Carlyle: an exposition of directors’ duties
Carlyle Capital Corporation Limited v Conway Others [04.09.17]
In September 2017, Lieutenant Bailiff Hazel Marshall QC (LB Marshall QC) of the Royal Court of Guernsey handed down a judgment in one of the largest claims in Guernsey’s history.
The $2 billion claim was brought by the liquidators of the Guernsey registered investment fund, Carlyle Capital Corp Limited (the Company), against its former directors and investment manager, following the Company’s collapse during the 2008 financial crisis.
The lengthy judgment provides helpful guidance on the duties of directors, as they apply in Guernsey, and it represents a significant decision for the wider offshore financial services market and for D&O insurers.
The Company was an investment fund trading in US residential mortgage backed securities (RMBS) which went into liquidation in March 2008, following the liquidity crisis in the US.
The liquidators of the Company brought over 180 claims against the directors and the investment manager. The claims alleged breaches of fiduciary duty, breaches of duty of skill and care, gross negligence, misfeasance, wrongful trading and breaches of contract. The liquidators’ primary contention was that the directors knew or ought to have known that the collapse of the Company was unavoidable and imminent and therefore should have pursued an alternate business strategy.
After a comprehensive review of the duties of directors, LB Marshall QC dismissed all of the claims against the directors and investment manager, holding that they had fulfilled their duties and that it could not be shown that the Company would have remained trading even if it had pursued an alternative business strategy.
Fiduciary duties and duties of care and skill
LB Marshall QC endorsed the distinction, well-recognised in the law of England and Wales and various common law jurisdictions, between two types of duties owed by directors: (1) fiduciary duties - founded on obligations of good faith, honesty and loyalty; and (2) duties of skill and care - founded primarily on competence.
The fiduciary duties of a director are measured subjectively. These duties include the duty to:
- Act bona fide in the best interests of the company
- Act for proper purposes/not to act for improper or collateral purposes
- Exercise independent judgment
- Avoid conflicts of interest.
A directors’ duty of skill and care, on the other hand, is an objective duty. In determining the scope of the duty, a court will consider the following five factors:
- The director’s role in the governance and management structure of the company
- The particular skills that the director had held out as having
- The director’s level of remuneration
- The size of the company and nature of the business
- The circumstances of the company at the time.
Delegation of duties
It was common ground that a director is generally entitled to delegate their functions, to some degree, although they cannot delegate their ‘irreducible minimum’ duty to oversee and monitor the affairs of the company.
Finding in favour of the defendants, LB Marshall QC accepted the following principles relating to a director’s delegation of duties:
- A director is entitled to regard information provided by fellow directors and by management as accurate unless there are reasons to doubt it, and a director must satisfy him or herself that there are no matters giving grounds for caution, enquiry or suspicion.
- A director is entitled to rely upon the advice of fellow directors and management in areas in which those other directors, or management, may be reasonably seen to have greater skill, expertise, or knowledge than him or herself.
- The responsibilities of a non-executive director do not go so far as to require them to overrule the specialist directors in their specialist field.
- A director is not obliged to supervise every aspect of their delegate’s activity, nor to be responsible for day-to-day management decisions; what is reasonable will depend on the circumstances.
Duty to have regard to the interests of creditors
It was made clear in Carlyle that a director’s fiduciary duties are owed to the company and not to its shareholders. In this respect, LB Marshall QC clarified, for the first time in Guernsey law, the extent to which a director’s duty to act in the best interests of the company will extend to the interests of creditors and prospective creditors when a company is insolvent or ‘in the zone of insolvency’. This is to account for the potential conflict of interest between a company’s creditors and its shareholders that arises when a company is in a sufficiently weak financial situation.
The precise point at which that conflict arises or a company will be considered to be ’in the zone of insolvency’ is difficult to determine. LB Marshall QC decided that it was the point when it can be understood that decisions about the company’s actions could prejudice the creditors.
Once the duty has arisen, its scope is fact-dependent and will not always require a director to treat the interests of creditors as paramount. Further, a decision to continue trading may be acceptable if there is a reasonable prospect of a return to solvency.
In dismissing the liquidators’ claims, the Royal Court provided a comprehensive review and analysis of the law relating to directors’ duties. The judgment covers a wide range of topics of interest under Guernsey law, while also engaging in a comparative analysis with the position in certain other common law jurisdictions.
The judgment will be of interest to directors, officers, and D&O insurers, as well as insolvency practitioners and legal professionals in offshore jurisdictions.