A review of directors liabilities of an insolvent company in the US and England.docx
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A review of directors liabilities of an insolvent company in the US and England.docx
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AreviewofdirectorsliabilitiesofaninsolventcompanyintheUSandEngland
J.B.L.2001,Jan,33-57
Page_
(Citeas:
)
©2012ThomsonReuters.
J.B.L.2001,Jan,33-57
Page_
(Citeas:
)
©2012ThomsonReuters.
J.B.L.2001,Jan,33-57
JournalofBusinessLaw
2001
Areviewofdirectors'liabilitiesofaninsolventcompanyintheU.S.andEngland
MohammadR.Pasban
©2012Sweet&MaxwellanditsContributors
Subject:
Insolvency.OtherRelatedSubject:
Companylaw
Keywords:
Corporateinsolvency;Directorsliabilities;Directorsliabilities;UnitedStates
*33Asacompanyapproachesfinancialdifficulty,aconflictofinterestsbetweenshareholdersandcreditorsseemsinevitable,andtheroleofitsdirectorsbecomesmoreandmorecrucial.Theissueofdirectors'dutiesandliabilities,especiallyinthecaseoffinancialdepression,hasbeenasignificantconcernoflawyers.Thisisparticularlysointhecaseofitsinsolvency,wherethecorporateshareholdersarereplacedbyitscreditorsasanewclassofbeneficiaries,andthedirectors'dutiesshiftfromtheformertothelatter.Theaimofthisarticleis,inthelightoftheLawCommissionproposedstatutorydraft,toexaminesuchduties,andtheliabilitiesresultingfrombreachofthosedutiesininsolvency.Wecompareadirector'sdutiesandliabilitiesininsolvencyinEnglandandtheUSA,inordertodrawapictureofthepresentstateofstatutoryaswellascaselawinthetwolegalsystems.
Introduction
Inacompany,twoorgansareimportant,shareholderswhomaketheirdecisionsingeneralmeetings,anddirectorswhocontrolandmanagethecompanyincollectiveco-operationasaboard.Thissituationbecomeslegallycomplexwhenbothorgansaredominatedbythesamepersons,moreparticularlywhenthecompanyisonthevergeofinsolvencyortechnicallyinsolvent.
Fromtheearlyhistoryofcompanylaw,thecompany'sdirectorshaveoweddutiesandobligationstoitsmembers.Dutiesarealsoowedasthenewtrendofcaselawdemonstrates,tothecompany'screditorsandtosocietyatlargewhoseinterestsshouldbeprotected.Additionally,acompany'sconstituentsmaysometimessufferlossthroughtheabuseoftheprivilegeoflimitedliabilitybyitsdirectors.Theissueofpersonalliabilityofdirectorsandtheirbeingcalledtoaccountforshelteringbehindthecorporatepersonality,andasshareholders,behindlimitedliability,iscurrentlymuchdiscussed.
Thetraditionalconceptoflimitedliabilitysimplymeansthatcompany'sdebtsorresponsibilities,inparticularwhenithasgoneintoinsolvency,shouldnotaffectitsdirectors'andshareholders'personalassets.Thecompanycreditorsarenot,thus,entitledtotargetthemforrecoveringthedebtsowedbythecompany,*34thoughevenintheearliestcasesthisdidnotpreventthecourtsfromholdingdirectorsliableasquasi-trusteesformanagingtheircorporationnegligently.1
Inmoderncompanylaw,whiletheconceptofthe“company”asaseparateentityfromitsshareholderswithitsownassetsandliabilitiesisrecognised,thereisanincreasingdemandfortheimpositionofliabilityuponthosewhohaveabusedtheprivilegeoflimitedliabilityfortheirowninterestattheexpenseofcreditorsandsocietyasawhole.
TheaimistoexaminetheattitudeofEnglandandWalesandtheU.S.withregardtothecompanydirectors'liabilitiesforthefinancialdistressoftheirrespectivecompaniesandcorporations.
ThesourceofthestudyinEnglishlawiscaselawandtherelevantstatutesincludingtheInsolvencyAct1986,theCompaniesAct1985,andtheCompanyDirectorsDisqualificationAct1986andtheirpredecessorsrespectively.
TheU.S.sourceoflawismainlybasedoncaselaw.Astothestatutorylaw,Federallaw,whichissupposedtotouchonthisarea--namelytheBankruptcyCode1978andtheSecuritiesAct1933andtheSecuritiesExchangeAct1934--doesnotattendtotheissueofdirectors'liabilitiesininsolvency.IfwearetofindanyparallellawtocomparewithEnglishlaw,wemustlooktoStatelaws,themostsignificantbeingapatternformanyStates'legislation,Delawarecorporationlaw.
ThemajordifficultyinherentintheU.S.partofstudyisthatbothFederalandStatestatutes,includingtheDelawareGeneralCorporationLaw,aresilentastothedirectors'liabilitiesininsolvency.ThisproblemtoalesserextentcanbealsoseenintheAmericancaselaw.IthasbeenacknowledgedevenbyAmericanlawyersthatsomeonereadingU.S.lawinthecorporateinsolvencyarea,willsoonfindthatonlya“fewjudgesorscholarshavetakenthisobservationtoheart”.2
Theotherdifficultyfacedbythestudyiscomingtoaclearunderstandingofthescopeofdirectors'dutiesbecausedirectors'liabilitiesinthisregardcanonlyresultfromabreachordisregardoftheirduties.
Forthepurposesofthisstudy,insolvencyinEnglishlawmeansthatdefinedinsection214(6)oftheInsolvencyAct1986.3InU.S.law,theinsolvencyisconsideredasacombinationofthedefinitiongivenbysection1302oftheDelawareGeneralCorporationLaw,4andsection101(3)oftheBankruptcy*35Code,5totheeffectthatfilinganypetitionunderChapter11forreorganisationorunderChapter7forliquidationmeansinsolvency.
CorporateDirectors'Duties
Directors'DutiesinGeneral
Generallyspeaking,Englishcompanydirectorsowetwomaindutiestotheircompanies,thedutyofcareandskill,andawholeseriesofdutiesusuallycombinedintermsoftheirdutiesasfiduciaries.6
ThosedutiesarealsorecognisedbyU.S.lawbutunderadifferentclassification.Inthatlegalsystem,adirector'sdutiestohiscorporationincludethefiduciarydutyofcareandthefiduciarydutyofloyalty.Inotherwords,theconceptoffiduciaryintheU.S.appliestoboththedutyofcareandthatofloyalty.
InbothEnglish7andU.S.8lawsthemainimplicationsofdutyofcarearetherequirementsofattentionandattendance.However,U.S.lawalsorecognisesanotherfunctionfordutyofcarewhichisthatofthedutyofenquiry.9Thisisquiteunderstandable,becausethereisacloseconnectionbetweenthedutyofcareandthebusinessjudgmentrule,10sinceinorderforadefendantdirectortoinvoketheprotectionoftherule,heshouldshowthathisbusinessdecision,whichhasbeenthesubjectofcomplaint,wasproperlyinformed.11
ThefiduciarydutyofloyaltyintheU.S.12orfiduciarydutyinEngland13bearasimilarmeaning,themainimplicationofwhichisdevotinganundividedloyalty*36tothecorporationonthepartofdirectors,ortoavoidstandingonbothsidesofatransactionwhichmayleadtoconflictofinterests.
DutiesOwedtoCreditors
DutiesPriortoInsolvency
ThetraditionalviewinEnglishlawhasbeenthatdirectors'dutiesareowedtothecompanyandtheinterpretationgiventotheterm“company”inthiscontexthasbeentakentoencompasstheshareholdersasabody--notindividualshareholdersandnotcreditors.14Thedirectorshavenotbeenconsideredtobetrusteesforthecreditorsandtraditionallyowednodutytothem.Onthebasisofthisview,creditorsareconsideredascontractualclaimantsandshareholdersasownersofthecorporation.Theformerare,thus,treatedasnotbeingentitledtoanythingmorethanwhatisagreeduponundertheparticularcontract.15
However,thereisnowanoticeabletrendinEnglishlawtoincludeacompany'screditorswithinthegroupofitsstakeholders.16InEngland,17likeNewZealand18andAustralia,19recentcaseshaveindicatedthatcertaindutiesareowedbydirectorstocreditorsevenpriortoinsolvency.20InWestMerciaSafetywearv.Dodd,21itwas,asclaimed,22suggestedthatdirectorsowedadutytocreditorsbeforewindingup,aviewthatfollowedWinkworthv.EdwardBaronDevelopmentCo.Ltd.23
*37Astotheappropriatestandardofassessingdirectors'duties,theEnglishcourtshaveappliedtherulethatdirectorsdonothavetodemonstratespecialcareinservingontheboard.24Thissubjectivestandardhasbeencriticisedastoolaxtosatisfytheneedsofmodernbusinessrelationshipsandprotectthecompanyanditsconstituents'interests.25
Asweshallsee,thelegislature,byenactingsection214(4)onwrongfultrading,hasrespondedtothecallforchange.26
MostoftheU.S.jurisdictions,particularlyDelaware,giveprecedencetothedirectors'dutiestoshareholdersonthebasisoftheargumentthatanydutyowedtocreditorsiscontractualratherthanfiduciary,27andtheclaimsofcreditorsofafinanciallyhealthycorporation,thatthedirectorshaveadutytothem,haveusuallyfailed.28
Thisviewisbasedonthetheoryknownas“agencytheory”.exemplifiedinClarkv.Lawrence,29whereitwasheldthatcreditorscouldnotsuedirectorsformismanagement.Accordingtothistheory,corporatedirectorsaretheexclusiveagentsofstockholders,andthecreditors'rightsareentirelygovernedbyprivatecontracts.30Acorporatedirectormay,thus,beheldliableifhebenefitscreditorsattheexpenseofshareholders.31
IntheU.S.,particularlyinDelaware,thisstandardistosomeextentthesubjectivestandardof“areasonablyprudentman”32basedon“carewhichordinarilycarefulandprudentmenwoulduseinsimilarcircumstances”.33
*38Directors'DutiesuponInsolvency
Onceacompanybecomesinsolventorevendoubtfullysolvent,becausetheprimarypersonsinterestedareitscreditors,thedirectors'dutiesshiftfromshareholderstocreditors.34TheEnglishcaseofBrady&Avonv.Brady35acknowledgedthisruleasfollows:
“Wherethecompanyisinsolvent,orevendoubtfullysolvent,theinterestsofthecompanyareinrealitytheinterestsofexistingcreditorsalone.”36
IntheleadingcaseofWestMerciaSafetywearv.Dodd,37DillonL
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