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Directors' Duty to Creditors of a Financially Distressed Company: a Perspective from Across the Pond Donna W

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Directors' Duty to Creditors of a Financially Distressed Company: a Perspective from Across the Pond Donna W Journal of Business & Technology Law Volume 1 | Issue 2 Article 13 Directors' Duty to Creditors of a Financially Distressed Company: A Perspective from Across the Pond Donna W. McKenzie-Skene Follow this and additional works at: http://digitalcommons.law.umaryland.edu/jbtl Part of the Bankruptcy Law Commons, and the Business Organizations Law Commons Recommended Citation Donna W. McKenzie-Skene, Directors' Duty to Creditors of a Financially Distressed Company: A Perspective from Across the Pond, 1 J. Bus. & Tech. L. 499 (2007) Available at: http://digitalcommons.law.umaryland.edu/jbtl/vol1/iss2/13 This Articles & Essays is brought to you for free and open access by the Academic Journals at DigitalCommons@UM Carey Law. It has been accepted for inclusion in Journal of Business & Technology Law by an authorized editor of DigitalCommons@UM Carey Law. For more information, please contact [email protected]. DONNA W. MCKENZIE-SKENE* Directors' Duty to Creditors of a Financially Distressed Company: A Perspective from Across the Pond I. INTRODUCTION THERE HAS RECENTLY BEEN A REVIVAL OF INTEREST IN THE subject of the directors' duty to creditors where the company is financially distressed,' and it was consid- ered in some detail by the Company Law Review Steering Group, which was set up by the British government to review core company law in 19982 and reported in 2001? Although the duty is now generally regarded as well-established in princi- ple,4 there are important aspects of it that remain unclear, and the role of the duty in modern law has been questioned. This Article briefly outlines the development Senior Lecturer, School of Law, University of Aberdeen. I am grateful to Judith Pearson, formerly School of Law, University of Aberdeen, and Rachel Grant, Messrs. Semple Fraser, Edinburgh, for helpful comments on an earlier draft of this Article; any errors remain the responsibility of the author. 1. See generally Andrew Keay, The Duty of Directors to Take Account of Creditors' Interests: Has It Any Role to Play?, 2002 J. Bus. L. 379 (U.K.) [hereinafter Keay, The Duty of Directors]; Andrew Keay, Directors' Duties to Creditors: ContractarianConcerns Relating to Efficiency and Over-Protection of Creditors, 66 M.L.R. 665 (2003) (U.K.) [hereinafter Keay, ContractarianConcerns]; Andrew Keay, Directors Taking into Account Creditors Inter- ests, 24 Co. LAW. 300 (2003) (U.K.) [hereinafter Keay, Directors Taking into Account]; Andrew Keay, Another Way of Skinning a Cat: Enforcing Directors' Duties for the Benefit of Creditors, 2004 INSOLV. INT. 1 [hereinafter Keay, Another Way of Skinning a Cat]; David Milman, Strategies for Regulating Managerial Performance in the "TwilightZone"-FamiliarDilemmas: New Considerations,2004 J. Bus. L. 493 (U.K.); Andrew Keay, A Theoreti- cal Analysis of the Director's Duty to Consider CreditorInterests: The Progressive School's Approach, 4 J.C.L.S. 307 (2004) (U.K.) [hereinafter Keay, A Theoretical Analysis]; Andrew Keay, Directors' Duties-Do Recent Canadian Developments Require a Rethink in the United Kingdom on the Issue of the Directors' Duties to Consider Creditor Interests, 2005 INSOLV. INT. 65; see also VANESSA FINCH, CORPORATE INSOLVENCY LAW: PERSPECTIVES AND PRINCIPLES (2002). The duty may, in fact, be more accurately expressed as a duty to take into account the interests of creditors that arise where those interests are at risk, but this is a familiar and convenient shorthand that will accordingly be used here. 2. See generally Co. LAw INVESTIGATIONS & DIRECTORATE, MODERN COMPANY LAW FOR A COMPETITIVE ECONOMY (Mar. 1998). 3. See generally Co. LAW REV. STEERING GROUP, MODERN COMPANY LAW FOR A COMPETITIVE ECONOMY: FINAL REPORT (June 2001) [hereinafter Co. LAW REV. STEERING GROUP, FINAL REPORT]. 4. Although it has been argued that no such specific duty in fact exists because in each of the cases where it has been referred to, liability was clearly based on other grounds. See L.S. Sealy, Directors' Duties-An Unnec- essary Gloss, 47 C.L.J. 175 (1988) (Eng.) [hereinafter Sealy, Directors' Duties-An Unnecessary Gloss]; see also L.S. Sealy, Personal Liability of Directors and Officers for Debts of Insolvent Corporations:A JurisdictionalPerspec- tive (England), in CURRENT DEVELOPMENTS IN INTERNATIONAL AND COMPARATIVE CORPORATE INSOLVENCY LAW 485, 486-87 (Jacob S. Ziegel ed., 1994) [hereinafter Sealy, Personal Liability of Directors and Officers]. JOURNAL OF BUSINESS & TECHNOLOGY LAW DIRECTORS' DUTY TO CREDITORS OF A FINANCIALLY DISTRESSED COMPANY of the duty in Great Britain before exploring the uncertainties surrounding the duty, the treatment of the duty by the Company Law Review Steering Group, the government's response, and the role of the duty in modern British law. II. THE DEVELOPMENT OF THE DUTY IN GREAT BRITAIN As has been noted elsewhere,5 the development of the duty has been well docu- mented,6 but a brief outline is useful here. The development of the duty in Great Britain builds on Commonwealth authority. The duty is generally regarded as originating in the famous dictum of Mason J. in the Australian High Court case of Walker v. Wimborne: "[iun discharging their duty to the company," the directors are required to take into account "the interests of its shareholders and its creditors. Any failure . to take [the creditors' interests into account] will have adverse consequences for the company" and for the creditors themselves! The approach in that case was followed in other Commonwealth cases that have also influenced the development of the law in Great Britain, most notably Nicholson v. Permakraft (NZ) Ltd.9 and Kinsela v. Russell Kinsela Pty Ltd.'° In Great Britain, the first signs of recognition of the duty appeared in Lonrho Ltd. v. Shell Petroleum Co. Ltd.," where Lord Diplock stated that the best interests of the company, in which the directors were bound to act, were "not exclusively those of its shareholders but may include those of its creditors."' 2 Other cases fol- lowed. In Re Horsley & Weight Ltd.," Buckley L.J. spoke of directors owing an indirect duty to creditors not to permit any unlawful reduction of capital. 4 In 5. See, e.g, Keay, The Duty of Directors,supra note 1, at 381. 6. See, e.g., Sealy, Directors' Duties-An Unnecessary Gloss, supra note 4, at 175-77; Neil Hawke, Credi- tors' Interests in Solvent and Insolvent Companies, 1989 J. Bus. L. 54, 54 (U.K.); Vanessa Finch, Directors' Duties Towards Creditors, 1989 Co. LAW. 23 [hereinafter Finch, Directors' Duties Towards Creditors];C. Riley, Directors' Duties and the Interests of Creditors, 1989 Co. LAW. 87, 87 [hereinafter Riley, Directors' Duties]; see generally D.D. Prentice, Creditor's Interests and Director's Duties, 10 O.J.L.S. 265 (1990) (Eng.) [hereinafter Prentice, Creditor's Interests]; Ross Grantham, The Judicial Extension of Directors' Duties to Creditors, 1991 J. Bus. L., 1 (U.K.) [hereinafter Grantham, The Judicial Extension]; Ross Grantham, Directors' Duties and Insolvent Compa- nies, 54 M.L.R. 576 (1991) (U.K.); Razeen Sappideen, Fiduciary Obligations to Corporate Creditors, 1991 J. Bus. L. 365 (U.K.); Vanessa Finch, Directors' Duties: Insolvency and the Unsecured Creditor, in CURRENT ISSUES IN INSOLVENCY LAW 87 (A. Clarke ed., 1991) [hereinafter Finch, Insolvency and the Unsecured Creditor]; D.D. Prentice, Directors, Creditors, and Shareholders, in COMMERCIAL ASPECTS OF TRUSTS AND FIDUCIARY OBLIGA- TIONS 73 (Ewan McKendrick, ed. 1992) [hereinafter Prentice, Directors, Creditors, and Shareholders]; Ross Grantham, The Content of the Director'sDuty of Loyalty, 1993 J. Bus. L. 149 (U.K.); Sealy, PersonalLiability of Directors and Officers, supra note 4; CORPORATE AND COMMERCIAL LAW: MODERN DEVELOPMENTS 173 (David Feldman & Frank Meisel eds., 1996) [hereinafter CORPORATE AND COMMERCIAL LAW]; see also sources cited accompanying supra note 1. 7. (1976) 137 C.L.R. 1 (Austl.). 8. Id. at 7. 9. [1985] 1 N.Z.L.R. 242 (C.A.). 10. (1986) 4 N.S.W.L.R. 722 (Austl.). 11. [1980] 1 W.L.R. 627 (H.L.(E.)) (Eng.). 12. Id. at 634. 13. [1982] 3 All E.R. 1045 (C.A.) (Eng.). 14. Id. at 1055-56. JOURNAL OF BUSINESS & TECHNOLOGY LAW DONNA W. MCKENZIE-SKENE Multinational Gas and Petrochemical Co. v. Multinational Gas and Petrochemical Services Ltd.," Dillon L.J. appeared not to recognise the existence of the duty, stat- ing clearly that directors owed fiduciary duties to the company but not to the credi- tors, present or future. 6 In the later case of West Mercia Safetywear Ltd. v. Dodd,7 however, he distinguished Multinational Gas and Petrochemical Co. on the basis that in that case, the company had been amply solvent,'8 and he went on to quote with approval another famous dictum, that of Street J. in Kinsela v. Russell Kinsela Pty Ltd.,' 9 to the effect that "where a company is insolvent, the interests of the creditors intrude [and] [t]hey become prospectively entitled . .to displace the power of the . ..directors to deal with the company's assets . .. [because] in a practical sense [the company's assets are their assets]. " The existence of the duty was also recognized by the House of Lords in Wink- worth v. Edward Baron Development Co. Ltd.,2' the Court of Appeal in Brady v. Brady,2 and indirectly in Re Welfab Engineers Ltd., and, more recently, in Yukong Lines of Korea v. Rendsberg Investment Corp. of Liberia (No. 2)," FaciaFootwear Ltd. v. Hinchcliffe,25 Clydebank Football Club Ltd. v. Steedman,26 Re Pantone 485 Ltd.,27 Colin Gwyer & Associates Ltd. v. London Wharf (Limehouse) Ltd.,2' and Re MDA Investment Management Ltd.29 III. UNCERTAINTIES SURROUNDING THE DUTY A. Direct or Indirect Duty? Perhaps the most important area of uncertainty has been the question of whether the duty is an independent one owed directly to creditors, with the result that any creditor can take steps to enforce it against the directors, or whether it is an indirect one owed to the company to take account of the creditors' interests, with the result that it can be enforced only by the company." 15.
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