Credit Management June 2019

LEGAL MATTERS
Cash Flows
A polluted river and ill-considered dividends
led to an interesting case of fraud.
AUTHOR – Peter Walker
THE effects of a river
polluted with polychlorinated
biphenyls – thankfully
shortened to PCBs
– have flowed from its
source in the USA to
London’s Court of Appeal, where there
was a significant judgment in the area
of defrauding creditor. Section 423 of the
Insolvency Act 1986 regarding ‘transactions
defrauding creditors’ figured prominently
in the case. The judgment started
with a reference to its chemical origins in
BTI 2014 LLC v Sequana SA [2019] EWCA
Civ 112.
Chemicals caused the pollution of
the Lower Fox River in Wisconsin in
the 50s and 60s. In 1978 BAT Industries
had acquired paper businesses
‘responsible for extensive pollution’ of
the river, but the claims in the USA under
the Comprehensive Environmental
Response, Compensation and Liability
Act 1980 (CERCLA) only commenced
in the 90s. Businesses manufacturing
carbonless paper had dumped the
resulting toxic chemicals into the river.
Carbonless paper was useful in the days
before the convenience of personal
computers and printers, because you
could write on the top paper and the
writing would be transferred to perhaps
as many as five or six pages underneath.
In the 80s I designed for a company a
stock control and ordering system based
on this technology, when I was unaware
of the toxic results of the manufacturing
of this paper.
Much later in 1998 the Lower Fox River
paper manufacturing businesses agreed
among themselves how to share the
environmental liabilities. The CERCLA
obligations embraced cleaning-up
costs and damages of natural resources
including the river pollution. There were,
however, various changes of ownership
of the companies and consequent
indemnities against liabilities.
In the year 2000, for example, a
company known as Sequana bought
another company known as AWA,
which owned the paper manufacturing
companies. It later sold those businesses
subject to an indirect indemnity relating
to the agreement made in 1998. It also
purchased a guaranteed investment
policy to provide funds for all aspects
of the Lower Fox River liability. By
2008 its value was US$250 million, but
consequently AWA ceased to be a trading
company.
BALANCE SHEET AND DIVIDEND
It was, however, a subsidiary of Sequana,
to which it paid the proceeds of the sale
of the businesses and other receipts. This
indebtedness was an asset in AWA’s books
as was the policy, but on the other hand it
had contingent indemnity liabilities. Its
balance sheet showed net assets of €517
million made up of share capital of €318.6
million, a share premium account of
€69.8 million and distributable reserves
of €128.6 million.
In the light of this information the
Directors of AWA decided in December
2008 to pay a dividend of €443 million.
To do that the paid-up share capital
was reduced to €1 million, and the
share premium account was cancelled.
No money changed hands, but the
indebtedness of Sequana was reduced to
€142.5 million.
That was December, but early in the
following year there was the question
of whether the contingent liability
concerning the environmental liability
should be included in the accounts
for the year ended 31 December 2008.
There was, of course, the guaranteed
investment policy, and it was decided
that it was sufficient to cover any
contingent liability, so there was no need
to include a provision for such a liability
in the accounts. I am mystified at such
a conclusion, but perhaps I am just a
grumpy old-fashioned accountant. There
was consequently a distributable reserve
of €137 million in the balance sheet.
The directors of AWA therefore decided
in May to pay a dividend of around €135
million to the parent company Sequana.
No money changed hands, because the
indebtedness of that company to its
subsidiary was reduced by that amount
to about €3.1 million. The decision to
pay this dividend was influenced by the
desire of the Sequana directors to sell
AWA to another company. The directors
thought that the sale of AWA under these
conditions would mean that Sequana had
limited, perhaps excluded, any guarantee
under the Lower Fox River risk.
COULD OR SHOULD NOT PAY
Both dividends of December and of May
were challenged in the lower court on
the basis that they were not lawfully
paid in accordance with Part 23 of
the Companies Act 2006 (a ‘could-notpay’
claim). The second challenge was
that the dividend was in breach of the
directors’ duties regarding creditors (a
‘should-not-pay’ claim). Mrs Justice Rose,
however, decided that the claim against
the directors in respect of the December
dividend failed. She also concluded
that the May dividend was caught by
the provisions of section 423(1) of the
Insolvency Act 1986.
That section defines ‘transactions
defrauding creditors’. They include gifts
or transactions for which there is no
consideration (s 423(1)(a)). There are
also transactions at an undervalue (s
423(1(c)). One remedy is to restore the
original position as if the transaction
had not happened (s 423(2)(a)), while
another is to make an order protecting
the interests of the transaction’s victims
(s423(2)(b)). The court, for example, may
only make an order if the purpose was
to place the assets beyond the reach of
someone making or potentially making a
claim (s423(3)(a)). The court alternatively
should be satisfied that the purpose of the
transaction was to prejudice the position
of an actual or potential claimant.
In the Court of Appeal Richards LJ
asked if a dividend was a transaction at
an undervalue, and he answered himself
that the declaration of a dividend created
a debt owed by the company to its
shareholders. It was also not a transaction
as a gift, because a dividend was a return
on the shareholders’ investment.
Richards LJ then considered whether
a dividend was a transaction for no
consideration. He favoured the view of
Lord Millett in a tax case, Inland Revenue
Commissioners v Laird Group plc [2003] 1
WLR 2476. At that time Lord Millett said
The Recognised Standard / www.cicm.com / June 2019 / PAGE 40