Jonathan Thornton 13 Nov 2017 02:58pm

Insolvency litigators turning to third party funding

It is a common misconception that trading whilst insolvent is an offence and one that leads to personal liability on the part of the directors

Indeed, company and insolvency lawyers are long-used to fielding queries from directors of companies fearful that they could be personally liable for “trading while insolvent”.

In reality, English law contains no such offence. But when Carlyle Capital went bust in March 2008, just months after a $350m flotation, it isn’t surprising the company’s liquidators sought redress from the company’s directors. Questions were asked about whether their directors could be at fault – how could things have gone so badly without them being involved?

The original $2bn lawsuit (played out in both the US and Guernsey) alleged breach by the directors of their fiduciary duties to the company, gross negligence, statutory misfeasance and wrongful trading. Indeed, the directors were accused of operating Carlyle Capital “in reckless disregard of…overt and manifest risks…”.

But the directors (represented by Philip Marshall QC of leading chambers Serle Court) were exonerated after a seven year battle in the courts. The cause of the collapse, according to the court, was “the unforeseen systemic liquidity crisis among the banks”. Moreover, Carlyle was “not reckless or negligent”.

The decision shouldn’t be a surprise, especially to common law lawyers. Wrongful trading in England occurs if a director knows (or ought to have known) that a company cannot avoid insolvent liquidation or administration, and does not take every step to minimise the loss to creditors. Where a company is insolvent, misfeasance means improper performance or misconduct by a director, which results in a loss to the company.

Her Hon Hazel Marshall QC, Lieutenant Bailiff, stated that Carlyle’s “business model was reasonable” and the directors “made judgements to enable [Carlyle] to try to regain health and strength which were reasonable at the time”. The directors, however, just did not appreciate the depth of the instability in the financial markets, and it is only looking back in hindsight that you can get a fuller appreciation.

The Royal Court in Guernsey seems to have taken a view that where a company goes into insolvency and the creditors look to the directors to meet some of the company’s liabilities, the courts will not second-guess the decisions of the directors. Instead it will take into account the context those decisions were taken in. This is a view that will reassure practitioners and businesspeople alike.

It follows that if it was reasonable for an appropriately skilled director to make the judgement that the directors did make, then the court will not apply the benefit of hindsight to those decisions, and won’t look to re-open them in the light of subsequent events. This means that unless no reasonable director could have reached that decision, the courts will not intervene.

But this shouldn’t be seen as giving complete freedom to negligent directors to do as they please. Each case turns on its facts.

Ultimately, directors will be taken to have an objective standard of ability, which is required of a suitably skilled director in their position. They will also be expected to have taken reasonable steps to ensure they are appropriately informed about the affairs of the company for which they are responsible, its cash position, as well as its trading position and prospects.

Directors will find it reassuring that, on the basis of this case, that the courts will not, with the benefit of hindsight, substitute their own commercial wisdom for those of the directors. They will simply need to follow the guidance above, take appropriate advice and make a reasonable decision based on the best information available to them.

Jonathan Thornton, Managing Partner and head of the corporate and commercial team at Russell-Cooke