure notes were not relevant to the exercise.  The absence of any disclosure notes in the interim accounts supporting the first dividend did not therefore, render the accounts defective.

Breach of fiduciary duty

So long as a company is solvent, the directors are under a duty to promote the success of the company, having regard to the interests of the members as a whole. This duty is subject to any enactment or rule of law requiring the directors to consider or act in the interests of the company’s creditors.  At common law, where a company is insolvent, the directors must consider the interests of the creditors as paramount.  The case law indicates that the duty arises at an earlier point than insolvency but precisely when that point is reached is not wholly clear from the authorities.

The Court rejected the suggestion that simply because the company was at risk of becoming insolvent at some indefinite point in the future, the directors were under a duty to consider the interests of creditors as paramount. The authorities suggested that the duty arose where the company’s prospects were much more pessimistic than this, such as on the verge of insolvency, precarious or in a parlous financial state.  The Court was not prepared to accept the situation where there was a proper provision for a liability in the company’s accounts but there was a real risk that the provision would turn out to be inadequate.

It followed that the decision to pay the dividend was not a breach of fiduciary duty.

Transactions defrauding creditors

The Court rejected S SA’s argument that a dividend payment was not capable of being a transaction to which section 423 of the Insolvency Act applied.

The test for whether a transaction was a transaction defrauding creditors was a subjective one: what was the intention of the person making the transaction (as opposed to a “reasonable” person)?   In this case, there was no evidence that the first transaction was made for the purpose of defrauding creditors, but there was evidence to show that A Ltd, through its directors, had the intention of removing from the S SA group the risk that the indemnity liability to BAT plc for the environmental clean-up might turn out to be much more than the amount available from the insurance policies receipts.  The intention was to put the assets beyond the reach of BAT plc if the receipts from policies were not enough to meet the indemnity claim.

WM Comment

There are a number of points to take from this case:

  • that a mistake in a statement of capital following a capital reduction does not invalidate the capital reduction
  • the absence of reasonable grounds for the opinion set out in the solvency statement will not invalidate the solvency statement – though it may give rise to a criminal liability
  • the absence of a provision in respect of a contingent liability – which is noted in the relevant accounts – does not mean a distribution cannot be justified by reference to those accounts
  • the point at which directors are under a duty to consider the interests of creditors as paramount requires at the very least for the company to be on the verge of insolvency or in a parlous financial state and the simple existence of a contingent liability which the company may not have the resources to meet is not sufficient to meet this threshold
  • that a dividend may be capable of being a transaction at an undervalue within the meaning of section 423 of the Insolvency Act.


[1] BTI 2014 LLC v Sequana SA and others [2016] EWHC 1686
[2] De Courcy v Clement and another [1970] 1 Ch 693