!Корпоративное право 2023-2024 / 2013-study-analysis_en

single day, the worst one day performance in many years. As the company cannot fulfil the margin calls on its forward sales contracts, the positions are closed by the counterparty. The closed positions have a negative value exceeding the company’s equity, leading to the company’s over-indebtedness. Trading partners refuse to enter into transactions with the company due to its financial position, and banks close all existing credit lines of the company.

Fiduciary duties: when a company is operating in the zone of / approaching cash flow insolvency the duties owed to the company (section 172 Companies Act 2006) become duties to promote the success of the company for the benefit of both creditors and shareholders and to take due care in so doing. When insolvent those duties are then to promote the interests of the creditors alone and to take care in so doing. The law remains somewhat unclear on what is the “verge” of insolvency and in what ways creditor interests are taken into account in this zone (priority versus plurality). On these facts the risk of failure that is apparent would mean that the interests of creditors would intrude. However, the business judgment taken to buy the futures would be judged according to the section 172 standard, which is a subjective standard (in practice a rationality standard). There appeared at the time to be a sound basis for this decision, accordingly there would be no breach. In relation to the duty of care the facts suggest that due care was taken which would comply with the UK’s dual subjective / objective care standard.

Wrongful trading: although wrongful trading could provide a remedy when taking risky decisions in the zone of insolvency, the facts suggest (low probability of price drop) that this would not provide a remedy in this context. The remedy imposes creditor-regarding obligations when a director should have realised there was no way of avoiding insolvent liquidation. The law has not attempted to define the probability of avoidance required by this provision. The low probability suggested in the facts would not be sufficient.

Hypothetical III: Duty of care

A large banking institution is engaged in retail as well as investment banking. In 2000, a new CEO was appointed, who also sits on the board of directors. The CEO made the decision to invest heavily in collateralised debt obligations (CDOs) backed by residential mortgage-backed securities, including lower-rated securities that pooled subprime mortgages to borrowers with weak credit history. The investments were initially successful, generating high profits for the company. However, beginning in 2005, house prices, particularly in the United States, began to decrease. Defaults and foreclosures increased and the income from residential mortgages fell rapidly.

As early as May 2005, economist Paul Krugman had warned of signs that the US housing market was approaching the final stages of a speculative bubble. Early in 2007, a large US subprime lender filed for bankruptcy protection and a number of investors announced write downs of several billion dollars on their structured finance commitments. In July, 2007, Standard and Poor’s and Moody’s downgraded bonds backed by subprime mortgages. At the end of 2007, two hedge funds that had invested heavily in subprime mortgages declared bankruptcy. In spite of these warning signs, the CEO had continued to invest in CDOs until shortly before the Lehman bankruptcy in September 2008, accumulating a total exposure of more than 20 billion Euro/Pounds/… . The subprime mortgage crisis necessitated massive write downs, leading to an annual loss of eight billion in 2008, which can be attributed in equal measure to the CDO transactions undertaken in 2005-2008.

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The CEO resigned in October 2008. As part of the resignation, the CEO entered into an agreement with the company providing that he would receive 50 million Euro/Pounds/… upon his departure, including bonus and stock options, and in addition an office, administrative assistant, car and driver until he would commence full time employment with another employer. In exchange, the CEO signed a non-compete agreement and a release of claims against the company. The agreement with the CEO was approved by all directors (the CEO abstaining from voting), acting on behalf of the company.

After the CEO’s departure and with a new management team in place, it transpires that the old CEO had used a number of ostensibly arms-length transactions with investment firms that were, however, controlled by the CEO’s nominees, to transfer assets at an undervalue to a company owned by the

CEO on the Cayman Islands. When the true nature of these transactions becomes known, the assets are no longer recoverable.

Questions:

Is the CEO liable for annual loss suffered by the company in 2008?

The UK does not have a US style business judgment rule, but in effect business decisions are similarly regulated. The standard that applies to the business decision - as distinct from the care taken in making the decision - is a subjective standard: to do what you consider promotes the success of the company for the benefit of the shareholders. Although there is some disagreement on this point, UK law does not require “reasonable decisions”. In practice, this results in the application of a rationality or plausibility standard: could the decision rationally or plausibly have made sense in the shareholders’ interests (assuming no verge of insolvency problem) at the time the decision was made. Clearly that is possible in this case even if some market participants claimed that the market was heading towards impending doom.

The duty of care as applied to decisions requires a reasonable decision-making process (as assessed by a dual subjective / objective reasonable director standard). The facts do not suggest that inadequate care was taken in deciding to make the sub-prime investments in a market in which everyone else (i.e., the average director) continued to party.

Have the directors (other than the CEO) breached their fiduciary duties by approving the agreement in conjunction with the resignation of the outgoing CEO?

Decision-making: this decision in a company that is UK Corporate Governance Code compliant would be made by the remuneration committee that consists only of independent non-executive directors.

Duty of care: The decision to make the resignation pay award is more problematic. But again a case that this was in the company’s interests can be made depending on the plausible assessment of the value of the release and the non-compete – at the time it was entered into. At the time major figures in UK banks resigned their posts in the early stages of the crisis it was not unreasonable to expect that those figures would work again in the sector. That proved to be inaccurate, but duty compliance is determined at the time the decision was made.

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Have the members of the company’s internal audit committee (of which the CEO was not a member) breached their fiduciary duties by not identifying the true nature of the ostensibly arms-length transactions and are they, accordingly, liable for the loss suffered by the company as a consequence of the transactions? Have the other directors (except the CEO) breached their duties?

The facts are not full enough to give clear direction on this issue. The non-arms-length transactions raise questions about the duty of care and monitoring and internal controls, particularly for directors who undertake particular responsibility for those controls. The duty of care in the UK does not allow directors to delegate power and then absolve themselves of responsibility for the exercise of that power. Furthermore, this duty takes account of the role and function of the director (e.g., audit committee member). However, the facts of the hypothetical do not provide much information to judge duty compliance in this regard. If the directors had taken care to ensure that internal controls were in place to provide for the reporting of such transactions, then the failure to actually report them to the directors would not result in a breach of duty. If on the other hand directors were aware of these red flags but had not taken steps to do anything about them then clearly this raises duty of care issues directly in relation to these transactions. It would also be relevant information more generally about care compliance in relation to these directors and the resignation pay-off.

Assuming that the company has a claim against the CEO or another director pursuant to one or more of the above questions, can a minority shareholder enforce the claim?

Issues:

Who can bring a claim on behalf of the company? Any shareholder regardless of when the share was purchased if the court gives permission to continue a derivative action.

Does the derivative action exist? If not, how does the law ensure that minority shareholders are protected against collusive behaviour by the majority and the directors? Yes a derivative action is permissible with the permission of the court. UK law also provides an unfair prejudice remedy that in some instances may be used to protect the shareholders (depending on the circumstances this remedy may create additional substantive protection or be a means to enforce other rights).

What is the threshold to bring a derivative action? Court approval

Do conditions exist that must be satisfied before a court will allow a derivative action to proceed (for example, will the court review whether the action is in the interest of the company or frivolous)? Yes, multiple conditions focused around good faith, company interest, and shareholder views (probable view) of the litigation.

Who bears the costs for a derivative action? Normal cost rules apply unless an indemnification order is awarded in favour of the derivative litigant to cover her costs (win or lose).

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Hypothetical IV: Duty of loyalty

A mining company (‘Bidder’) considers expanding business operations. The board identifies assets held by another company (‘Target’) as a possible acquisition. The following scenarios ask you to consider the liability of a director (‘A’) on the board of Bidder.

Director A is also majority shareholder in Target, holding 60 percent of the outstanding share capital of the company. As majority shareholder of Target, he is interested in an acquisition that is beneficial to Target. He proposes that Bidder purchase the assets for 10 million

Euro/Pounds/…, knowing that the value ranges between 7 and 8 million. Director A does not disclose his interest in Target to the board of Bidder. A majority of the directors approves the acquisition. A’s vote was not decisive for the positive vote.

Does the law require directors to disclose direct or indirect interests in transactions with the company? Yes.

Is this duty laid down in the companies act or does it derive from the fiduciary position of the director? The duty is laid down in the Act, but common law rules will apply if there is non-compliance.

If the director violates the disclosure obligation, is the transaction void or voidable or does the director have to pay damages? The transaction is voidable. Possible remedies include equitable compensation and accounting for profits.

As in scenario 1, but Director A discloses his interest in Target to the board of Bidder, and a majority of the uninterested directors approves the acquisition.

Issue: Does the interested director have to abstain from voting when the board decides on the conflicted interest transaction? It depends on the articles of association. Typically yes.

If he/she fully informs the board and abstains from voting and the board approves the transaction, is it valid? Yes.

As in scenario 1, but when the shareholders of Bidder learn of A’s interest in Target, they ratify the transaction, believing that it is in the company’s interests.

Issue: Can the shareholders authorise or ratify a related-party transaction? Yes.

Can the conflicted director vote on such a resolution if he/she is also shareholder? She can vote but the votes will not be counted for the purposes of the ratification resolution, so effectively no.

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How is minority shareholder protection ensured? For example, can the minority shareholder appeal to the courts and claim that the transaction was not in the company’s interest? A non-disclosed or approved transaction is a breach of duty which can be enforced derivatively (subject to the conditions outlined above). The claim would not be that the transaction is not in the company’s interest, rather a claim for breach of the applicable duty requiring disclosure.

Director A is majority shareholder and managing director in a competitor of bidder (‘Rival’), which is also active in the mining business. The assets held by Target that Bidder seeks to acquire consist in claims near Rival’s own mining territories. Director A is of the opinion that the assets are more valuable for Rival than for Bidder. He therefore arranges for Rival to make a competing and higher offer than Bidder, and Target accordingly decides to sell the assets to the former company.

Issue: Does a corporate opportunities doctrine exist? Yes.

If yes, when does it apply (for example, only if the opportunity falls within the company’s line of business and the company is legally and financially able to pursue the opportunity, or are all business opportunities caught that would be theoretically of value to the company)? All business opportunities under current case law. Financial capacity is irrelevant. No line of business restriction (currently).

If not, what are alternative mechanisms to protect the company and the (minority) shareholders? Is the duty not to compete with the company a substitute for the duty-of- loyalty based corporate opportunities doctrine? Is it equally effective? N/A

As in scenario 4, but A resigns from his position as director of Bidder before Rival makes the competing offer.

Issue: Does the prohibition to exploit corporate opportunities (or the duty not to compete) continue to bind the director after resignation? Yes.

If the duty continues to apply, how is this dogmatically justified? In two ways: (1) as the continuing application of the fiduciary duty to opportunities identified during the director’s tenure or (2) (under pre-Companies Act 2006 case law) on a proprietary type basis – that under certain conditions the opportunity belongs to the company (the maturing business opportunity approach).

As in scenario 4, but after an initial expression of interest by Bidder in acquiring the assets and before Rival has taken any steps to make a competing offer, the Bidder board determines that an investment of that size is not advisable at the present time in light of Bidder’s weak financial position.

Issue: See the remark regarding scenario 4. Does the corporate opportunities doctrine (or the duty not to compete) even apply if the board of directors resolves that the

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company should not pursue the opportunity? This is not clear. But a strong case can be made that it does.

Can the conflicted director participate in the decision of the board? Traditionally the noninvolvement of the director would not be sufficient to allow the opportunity to be taken. The codification of this provision in the Companies Act opens some room to argue that this rule no longer applies. However, participation (even minority participation) would most likely result in the opportunity not being available to the director.

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