When a company seeks investment, they do so not only for financial support, but also for a mentoring hand that will help guide their business to commercial success.
But while that may be the expectation, the relationship between investor and investee needs to be nurtured and expectations must be managed as the journey progresses. And if one party isn’t happy with the conduct of the other, there are paths that can be followed.
2022 yielded some interesting case law that provides useful guidelines to shareholders, sponsors, and management teams of both performing and underperforming portfolio companies on issues concerning the relationship between companies and their backers.
The case law as reported were:
- BTI 2014 LLC v Sequana SA and others [2022] UKSC 25
- Barclay-Watt v Alpha Panareti Public Ltd [2022] EWCA Civ 1169
These cases are important to understand because they deal with directors’ extended duties and liabilities as well as the class of actions that can be taken by shareholders.
We will go through the key highlights of the cases below.
BTI 2014 LLC v Sequana SA
This case brings clarity in terms of where directors’ duties lie when prioritising both creditors’ and shareholders’ interests and the framework for directors to follow when they are faced with the possibility of insolvency.
The appellants in this case sought to overturn a ruling by the Court of Appeal that said a “real but not remote risk” of insolvency is not sufficient to impose a duty on the company’s directors to take into account the interests of the company’s creditors. This appeal therefore put in issue the question of whether and when such a duty is imposed upon the directors of a company.
The Supreme Court decided that:
- A director’s duty to act in the interests of the company should consider the interests of the company’s creditors “as a whole”.
- When the company is financially stable, the shareholders will have the predominant economic interest in the company and their interests will normally be aligned with the company’s creditors.
- However, when the directors know, or ought to know, that the company is insolvent, or bordering on insolvency, or when an insolvent liquidation or administration is ‘probable’, the directors should have regard to the company’s general body of shareholders and creditors.
- In the event that shareholders’ and creditors’ interests are in conflict, a balancing act that reflects the financial position of the company will be necessary. The court held that “as a general rule […] the more parlous the state of the company, the more the interests of the creditors will predominate, and the greater the weight which should therefore be given to their interests against those of the shareholders”.
The Supreme Court diverged from the Court of Appeal in ruling that the interests of creditors and shareholders are likely to remain aligned at the point when it merely appears that a company “is likely to become insolvent at some point in the future” (i.e. without the sense of imminency of a company ‘bordering’ on insolvency, or that this is probable), and therefore whether creditors’ interests were paramount at that point.
The Court was split on whether the duty was engaged when an insolvent liquidation or administration is ‘probable’, with the majority considering that the duty arose in such circumstances.
When it appears that there is no reasonable prospect of avoiding insolvency (following both cashflow and/or balance sheet tests), directors will need to work through their decisions carefully and be mindful of their potential personal liability should they fail to properly consider the interests of creditors. It is also important that directors take advice when entering into transactions that could prejudice creditors or when facing insolvency (for example, the payment of dividends).
Barclay-Watt v Alpha Panareti Public Ltd
This case was brought by investors who challenged directors for not carrying out their duties properly.
The case concerned an alleged breach of duty of care by Alpha Panareti Public Ltd (“APP”) to UK investors by APP’s sales personnel marketing new build properties constructed overseas without providing appropriate warnings of certain risks. The High Court found that APP had made numerous misrepresentations and given negligent advice, and in doing so had breached its duty of care to those investors and was therefore liable for its tortious acts.
The company appealed the first instance decision and investors cross-appealed, arguing that the High Court should also have found one of the two directors of APP personally liable for the company’s wrongdoing as a joint tortfeasor. The director in question was the Managing Director of APP and, it was argued by the investors, the driving force behind the marketing plan, although it was held by the High Court that he had no personal contact with the investors.
Both appeal and cross-appeal were unsuccessful, and ultimately the Court ruled:
- That a director could not have personal liability where they had not assumed a personal responsibility to the wronged party and a “special relationship” did not exist, and that assumption of personal responsibility had not been relied on.
- In respect of whether the director had been an accessory to APP’s tortious acts, the Court considered that it was important that the tortious acts here concerned negligent omissions, not deliberate deceit, and the director was not accused of deliberately preventing the company’s sales personnel from giving appropriate warnings of the risks.
It should be noted that this judgment will not protect a director that:
- (i) has in some manner assumed personal responsibility to the wronged party for the tortious act, or
- (ii) made a conscious decision that the company should make the tortious act in question and so give rise to liability as an accessory.
Key Takeaways
- Plan and have suitable insurance in place
- At Board level, implement a good and transparent communication best practice policy between sponsors, and management teams. If it doesn’t feel right, it probably isn’t so when it comes to dividend distributions honest conversations about current (not past) performance are best.
- For management teams, having an actionable and workable plan running different scenarios in the event of distress is a must-have.
- Consider due diligence, pre-investment risks analysis, detailed investment structures, and a balanced contractual framework that governs the relationship.
- Look beyond the figures, it all boils down to having the right approach with people.
- Not all disagreements need the court. Legal actions are disruptive and can indeed create distress, seek resolution from a commercial and operative point of view by having the right pair of hands to help.
At GoTo Generator we have a broad range of skill sets to assist where needed most. When it comes to company, contractual and insolvency law issues we take a practical and commercial view to plan and action in order to help navigate challenges in the interest of the business as a whole.
We have good working relationships with first class lawyers and barristers and are able to quickly mobilise expert teams to support our clients.
Contact us for support.
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About GoTo Generator
Generator are senior specialists collaborating in teams on projects to deliver value-based outcomes.
Our promise to our clients:
- We deliver outcomes faster and more efficiently than individual providers
- We operate an expertise-based model which means the senior specialists who take on the project PLAN, EXECUTE and DELIVER the project
- We share our experience and expertise using our hands-on approach
- We deliver faster results often achieving multiples of ROI on EBITDA/Cash
- We work with companies who have a strong desire and ambition to grow, accepting that change is part of that process.
