Brink of Insolvency – Directors’ Duties post-Carlyle 31 October 2017
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This is the second Briefing Note in our series arising out of the case of Carlyle Capital Corporation Ltd v Conway & Others. Babbé acted as lead counsel for the Defendants and successfully defeated all the claims brought against the Defendants in the case. This note focuses on how directors’ duties change when a company is at risk of insolvency.
In the case, the Plaintiffs alleged that, as Carlyle Capital Corporation Ltd (“CCC”) was insolvent or in the zone of insolvency in August 2007, the directors had a duty to have proper regard to creditors’ interests in the decisions they took and, as a result, should have taken immediate steps to sell some of CCC’s assets to improve CCC’s overall financial position.
The Defendants denied this allegation for two reasons. Firstly, on the ground that this duty never arose since at the time CCC was never insolvent or close to insolvency. Secondly, even if the duty had arisen, the directors had fulfilled it by adopting a strategy of preserving the company’s assets from August 2007 onwards and that such strategy was in both the best interests of CCC’s creditors and its shareholders. The directors were not in a position to foresee the subsequent financial crisis in March 2008 and which ultimately led to the demise of CCC.
The case considered when a director is under a duty to have regard to creditors’ interests, the nature of such duty and the extent to which it applied in the specific circumstances of CCC.
Carlyle Capital Judgement
The Judge in the case (Lieutenant Bailiff Hazel Marshall QC) confirmed that, as a matter of Guernsey law, directors have a fiduciary duty to take proper regard of creditors’ interests when a company is close to insolvency.
The Judge decided that the phrase “on the brink of insolvency” best described when such duty arose (rather than alternative phrases such as “in the zone of insolvency” which might be taken as suggesting a longer period pre- insolvency). She summed up the approach to be taken in Guernsey as:
“In my judgment the principle, as it applies in Guernsey law is that once it is recognised that the company is “on the brink of insolvency”, the directors’ duty to act in the best interests of the company extends to embrace the interests of its creditors, and requires giving precedence to those interests where that is necessary, in the particular circumstances of the case, to give proper recognition to the fact that the creditors will have priority of interest in the assets of the company over its shareholders if a subsequent winding up takes place.”
In the particular circumstances of the Carlyle case, the Judge confirmed that the interests of the creditors and shareholders of CCC were aligned and the Court held that the Directors had discharged their fiduciary duty in this regard.
Key Points from Carlyle Capital judgement
- removes any doubt that the fiduciary duty of directors to have proper regard to the interests of creditors does form part of Guernsey law. Prior to this judgment there had been no Guernsey authorities which indicated whether or not this was the case
- clarifies that the duty arises when a company is “on the brink of insolvency”
- explains that the duty requires directors to have proper regard to the interests of creditors, giving them precedence where necessary in particular situations
- provides guidance as to which factors the Court will look at in determining whether the directors have breached this duty and
- re-iterates that the specific factual circumstances of any case need to be carefully evaluated.
For more information on this and any legal principles applicable when companies are at risk of insolvency, please contact Todd McGuffin and Nick Robison.
This note is for information purposes only and is not intended to be legal advice.