This article first appeared in the June 2015 edition of Corporate Rescue & Insolvency journal. Written by Luci Mitchell-Fry in Dentons' London office and Hanna Kappstein in Dentons' Berlin office.

Key Points

An English director of a company with main operations in another Member State should take advice on their duties as a director in that Member State if there is a chance the company's centre of main interests (COMI) could be there for the purposes of an insolvency filing.

The question of whether s 64 of the German Limited Liability Companies Act (s 64) is a provision of insolvency law in the sense of Art 4 (1) of the European Insolvency Regulation (EIR) and therefore applicable to an English director of a company with main operations in Germany, is to be considered by the ECJ following a referral by the German Federal Court of Justice in December 2014 in the German case of K Montage und Dienstleistungen Ltd.

There have been several helpful decisions and comment by the English court on the question of jurisdiction over directors of overseas companies in the context of wrongful trading, directors' duties, and disqualification. Most recently, the Supreme Court in Bilta has considered more generally the law applicable to overseas persons.

Introduction: a question of jurisdiction

In K Montage the German Federal Court of Justice has made a request for a preliminary ruling by the European Court of Justice (ECJ). K Montage was an English private company limited by shares with its main business and a registered branch office in Germany. Its director was not domiciled in Germany. Main insolvency proceedings were commenced in Germany in accordance with Art 3 para 1 EIR on the basis that K Montage's COMI was there. The German insolvency administrator brought claims against K Montage's director to recover certain payments made at a time when the company was already illiquid. Agreeing with the decisions of the lower courts, the German Federal Court of Justice considered the director liable under German law for these payments. In so doing, it applied a provision of the German Limited Liability Companies Act to the English-domiciled director of this English limited liability company.

Article 4(1) of the EIR provides that “the law applicable to insolvency proceedings… shall be that of the Member State within the territory of which such proceedings are opened” (the lex concursus). Recital 23 to the EIR provides that the EIR should set out “uniform rules on conflict of laws” to replace national conflict of law rules. Further, “the lex concursus determines all the effects of the insolvency proceedings, both procedural and substantive, on the persons and legal relations concerned”. The lex concursus has jurisdiction to hear avoidance actions against defendants who are resident in other EU states (Seagon v Deko Marty Belgium [2009] 1 WLR 2168 and those who are resident in non-EU Member States (Schmid v Hertel [2014] 1 WLR 633).

What are the “laws applicable to insolvency proceedings” under Art (4) EIR? Are they limited to a Member State's domestic insolvency laws? What about Member States whose general corporate or civil law contains provisions that apply in an insolvency context, but are not included in their insolvency law? Should it be substance over form, to avoid inconsistencies in the application of Art 4(1) EIR between those states with all-encompassing insolvency laws and those whose insolvency laws are contained in a wide range of other (eg corporate) laws?

The German court's decision

The provision of German law relied on by the German insolvency administrator in K Montage is s 64. This section provides for personal liability of directors for payments made after the point in time when it was clear that the company was illiquid or over-indebted, unless the payments are those that a diligent, prudent and conscientious manager would settle.

According to the German Federal Court of Justice in its K Montage decision, as well as according to the prevailing view in German legal literature, from a German domestic law perspective, s 64 is a provision of insolvency law. Moreover, in K Montage, the German court treated s 64 as “the law applicable to insolvency proceedings” for the purposes of Art 4(1) EIR. In other words, the German Federal Court of Justice is of the opinion that s 64 is to be qualified as a provision of insolvency law both from a German domestic law perspective and from a European law perspective. The court gives the following reasons for its point of view.

Although the existence of an insolvency proceeding is not required for claims to be brought against directors under s 64, an insolvency administrator usually brings such claims against directors. Secondly, s 64 preserves the company's assets from financial outflow which is also in favour of the company's future insolvency creditors.

Since the German Federal Court of Justice is of the opinion that s 64 has to be qualified as insolvency law (also) from a European law perspective, the court ruled that the fact that K Montage's COMI was in Germany, and insolvency proceedings had been commenced there, meant that s 64 would apply to the question of directors' duties for any companies which are comparable to a German limited liability company (GmbH). According to the German Federal Court of Justice, a private company limited by shares (like K Montage) and a German GmbH are comparable because in both company types the shareholders are, in principle, not personally liable for company debts and the business is conducted by a person who is not necessarily a shareholder. In both types of company there is a danger the directors might make payments after the company is already insolvent thus diminishing the insolvency estate at the expense of the creditors. In the court's view, these circumstances justify that directors of a German GmbH and of an English private company limited by shares are treated equally when it comes to the question of liability for payments made in an insolvency situation. Therefore, pursuant to Art 4(1) of the EIR, the German Court applied s 64 to the English director of K Montage, finding her personally liable under German law.

There has long been debate in Germany about whether — from a European law perspective — the issue of directors' liability is a matter of the insolvency law regime or the corporate law regime. The German Federal Court recognises that the question of whether s 64 should be considered as insolvency law (rather than corporate law) from a European law perspective is a matter for the ECJ.

The position in England

What if the English court were faced with a wrongful trading claim by a liquidator of an English company against a German domiciled director? English law on directors' duties is codified in the Companies Act 2006. However, the Insolvency Act 1986 (IA 1986) contains certain provisions for dealing with delinquent directors, for example, s 212 (summary remedy against delinquent directors), s 213 (fraudulent trading), and s 214 (wrongful trading). The provisions of the Company Directors Disqualification Act 1986 (CDDA 1986) are also relevant. Unlike s 64 in Germany, any claim under ss 212–214 of the Act requires an insolvency to be afoot in England as, currently, the claim can only be brought in the course of winding up (this will extend to administrations once the Small Business, Enterprise and Employment Act 2015 comes into force). These sections apply to any company in liquidation: a German company can enter liquidation here, for example, if its COMI is here, or by being wound up as an unregistered company under s 221 of the Act. Unlike s 64, ss 212–214 form part of English insolvency legislation rather than English corporate legislation.

Re Howard Holdings [1998] BCC 549 concerned a Panamanian company being wound up in England as an unregistered company under s 221. Its directors were resident in Monaco. The court held that, the winding up order having been made, “there can be no doubt that the Court has jurisdiction to make declarations against foreign directors of foreign companies pursuant to s 214”. Accordingly, the English court has jurisdiction to apply s 214 to directors of a foreign company when the foreign company has been wound up under s 221.

In Base Metal Trading Ltd v Shamurin [2005] BCC 325 (BMTL), the Court of Appeal was asked to consider the question of the proper law applying to the duties of a director of a company incorporated in Guernsey for tax reasons, whose business was carried on entirely from Russia by Mr Shamurin, a Russian national. BMTL claimed against Mr Shamurin for various breaches of duty in relation to speculative trades on the London Metal Exchange. The Court of Appeal agreed with the judge at first instance that the proper law of any claim in common law and contract was Russia. As to a claim in equity, the Court of Appeal held that “the law of the place of incorporation applies to the duties inherent in the office of director and it is irrelevant that the alleged breach of duty was committed, or the loss incurred, in some other jurisdiction” (per Lord Justice Arden, para 69). However, Arden LJ observed that while provisions of English insolvency law may be used to enforce directors' duties where a foreign company is being wound up here, the content of those duties will be a matter for the state of incorporation. But as to the conduct of liquidation generally “the English Courts must apply the mandatory scheme laid down by English law even if the company is incorporated abroad” (at para 67). Arden LJ used the example of s 212 of the Act, which enables a liquidator to claim compensation for breach of duty against directors, but does not lay down the content of that duty.

Adopting the approach of Arden LJ, there is a distinction to be made between the general duties of a director (codified in England under the Companies Act 2006) and ss 213 and 214, which form part of the English domestic insolvency regime. Unlike s 212, the statutory duties in ss 213 and 214 are prescribed and, for the purposes of Art 4(1) EIR, they comprise the “law applicable to insolvency proceedings” and will be imposed on foreign directors of a foreign company in liquidation in England.

The recent Supreme Court decision in Bilta (UK) Ltd (in liquidation) v Nazir [2015] UKSC 23 did not concern a claim against a director, rather a “person” within the meaning of s 213. In relation to an English company in liquidation, s 213 was held to have extra-territorial effect and was applied against an individual domiciled in France. The Supreme Court exercised this jurisdiction based on English domestic law. There are other sections of the Act which have been held to have extra-territorial effect, for example, s 238 of the Act (Re Paramount Airways [1993] Ch 223). The Supreme Court commented: “It would seriously handicap the efficient winding up of a British company in an increasingly globalised economy if the jurisdiction of the court responsible for the winding up of an insolvent company did not extend to people and corporate bodies resident overseas who had been involved in the carrying on of the company's business.” The end result in Bilta follows a general trend in the jurisprudence, and sits well with the observations of Arden LJ in BMTL, albeit on different facts.

What about disqualification? Can it apply to directors of overseas companies being wound up here? In Re Eurostem Maritime Ltd [1987] BCC 190, the court's obiter view was that it had power to disqualify a director of a foreign company being wound up in England. The case concerned seven companies being wound up in England, three of which were incorporated in Liberia and four in England. The Official Receiver sought an order disqualifying a director under the then s 300 Companies Act 1985. The court made the disqualification order based on the conduct of the director in relation to the English companies (albeit taking into account the conduct in relation to the Liberian companies), such that it was not necessary to decide on the jurisdiction question in relation to the overseas companies. However, the court expressed it was likely the power of disqualification would apply in respect of any company being wound up in England, whether or not the company was incorporated here. This position was endorsed in the subsequent cases of Re Seagull Manufacturing Co Ltd (No.2) [1994] 1 WLR 453 and Official Receiver v Stojevic [2007] EWHC 1186 (Ch) which both concerned English registered companies in liquidation in England but with directors resident abroad. In these cases, the court considered that s 6(1) of the CDDA extended to any company, wherever incorporated, capable of being wound up under the Act and its directors, of whatever nationality, could be disqualified under the section.

Comment

As a matter of English law, the general duties of a director are a matter for the law of the place of incorporation of the company. In an English insolvency of, for example, a German company, the English court could use s 212 to enforce German law duties of a director. More significantly for the purposes of Art 4(1), however, the English court would have jurisdiction to apply provisions such as s 214 to the foreign director, because that provision forms part of the English insolvency regime. The issue in K Montage arises because s 64 is situated in the German Limited Liability Companies Act and not in the German Insolvency Code. The question whether s 64 nevertheless forms part of “German domestic insolvency legislation” in the sense of Art 4(1) EIR can only be decided by the ECJ, though it will be several years before the ECJ considers K Montage.

New Art 6 of the recast EIR (likely in force in early 2017) provides that the lex concursus has jurisdiction for actions which derive from the insolvency proceedings and are closely linked to them, such as avoidance actions against defendants in other Member States. New Art 6 further provides that where such an action is related to an action based in civil and commercial matters against the same defendant, both actions may be brought in the court of the defendant's domicile. New Recital 34 supplements this with an example: “if the insolvency practitioner wishes to combine an action for directors' liability on the basis of insolvency law with an action based on company law or general tort law” the claim can be brought in the defendant's domicile. So the question of whether the directors' liability is one of insolvency law, or general company or tort law, remains relevant. Directors of global companies need to consider carefully whether there is any risk of an insolvency in different Member States, and take appropriate advice on their duties. This advice should not be limited to domestic insolvency law of that Member State, but any law which relates to directors' duties. The directors should consider carefully the potential consequences of any COMI migration on the law applicable to their duties.