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Directors’ Duties in a Distressed Scenario: Where Are We Now?
Richard Tett, Partner, and Emma Norman, Associate, Freshfields Bruckhaus Deringer LLP, London, UKIntroduction
The topic of English law directors’ duties covers a broad range of aspects, each of which could form the subject of a detailed paper. The purpose of this article is to provide an overview of the sources of law which govern a director’s conduct, to explain how those duties apply in a distressed scenario and to summarise recent case law on the subject of de facto and shadow directorship.
The latter is likely to be of particular interest to restructuring and insolvency professionals. This is because it has the potential to impact upon the behaviour of lenders (who may take a more active role in the affairs of a distressed borrower) and may also expand the base of people against whom an officeholder can seek redress when investigating directors’ conduct following the commencement of an administration or liquidation.
Significant scope
A director’s general duties are set out in the Companies Act 2006 ('CA06') which codified various common law rules and equitable principles. This is not, however, an exhaustive list of the duties owed by a director as the statutory duties will be interpreted in line with the common law and equitable principles from which those duties derived over time. One further distinction which can be made is the difference between 'ordinary' duties and 'fiduciary' duties. The latter incorporate an element of trust and loyalty and, as such, represent a higher standard of care.
A director will also need to be mindful of other laws governing his conduct which, whilst not strictly 'duties', nevertheless impose obligations on directors to act in certain ways, for example, the wrongful trading regime set out in the Insolvency Act 1986.
When judging a director’s conduct, the standard of care to be expected of a director is both objective (the standard to be expected of someone in his office) and subjective (taking into account any additional skill and experience possessed by the particular director). When judging whether a director has breached his specific duty to act in good faith in the best interests of the company, the standard to be applied is largely subjective i.e. a director’s duty is to do what he honestly believes to be in the company’s best interests. However, when a breach of that duty is alleged, the court may inquire into the basis for and reasonableness of the director’s belief as an evidentiary matter. The fact that his alleged belief was unreasonable may provide evidence that it was not, in fact, honestly held at the time.
Financial context is key
A director’s duties are owed to the company. In practice, this usually means that the duty is to act in the interests of the company’s shareholders as a whole. However, in a distressed situation there is likely, at some stage, to be a shift whereby the interests of creditors intrude upon, ultimately to the point of displacing, the interests of shareholders. Indeed, the CA06 recognises that in certain circumstances, directors will be required to 'consider or act in the interests of creditors of the company'.
The period in which a balancing of shareholder and creditor interests is required is commonly referred to as the 'twilight period'. There is no precise formulation of when the shift occurs as it will be highly fact specific, but it can be one of the most challenging periods for the directors as they seek to balance the interests of the shareholders and creditors.
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