The Shifting of Directors' Duties in the Vicinity of Insolvency

• Date: 01 June 2015
• Published date: 01 June 2015
• DOI: http://doi.org/10.1002/iir.1236
• Author: Andrew Keay

The Shifting of Directors’Duties in the

Vicinity of Insolvency

Andrew Keay*

Professor of Corporate and Commercial Law, Centre for Business Law and Practice, School of Law, University of Leeds

and Barrister, Kings Chambers, (Manchester, Leeds and Birmingham), UK

Abstract

Directors are obviously critical to the management of companies, and perhaps even

more so when a company is in financial difficulties. This paper examines the position

of directors when their company is in the vicinity of insolvency. It provides an analytical

exposition of the law that exists in common law jurisdictions where, in the vicinity of

insolvency, there is a shift in the nature of the duties of its directors, namely, directors

have to take into account the interest of the creditors when exercising their powers and

discharging their duties. The paper endeavours to identify and discuss the main

problems that exist with this shift in the nature of duties so that if other jurisdictions

do consider implementing it, they are aware of the drawbacks and may be able to

address them. Copyright © 2015 INSOL International and John Wiley & Sons, Ltd

I. Introduction

The role of directors in companies is incredibly important for many reasons. In order to

discharge this role in most jurisdictions around the world, either the legislation or the

company’s own articles of association (by-laws) endows them with broad powers to

manage the affairs of the company. This power inevitably means that obligations and

responsibilities are placed on directors. Of great importance in this regard are the duties

that are imposed on directors, predominantly by statute, but alternatively in some

jurisdictions, such as Hong Kong, by case law. In some jurisdictions, such as Australia,

dutiesarelaiddowninbothcaselawandlegislation.Muchdiscussionhasbeenentered

into across the world concerning the nature of the duties owed by directors and,

particularly, in relation to whom those duties are owed. The duties are often said to

be owed to the company. Legislation often provides that the duties are to be exercised

in the best interests of the company. This can mean a number of things. It often will

depend on how the courts decide what ‘company’means in the circumstances.

Generally speaking, the focus tends to be in Anglo-American jurisdictions, and even

* E-mail: a.r.keay@leeds.ac.uk

Copyright © 2015 INSOL International and John Wiley & Sons, Ltd Int. Insolv. Rev., Vol. 24: 140–164 (2015)

Published online 1 June 2015 in Wiley Online Library

(wileyonlinelibrary.com). DOI: 10.1002/iir.1236

some civil law systems such as China, on the interests of the shareholders, while in some

jurisdictions, such as Germany and the Netherlands, the interests of other stakeholders

might come into play regularly or at least in certain specified circumstances.

The general approach, particularly in Anglo-American jurisdictions, is that when a

company is solvent, the shareholders’interests are primary as they have invested

capital in the company, and if the company is successful, then they will benefit substan-

tially; but, if the company fails financially, the shareholders will lose much, if not all, of

their investment because all creditors will be paid before shareholders have any of

their investment returned to them. But in the case where a company is in financial

difficulty and might be within the vicinity of insolvency, a change of approach might

well apply. The vicinity of insolvency might be seen as an imprecise term. But usually

it is regarded as a point of time that is often referred to as ‘the twilight zone’or ‘zone of

insolvency’, when the company is in financial distress and may well be moving from

solvency towards and even into insolvency. It has been said that it is a period ‘in which

there is a deterioration of the company’sfinancial stability to the extent that insolvency

has become imminent.’

1

As one might expect, whether a company is in the vicinity of

insolvency or not depends on the meaning that is given to insolvency in any particular

jurisdiction. In some jurisdictions, there is a shift in the nature of the duties of

directors which are owed when their company is in the vicinity of insolvency. I

explore the theoretical reason behind this shift briefly later on.

Over the past 40years, we have seen a substantial jurisprudence develop in the

UK and many other common law jurisdictions, such as Ireland, Australia, New

Zealand and Singapore, in relation to the shifting of the duties of directors when their

company is in insolvency or in the vicinity of insolvency.

2

That is, there is a shift in

the duties of directors to the extent that they are under a duty to take account of the

interests of the creditors of the company. In recent years, Working Group V

(insolvency law) of UNCITRAL has been studying the obligations of directors in

the period approaching insolvency, and the Working Group has sought to identify

the options that are available when a company is in the vicinity of insolvency in order

to inform policymakers as they seek to devise appropriate legal and regulatory

frameworks.

3

The Group has referred to the common law developments, which

involved the shifting of directors’duties and which are discussed in this paper.

4

1. UNCITRAL Legislative Guide on Insolvency Law,

‘Directors’obligations in the period approaching insol-

vency”Working Group V, 43

rd

session, New York,

15–19 April 2013 at para 22, and accessible at :

http://daccess-dds-ny.un.org/doc/UNDOC/LTD/V13/

807/89/PDF/V1380789.pdf?OpenElement (accessed,

1 December 2014)

2. The United States has also seen developments in

this area. See, for in stance, Credit Lyonnais Bank Ne-

derland,NV v Pathe Communications Corp (1991 Del

Ch WL 277613; LEXIS 215; (1992) 17 Delaware

Journal of Corporate Law 1099; North American Cat holic

Educational Programming Foundation Inc v Gheewalla,

930 A 2d 92 (Del, 2007); A. Dionee, “Living on

the edge : fiduciary duties, business judgment and

expensive uncertain ty in the zone of insolven cy”

(2008) 13 Stanford Journal of Law, Business and Finance

188; S. Willett, “Gheewalla and the Dire ctors’

dilemma”(2009) 64 Business Lawyer 1087; N.

Rubin, “Duty to creditors in insolvency and the

zone of insolvency : Delaw are and the alternati ves”

(2011) 7 New York Unive rsity Journal of La w and

Business 333.

3. The latest being, UNCITRAL Legislative Guide on

Insolvency Law, ‘Directors’Obligations in the period

approaching insolvency’Working Group V, 43

rd

session, New York, 15–19 April 2013 and accessible

at : http://daccess-dds-ny.un.org/doc/UNDOC/

LTD/V13/807/89/PDF/V1380789.pdf?OpenElement

(accessed, 1 December 2014)

4. It has not clearly endorsed the approach although

there are comments in recommendations that suggest

that the Working Group seem to think that it needs

to be considered: at pp 14–15.

The Shifting of Directors’Duties in the Vicinity of Insolvency 141

Copyright © 2015 INSOL International and John Wiley & Sons, Ltd Int. Insolv. Rev., Vol. 24: 140–164 (2015)

DOI: 10.1002/iir