Worldwide: Is There A Case For A More Balanced Approach To Insolvency And Directors/Managers Liability?

Last Updated: 21 March 2016
Article by Nigel Feetham

It has been said that insolvency practitioners (IPs) tend to be misunderstood and even less appreciated. Partly discharging a public function as an officer of the Court, and partly a private function in the interest of private stakeholders (primarily creditors), admittedly the role of an IP is not easy one.

There is always a balancing act for any IP when seeking to maximise recoveries for the benefit of an insolvent estate and its creditors. Cost is certainly an important one. The high cost of liquidation has been the subject of much media attention in many countries around the world. A criticism often levelled is that insolvencies tend to become 'overlawyered'. Litigation (especially unsuccessful litigation) will add to the cost of any liquidation and unrecoverable cost reduces the amounts available for creditors.

There is no doubt that insolvency litigation is often complex and hard-fought. But an IP is usually able to spend large amounts on litigation, beyond the financial means of the ordinary defendant. This puts the IP in a special position of responsibility. An IP could, however, legitimately argue that they must apply the law as they see it, or rather, as their legal advisers interpret it.   

There is perhaps a dint of irony that most IPs are accountants working in accountancy firms. The reason why I say this is because when some large enterprises are placed into an insolvency process around the world, we sometimes see media reports where questions are asked about the work of the auditors and also see cases of threatened or actual litigation by IP members of one large accountancy firm against rival firms of auditors. Unsurprisingly, the usual public statement of an audit firm threatened with litigation is that they stand by their audit work and will vigorously defend any legal proceedings.

Of course, an IP of an audit practice can view a set of historical circumstances concerning directors and managers of an insolvent company with a different lens to how they might view them if they themselves had been discharging the role of auditor. There is also a risk that IPs might set higher standards for directors and managers than what regulators themselves have expected of the entities they regulate.

The situation could be complicated by the fact that the interpretation of factual questions and matters of evidence can be highly subjective. This is just as true in respect of the opinions that we all hold in most fields. In our daily lives we are confronted with choices that require us to take a position on something. These are determined to a large extent by our personal views and influences. Except in the most clear-cut cases where something is black or white, there is invariably a middle space of interpretation of evidence. This is also visible in the judicial decision-making process where often decisions are very fact specific or could have gone either way (including depending on which judge sat to hear the case). Against such background, it is important that liquidators do not lose their own sense of objectivity nor to look at things with the benefit of hindsight.  

In numerous countries we have seen an increase in insolvencies and related litigation since 2009. In some jurisdictions the courts have yet to define the responsibilities and duties of liquidators in any detail. In much of my writings I have been particularly interested in the concept of 'jurisdictional competition'. In small jurisdictions especially, decisions taken by governments, regulators and judiciary can often have a disproportionate impact on a jurisdiction's future competitiveness. Insolvency is one such area as those who assume the responsibility of director or manager of a company will not do so if they considered they were putting themselves disproportionately in harm's way.

Successful entrepreneurs (which includes directors and managers) will usually support or set up a business venture where others will not. Often the difference between business success and failure boils down to luck; for instance, market conditions prevailing at the time. To stigmatise insolvency is to ignore the fact that capitalism is about risk-taking and that businesses can fail for reasons other than wrong-doing. Unfortunately, however, insolvency can sometimes be the start of the blame-game. Allegations following an insolvency can also have the potential to sully people's well-earned reputations and dampen entrepreneurial flair.

The legal concept of limited liability provided a liability shield for investors that became the engine of growth in Western economies and allowed capital to be deployed at a large scale in risky ventures without businessmen being exposed to personal bankruptcy. Equally, in some jurisdictions companies are permitted under applicable legislation to indemnify its directors and officers from liability for negligence (such as Bermuda) or to limit the liability of directors and officers (save for fraud and dishonesty). Others do not permit this. There is certainly a strong case for allowing the limiting of directors' and managers' liability where concerns arise about the potential for unpredictable personal exposure and the impact this might have in attracting and retaining qualified and experienced directors and managers. Unfortunately, when that happens economic development can suffer and this is even worse in a difficult economic climate.  

There is no doubt that the prospect of personal liability also tends to make directors extremely risk-averse and that directors will more likely jump to petition for an insolvency process sooner than what they might otherwise have done. Once a financial services company, for instance, enters an insolvency process (including administration or provisional liquidation) the business, in all probability, will no longer be saved, whereas outside an insolvent process the business might recover, especially where questions of liability and solvency are complex and not clear-cut. Judges are sometimes conscious of the conundrum facing directors of financial services businesses and provided the regulator (who is supposedly closer to the regulated business) does not step in to appoint an IP, the Court could be persuaded, where a third party petitions, that a formal insolvency process is a decision of last resort. Of course, all bets are off when the directors believe or are advised that the company cannot avoid insolvency. 

Since the global financial crisis the debate about insolvency has taken centre stage. In my view it is a discussion which interested parties and stakeholders (including trade bodies, IPs and governments) should be encouraged to have, especially in these uncertain economic times.

Postscript to the Article: In many of my writings I try to bring together my fascination for history with my professional and academic interest in risk and commerce. Here is one of my favourite quotes on risk and risk management uttered more than 500 years ago: "All courses of action are risky, so prudence is not in avoiding danger (it's impossible), but calculating risk and acting decisively. Make mistakes of ambition and not mistakes of sloth. Develop the strength to do bold things, not the strength to suffer." Niccolò Machiavelli.

Nigel Feetham is a senior partner at Hassans (a Gibraltar law firm) and Visiting Professor at Nottingham Law School, Nottingham Trent University.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Nigel Feetham
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