Introduction
Who are the directors?
Solvent companies – directors' duties
Duty to disclose interests
Indemnities
Relief
Companies in financial distress
Guernsey insolvency procedures
Wrongful and fraudulent trading
Disqualification
Practical steps relating to insolvency


Introduction

In the current economic environment, directors will be focused on avoiding any breach of their fiduciary duties, particularly if they are directors of companies experiencing or are at risk of financial distress.

This article provides a general overview of the duties of directors of Guernsey companies in these circumstances.

Who are the directors?

A "director", as defined in the Companies (Guernsey) Law 2008 (the Companies Law) "includes an alternate director and any person occupying the position of director, by whatever name called". Therefore, in addition to formally appointed directors, and alternate directors, shadow directors and other persons occupying the position of directors (although not formally appointed as such) are subject to directors' duties.

Solvent companies – directors' duties

Directors' duties in Guernsey arise from customary law, statute and contractual obligations but are not codified under the Companies Law and instead are drawn from the English common law duties in place prior to the introduction of the United Kingdom Companies Act 2006. This has been confirmed in multiple cases in the Royal Court of Guernsey, including the well-publicised Carlyle Capital Corporation Limited (in Liquidation) and others v Conway and others.(1) There are four fiduciary duties owed by directors to companies for which they are appointed and one "competence-based" duty. These are to:

  • act bona fide in the best interests of the company;
  • act for proper purposes or not to act for collateral or improper purposes;
  • exercise independent judgment;
  • avoid conflicts of interest; and
  • exercise reasonable skill and care.

In addition, the English case law in this area is highly persuasive in Guernsey (including the Court of Appeal and Supreme Court decisions in BTI v Sequana.(2)

Article 160 of the Companies Law provides for the ratification by a company of conduct by a director which exceeds their powers or amounts to negligence, default, breach of duty or breach of trust in relation to the company. This breach must be ratified by the members and may be taken by ordinary resolution unless the memorandum or articles require a higher majority (or unanimity).

Subject to the Companies Law, where the ratification resolution is proposed as a written resolution, members with a personal interest, direct or indirect, in the ratification are not eligible to vote on the ratification written resolution. Subject to the Companies Law, where the resolution is proposed at a meeting, it is passed only if the necessary majority is obtained disregarding votes in favour of the resolution by members with a personal interest, direct or indirect, in the ratification. These will, however, not apply in respect of ratification of conduct by a director which exceeds their powers.

Duty to disclose interests

Article 162 of the Companies Law provides that a director must immediately after becoming aware of the fact that they are interested in a transaction or proposed transaction with the company, disclose to the board of directors the nature and extent of their interest.

The above will, however, not apply if the transaction or proposed transaction:

  • is between the director and the company; and
  • is or is to be entered into in the ordinary course of the company's business and on usual terms and conditions.

In addition, this may be supplemented by provisions in the company's articles of incorporation preventing an interested director from voting or being counted in the quorum at the relevant board meetings considering the transaction.

Indemnities

Under article 157(2) of the Companies Law, any provision by which a company directly or indirectly provides an indemnity (to any extent) for a director of the company, or an associated company, or a body corporate that is an overseas company and a subsidiary of the company, is void. This is against any liability attaching to the director in connection with any negligence, default, breach of duty or breach of trust in relation to the company of which they are a director. This, however, does not:

  • prevent a company from purchasing and maintaining for a director of the company, or an associated company, insurance against any such liability; and
  • apply to any indemnity against liability incurred by a director to a person other than the company or an associated company subject to such indemnity provisions meeting certain requirements.

Relief

Under article 522 of the Companies Law, the Royal Court may relieve a director of liability in proceedings for negligence, default, breach of duty or breach of trust against the director. Any relief would be given on the basis that if it appears to the Royal Court that the director has acted honestly, reasonably, and having regard to all the circumstances of the case (including those connected with their appointment), they ought fairly to be excused.

Companies in financial distress

When a company faces financial distress with the likelihood of becoming insolvent, while the duties set out above will continue to apply, the primary focus of a director's duties will be to consider creditors' interests and minimise loss to creditors.

The Supreme Court confirmed that,(3) where a company is insolvent or nearing insolvency, the directors' duty to act in the best interests of the company will also include the interests of the company's creditors as a whole (the creditor duty). This is a sliding scale, as the greater the company's financial difficulties, the more the directors should prioritise the interests of creditors. However, merely a "real risk" of insolvency was not deemed to be sufficient to trigger the creditor duty. It is engaged at the point that the directors know, or ought to know, that the company is insolvent or bordering on insolvency, or that an insolvent liquidation is probable. Where an insolvent liquidation is inevitable, the creditors' interests become paramount as the shareholders cease to have any valuable interest in the company. The directors must consider the interests of creditors as a whole rather than individually.

Guernsey insolvency procedures

Under Guernsey law, a company becomes insolvent when it is unable to meet the solvency test. For non-regulated companies, it is a two-part test (cash flow solvency and balance sheet solvency). The cash flow solvency commonly called the cash flow test requires a company to demonstrate that it is able to pay its debts as they become due whilst the balance sheet solvency requires a company to show that the value of its assets is greater than the value of its liabilities. For regulated companies, there is a third part to the test that concerns compliance with the solvency requirements imposed by their specific regulatory regimes. The solvency test is cumulative, meaning that a company is insolvent if it fails any applicable part of the test.

Failure of a company to meet the solvency test may result in the commencement of Guernsey insolvency procedures, of which the main procedures are administration, voluntary winding up or compulsory winding up under the Companies Law.

There is also an informal procedure known as "désastre". This is, in essence, a procedure for the recovery of debts and it is not a requirement that the debtor be insolvent or likely to become insolvent.

Following the commencement of winding up, a liquidator may apply to the Royal Court for:

  • orders to set aside or vary transactions previously entered into by the company, such as transactions at an undervalue and preferences; and/or
  • orders that the directors be held personally liable for wrongful or fraudulent trading.

Wrongful and fraudulent trading

Under article 434 of the Companies Law, a director may be personally liable for wrongful trading if:

  • the company has gone into insolvent liquidation;
  • at some time before the commencement of the winding up of the company, the person knew or ought to have concluded that there was no reasonable prospect of the company avoiding going into insolvent liquidation; and
  • the person was a director of the company at the time.

The court shall not make a declaration if it is satisfied that the director took every step with a view to minimising the potential loss to the company's creditors that (assuming them to have known that there was no reasonable prospect of the company avoiding going into insolvent liquidation) they ought reasonably to have taken.

Under article 433 of the Companies Law, any person (including a director) may be held personally liable for fraudulent trading if, in the course of winding up, it appears that any business of the company has been carried on with intent to defraud creditors or for any fraudulent purpose. As this action requires proof of fraud (which has a high burden of proof), wrongful trading actions are more common in practice.

Disqualification

Under article 428 (3) of the Companies Law, if a director has engaged in wrongful or fraudulent trading, or has been found liable for other misconduct in connection with a company, the Royal Court may order that they should not be involved in the management of any company for a period of up to 15 years. If a person breaches a disqualification order, they will be personally liable for the company's liabilities incurred during such time.

Practical steps relating to insolvency

From the point at which a director knows or should know that the company is or is likely to become insolvent, the primary focus of their duties shifts from acting in the interests of the company and its shareholders, to acting in the interests of its creditors. To ensure compliance with such duties and minimise any risk of personal liability, a director in these circumstances should:

  • continue acting as a director, while taking all reasonable steps to minimise the potential loss to creditors (resigning or ceasing to be involved in the company's management will not release a director from any existing personal liability);
  • obtain professional advice from lawyers and accountants, including on the current financial position of the company;
  • keep regularly updated on the current financial position of the company, including whether the company is breaching any financial covenants in its finance documents (directors should not close their eyes to the reality of the company's position);
  • arrange for regular board meetings to monitor and discuss the company's financial position and steps to be taken to minimise loss to creditors, with the board meetings being fully minuted;
  • if possible, obtain equity financing from shareholders and negotiate with creditors for waivers and amendments in relation to existing finance documents;
  • liaise with major creditors in a pro-active way; and
  • regularly review options short of commencing insolvency proceedings, or determine whether the company should immediately cease to trade and commence insolvency proceedings itself if this is the only way to minimise further loss to its creditors.

For further information on this topic please contact Paul Chanter at Ogier by telephone (+44 1481 721672) or email ([email protected]). The Ogier website can be accessed at www.ogier.com.

Endnotes

(1) Guernsey judgment 38/2017.

(2) [2019] EWCA Civ 112 and [2022] UKSC 25.

(3) In BTI 2014 LLC v Sequana SA [2022] UKSC 25.