Carlyle Capital v Conway: In The Line of Duty

A recent judgment of the Guernsey Royal Court provides comprehensive guidance on the duties of directors.   In Carlyle Capital Corp Limited (in liquidation) and ors v Conway and ors there is extensive consideration of the duties owed by a director to the company and the standard of care to be expected.  The judgment will be of great interest to the wider offshore financial services market.

Particular consideration was given on when a company is on the brink of insolvency. Guidance is given as to the point at which a company finds itself in that position and the extent to which directors’ duties may differ at such time.  This is a developing field in Jersey and this aspect of the judgment should be of particular interest to the Jersey financial services community.

The liquidators of Carlyle Capital Corp Limited (“CCC”) brought a claim against the directors and investment manager for nearly US$2 billion.  CCC was a Guernsey registered fund that was unable to weather the storm of the financial crisis in 2008.  It was claimed that by failing to act sooner to sell off assets, the directors were liable for the losses.  The trial lasted 6 months with evidence from 16 expert witnesses and extensive consideration of authorities from a number of jurisdictions.  The allegations included breaches of fiduciary duty, gross negligence, misfeasance, wrongful trading and breaches of contract.

FIDUCIARY DUTIES

The judgment makes a clear distinction between the two types of duties owed to the company: (1) fiduciary duties and (2) duties of skill and care.

It was highlighted that fiduciary duties are owed to the company, not to its shareholders.  They are characterised as involving integrity, honesty and loyalty and can be divided into four sub-categories:

  1. Duty to act in good faith in the best interests of the company;
  2. Duty to act for “proper purposes”;
  3. Duty to exercise their own independent judgment;
  4. Duty not to act where there is any, or any possible, conflict.

 Good faith

This is a subjective duty to act in what the director bona fide believes is in the best interests of the company.  If the director errs in judgment and makes a decision with poor results but honestly considered it in the best interests, then he is not in breach of fiduciary duty.  Although if it is readily apparent that an action is not in the company’s best interests then this will cast doubt on whether he did honestly hold that belief.

Failure to consider the interests of the company at all, or a very cursory consideration, will not be sufficient to allow a director to claim he has acted in good faith.

Even where there is an honest belief, if this was a result of some other failing on the director’s behalf, for example failure to apprise himself of the relevant facts or figures, then it may give rise to liability for breach of duty of care. The importance of the distinction between liability for a breach of fiduciary duty or the duty of care may arise when there is an exoneration or indemnity clause which is only operative where a director has acted in good faith.

Importantly, the judgment repeatedly rejects an approach which would draw the court into making judgments on the merits of commercial decisions: “…the court must be satisfied that the decision complained of went beyond a mere error of commercial judgment”.

Interests of creditors

It is well established that when a company becomes insolvent, the directors must consider the interests of creditors and prospective creditors. The issue here was when a company is in financial difficulty but not yet fully insolvent, at what point does the duty to consider creditors kick in?  It was held that this point arises “when it can be seen that decisions about the company’s actions could prejudice the creditors’ prospects of recovering their debts in a potential liquidation.”

Proper purposes

This duty is concerned with whether a director has acted within his powers. It is purely a matter of law or construction of the Memorandum and Articles.  It follows that directors can be in breach of this duty whilst acting in good faith if they did not realise what they were doing was ultra vires.  Directors should always give consideration to whether they have the power to take a particular action and, if in any doubt, seek professional advice.

Own judgment

A director should not simply do as others tell him. However it is not a breach of duty to follow the views of fellow directors where they have particular expertise in an area.

Conflict

There is no rule of law to prevent an individual being a director of more than one company, even if those companies are in competition. This is subject to the proviso that a director in that position will have to manage his affairs so as to discharge the duties owed to both companies.  Conflict may be avoided by making full disclosure and obtaining the consent of each before taking any action.

Association with another company within a wider group does not make a director incapable of performing his duty, nor does it mean that a decision cannot be in the company’s best interests just because it also benefits a parent or associated company.

DUTY OF SKILL AND CARE

This duty comprises five factors: the director’s role in the governance and management structure; his particular skills; level of remuneration; size of the company and nature of its business; the circumstances of the company at the time.

It is common ground that a director is entitled to delegate his functions.  However, there is an “irreducible minimum” below which a director cannot delegate the duty to monitor and oversee the affairs of the company.  The extent of delegation permissible will of course vary in companies of differing size and complexity.

The judgment considered whether directors have a duty to seek professional advice. Whilst the law does not specify this is mandatory, “it may go a long way towards demonstrating that they were not in breach of a duty of care to the company. Indeed, it may even be decisive in their favour”.

PRACTICAL IMPACT

This judgment offers an up to date approach by a court to each of the different aspects of directors’ duties. It dissects the relevant tests and the subjective and objective elements of each. Nevertheless, whenever a court lays down guidance, it can only ever be that: a guide.  Any case will always be fact dependent and there will often be no clear cut answer as to whether a proposed decision or course of action would be in breach of duty.  Applying the guidance in practice will often be far from straightforward.  Professional advice should be sought where in any doubt as to the possible liabilities which may result from a particular course of action.  This is even more important for a company on the brink of insolvency when the directors’ duties may diverge from those that apply in more salubrious times.

 

Clara Hamon, Senior Associate

clarahamon@bakerandpartners.com