Duty to act in good faith
Duty to exercise independent judgement
Duty not to act where there was actual or possible conflict of interest
Duty to exercise powers for proper purposes
Duty to consider interests of creditors when company at risk of insolvency
This article is part of a series on director's duties in Guernsey. For the first article in the series, see "Carlyle case: introduction to director's duties in Guernsey".
In Carlyle Capital Corporation Limited (in Liquidation) v Conway, the plaintiffs alleged that the defendants had acted in breach of their fiduciary duties in numerous ways.
The first alleged breach was a breach of the duty to act in good faith.
The learned Lieutenant Bailiff (the judge) stated that this duty is to act in what the director genuinely believes is in the best interests of the company and "is the essential fiduciary duty of a company director".(1) The judge considered that other duties described as "fiduciary" were really just particular applications of this essential duty and within the scope of this duty. The judge held that a management or governance decision of a director, honestly and responsibly made, amounts to due performance of that director's duty of good faith and confirmed that the test for this is subjective.(2) Therefore, a claim for breach of fiduciary duty only lies where it is shown that the directors did not honestly consider their action to be in the best interests of the company.(3)
Objectivity only comes into play in two scenarios. The first scenario is:
if the relevant decision appears clearly and objectively not to have been in the best interests of the company, [as] this could certainly cast doubt on a director's assertion that he genuinely believed that it was.(4)
An example of this could be if a director sold a sports car owned by their company to themselves for £10. The director would be unlikely to be believed if they were to tell the court that they genuinely thought that this was in the best interests of the company.
This is an evidential point, such that the apparent reasonableness (or otherwise) of a decision by a director may be material to an inference as to the directors' state of mind in making it. However, this does not import into the test any requirement that the decision must be in the best interests of the company as determined objectively by the court.(5)
The second scenario where objectivity may come into play is if the directors did not in fact consider the interests of the company at all.(6) In that situation, the test that the court will apply is to examine the relevant decision that a hypothetical director, acting genuinely in the apparent best interests of the company, could reasonably have made in the circumstances.(7) If the decision was within that ambit, then the director will not be liable for breach of fiduciary duty.
In the case of the Carlyle Capital Corporation Ltd (CCC), the plaintiffs argued that this duty was breached. They said that the amendment and subsequent suspension of CCC's risk management measures in its investment guidelines was "plainly" not in CCC's best interests.(8) However, the judge held that even had it been a breach on its own, which it was not, it caused no loss and added nothing to the key complaint of the plaintiffs.(9) Further, the judge found that in fact the defendants had made their decisions in what they genuinely believed to be in the best interests of CCC and that such decisions were, in any case, objectively viewed, within the range of decisions that a reasonable director could properly regard as being in the best interests of CCC.(10)
Duty to exercise independent judgement
The plaintiffs raised this breach of duty particularly in respect of the independent directors (IDs) and their independent powers of oversight and separate approval.(11) The plaintiffs alleged that the IDs were not truly independent, but merely acted as a rubber stamp for decisions made by the holding company (Carlyle), including decisions relating to the approval of the reduction and suspension of CCC's liquidity cushion guideline, and also relating to refraining from both selling residential mortgage-backed securities (RMBS) and seeking to raise further equity capital.
It was also alleged that CCC had failed to convene sufficient board meetings and that the IDs had abrogated their duties to CCC by permitting Carlyle and Carlyle Investment Management LLC (CIM) to run CCC as they saw fit after August 2007.
The judge held that a director will breach the duty to exercise independent judgement if they merely do what they are told by others or acquiesce without question or consideration in what others ask them to do. A director must make their:
own decision, on all matters where a decision is required of them qua director. They have a duty which is an 'irreducible' minimum, to oversee and keep themselves sufficiently informed about their company's affairs in order to do so.(12)
The judge went on to qualify that this duty did not mean that a director must act entirely alone, nor that they must ignore the views of their fellow directors, but that they must exercise their own judgement based on their own assessment of the facts.(13) The judge also accepted that, where a director is not an expert in a matter but knows their fellow director is, this duty does not mean the director must:
either . . . make a decision without ascertaining the views of the expert director or without having regard to them, or to make himself a sufficient expert in the area that he can assess the opinions of the expert director from a position of expertise.(14)
The judge held that the directors had exercised independent judgement throughout all decisions they made in respect of CCC.(15)
Duty not to act where there is actual or possible conflict of interest
The plaintiffs alleged that there was a conflict between, on the one hand, the corporate and reputational interests of Carlyle and the personal financial interests of the Carlyle directors of CCC, and, on the other hand, the interests of CCC.
The plaintiffs said that the best interests of CCC required a "prompt restricting" of its business, but that the reputational interests of Carlyle and CIM, the corporate interests of Carlyle and the personal interests of the Carlyle directors of CCC allegedly all conflicted with that and effectively made the directors wrongfully cause CCC to continue too long in "business as usual" mode because they did not want to jeopardise these other conflicting interests.(16)
With respect to this duty, the parties agreed that an objective test must be applied when assessing whether there is a material conflict of interest.(17) The judge agreed with the defendants in holding that there was no rule in English law preventing a person from being a director of more than one company, even if both companies are in competition and that Guernsey law would follow this rule.(18)
The judge noted that the rule is subject to two qualifications. First, that the director in that position is able to arrange their affairs so that they can discharge their duties to both companies as loyally as if each were their only principal. Second, that any such conflict can be avoided by the director making full disclosure of the position and obtaining the consent of each principal to their also acting for the other.(19)
The judge held that there was no evidence to support the plaintiffs' allegations of conflict and found that in fact the directors had felt no tension between CCC's own interests, which they saw as being survival and recovery, and Carlyle's best interests, which they also saw as being CCC's survival and recovery.(20)
In terms of the personal interests of the directors, the judge held that she had some difficulty in seeing any real substance, as opposed to theory, in the alleged conflict of interest itself.(21)
Duty to exercise powers for proper purposes
The plaintiffs alleged that the defendants had acted with the improper purpose of prioritising Carlyle's reputational interests over the interests of CCC. Carlyle's interests were said to be to avoid having to disclose CCC's poor financial performance, which would in turn disclose Carlyle's failure to make CCC a liquid investment company and thereby put at risk what the plaintiffs called Carlyle's strategic objectives.(22)
The Carlyle strategic objectives were alleged to be:
- the intended sale of 7.5% of Carlyle to a Middle Eastern sovereign wealth investor;
- the obtaining of a $875 million loan for Carlyle from a consortium of banks; and
- the future initial public offering of the Carlyle itself.(23)
The judge accepted that a director, even if they are acting in good faith and in the interest of the company and its members as a whole, must nevertheless use their powers for the purposes for which they were conferred.(24) However, the judge could find no evidence at all which might have justified the allegations made by the plaintiffs regarding the alleged improper purpose, and she made clear that neither the decision not to embark on generally selling RMBS, nor the broader decision to continue keeping CCC's business alive, was due to any prioritisation of the interests of Carlyle or the personal interests of any defendant over the perceived interests of CCC as a discrete company.(25) These allegations were therefore dismissed.
Duty to consider interests of creditors when company is at risk of insolvency
The plaintiffs alleged that as CCC was insolvent or in the zone of insolvency in August 2007, the directors had a duty to have proper regard to creditors' interests in the decisions they took and, as a result, should have taken immediate steps to sell some of CCC's RMBS assets to improve its overall financial position.
The defendants denied this allegation on the grounds that:
- this duty had never arisen, since at the time CCC was never insolvent or close to insolvency;
- even if the duty had arisen, the directors had fulfilled it by adopting a strategy of preserving the company's assets from August 2007 onwards; and
- such strategy was in the best interests of both CCC's creditors and its shareholders.
The directors were not in a position to foresee the subsequent financial crisis in March 2008, which ultimately led to the demise of CCC. This was the first Guernsey case to consider whether the duty in English law to have proper regard to creditors' interests when a company gets into serious financial trouble is part of Guernsey law. The judge confirmed that the duty did exist in Guernsey law and relied heavily on English cases in this regard, especially the Supreme Court decision of Bilta (UK) Ltd v Nazir,(26) but put her own interpretation of precisely when and what that duty entails. She accepted that this duty was subsumed into the duty of good faith, since the basis of the duty is that when a company is or is nearly insolvent, the reality of the situation is that the assets it has belong to the creditors rather than the shareholders, as they have priority over those assets in a liquidation.(27)
The judge considered that the duty does not so much "arise" by coming into existence at one particular moment, as it acquires separately discernible influence because of changing circumstances. In other words, it comes into existence when the interests of creditors and shareholders as to the course of the company's future activities begin to diverge. This tends to happen gradually and is very fact-dependent, so identifying a clear point when the duty "arises" is not easy.(28)
It was common ground between the parties that the tipping point for when the extended duty is established can be something short of actual insolvency, but the parties differed as to the proper description of the legal test for the onset, short of insolvency, of such duty.
The judge decided that the phrase "on the brink of insolvency" best described when the duty arose. She rejected the phrase "zone of insolvency" proposed by the plaintiffs, since it suggested a longer period pre-insolvency, which did not convey the appropriate sense of imminence. She further described the duty as arising when it can be seen that the decisions about the company's actions could prejudice the creditors' prospects of recovering their debts in a potential liquidation.(29)
Regarding the content of this duty, the judge considered that stating that the interests of creditors became paramount when this duty arose was too "absolutist". She preferred using the words "proper regard" and stated her position as follows:
In my judgment the principle, as it applies in Guernsey law is that once it is recognised that the company is 'on the brink of insolvency', the directors' duty to act in the best interests of the company extends to embrace the interests of its creditors, and requires giving precedence to those interests where that is necessary, in the particular circumstances of the case, to give proper recognition to the fact that the creditors will have priority of interest in the assets of the company over its shareholders if a subsequent winding up takes place.(30)
The judge further clarified that the duty was to have regard to the interests of the general body of the company's unsecured creditors as an abstract class.(31)
In the particular circumstances of this case, the judge confirmed that the duty had arisen from August 2007,(32) and also that there was no evidence that the defendants had given separate consideration to the interests of the creditors.(33) However, she found that since the interests of the unsecured creditors and shareholders of CCC were aligned, and the defendants had taken all material decisions and actions in the best interests of CCC,(34) the defendants had not breached their fiduciary duty in this regard.(35)
In the recent English Court of Appeal case of BTI 2014 LLC v Sequana,(36) the judges rejected the use of terms such as "brink of insolvency", used by the judge in the Carlyle case, to determine when this fiduciary duty arises. They instead stated that the duty arises when the directors knew or ought to have known that the company was likely to become insolvent. This new formulation, if it is not overturned, is likely to be persuasive when this issue arises in future Guernsey cases.
However, the Supreme Court heard the appeal of that Court of Appeal decision on 4 and 5 May 2021 and judgment has not yet been handed down. The forthcoming judgment should clarify whether the trigger for the directors' duty to consider creditors is merely a real risk of, as opposed to a probability of or close proximity to, insolvency.
For further information on this topic please contact Bryan De Verneuil-Smith or Simon Davies at Ogier by telephone (+44 1481 721672) or email ([email protected] or [email protected]). The Ogier website can be accessed at www.ogier.com.
Endnotes
(1) At [370] of Carlyle (Guernsey Judgment 38/2017).
(2) At [378] of the trial judgment.
(3) At [379] of the trial judgment.
(4) At [382] of the trial judgment.
(5) At [381]–[382] of the trial judgment.
(6) At [383] of the trial judgment. The judge relied on the decision of Pennycuick J in the English case Charterbridge Corp Ltd v Lloyds Bank Ltd [1970] Ch. 62; see [1969] 3 WLR 122 Ch D for this principle.
(7) At [384] of the trial judgment.
(8) At [372] of the trial judgment.
(9) At [1422] of the trial judgment.
(10) At [2639] of the trial judgment.
(11) The judge found that the IDs' function was to bring a dispassionate oversight view to the board's decisions from a more detached perspective; see [1108] of the trial judgment.
(12) At [481] of the trial judgment.
(13) For example, the judge found that the IDs were entitled to accept the recommendations of the executive directors regarding the reduction or suspension of the liquidity cushion requirement, since the IDs had given the matter critical and independent thought and their queries or suggestions had been reasonably answered; see [1422] of the trial judgment.
(14) At [482] of the trial judgment.
(15) At [1510], [2639] of the trial judgment.
(16) At [498] of the trial judgment.
(17) At [485] of the trial judgment.
(18) At [494] of the trial judgment.
(19) At [495] of the trial judgment.
(20) At [1479] of the trial judgment.
(21) At [1499] of the trial judgment.
(22) At [2281] of the trial judgment.
(23) At [1489]–[1493], [1502], [1505] of the trial judgment.
(24) At [472]–[477] of the trial judgment.
(25) At [2478] of the trial judgment.
(26) Bilta (UK) Ltd (In Liquidation) v Nazir [2015] UKSC 23; [2015] BCC 343.
(27) At [436] of the trial judgment.
(28) At [435] of the trial judgment.
(29) At [446] of the trial judgment.
(30) At [455] of the trial judgment.
(31) At [463] of the trial judgment.
(32) At [1440] of the trial judgment.
(33) At [1443] of the trial judgment.
(34) At [2638] (3) of the trial judgment.
(35) At [1445] and [1447] of the trial judgment.
(36) BTI 2014 LLC v Sequana [2019] EWCA Civ 112; [2019] BCC 631.
An earlier version of this article was first published by Sweet & Maxwell.