Cayman Islands Restructuring: Recent Common Law Insights for Directors as They Enter the Insolvency Zone | Conyers
Partner Conyers Jonathon Milne and partner Rowana Kay Campbell in the Cayman Islands, and partner Anna Lin in Hong Kong, explain why Cayman’s new restructuring regime is likely to be a welcome addition to the legislative landscape for cautious administrators – particularly in light of current macro-economic conditions and the difficulties many businesses are facing.
A much anticipated corporate restructuring regime will be enacted in the Cayman Islands later this year through amendments to Part V of the Cayman Islands Companies Act.
This scheme is accompanied by a new statutory power granted to directors to apply to the Cayman Court for the appointment of a suitably qualified restructuring agent when the company concerned is in financial difficulty and intends to present a proposal to its creditors. .
This new power will be important for administrators who have a duty to take into account the interests of creditors.
Referring to very recent authorities, this article focuses on the duty of directors to consider the interests of creditors and under what circumstances this duty could be triggered.
For a brief note on some of the other changes taking effect under the new regime, see: “A Summary of the New Regime for Restructuring Agents”.
Benefit of the restructuring regime
The new restructuring regime will allow a company that is or is likely to become insolvent to promote a restructuring under the supervision of a court-appointed restructuring agent and with the benefit of a statutory moratorium on claims against the company .
The new restructuring request can be made by the directors without specific shareholder authorization or express powers in the company’s articles of association. Therefore, the common law situation in Re Emmadart (see “case references” below) that, without express contractual permission, directors must obtain shareholder approval before initiating insolvency proceedings, will cease to apply in the Cayman Islands as of date of entry into force of the new regime.
This will help avoid the risk of confusion, delay and unnecessary expense. Above all, it will enable directors to act decisively and in accordance with their overriding fiduciary duties.
Missions of the administrators
It is important to note that the duties of a director, in general, are due to the company. It is well established that directors must, among other things, act in good faith and in the best interests of the company. The analysis of a company’s interests at a given time necessarily leads to an assessment of the situation of shareholders and creditors.
Therefore, the financial situation of the company will have a significant impact on the relevant interests, i.e. the interests of shareholders and/or creditors. As long as the company is solvent, the directors of the company inevitably manage and conduct business for the benefit of the shareholders. However, when the company is or is likely to be insolvent, the interests of the creditors take precedence over those of the shareholders and the directors are required to take into consideration the interests of the creditors (see Prospect Properties vs. McNeill in “case references” below).
Circumstances triggering the right of interest of creditors
The decision of the UK Court of Appeal in BTI 2014 against Sequana SA and others and Bat Industries plc and others v Sequana SA (together referred to as “Sequana”) is the primary authority on when and under what circumstances the duty of directors to act in the interest of creditors might arise. The UK Supreme Court has heard an appeal from Sequana decision on May 4 and 5, 2021, and the date of delivery remains to be confirmed.
Sequana concerned an action against the directors for an alleged breach of the duty of care, by authorizing the payment of dividends when the company had ceased its activities and had important liabilities. The UK Court of Appeal, reviewing and summarizing a long line of common law authorities, has discussed four possible responses to when the interest obligation of creditors is triggered: (i) when the company is insolvent; (ii) when the company is approaching or approaching insolvency or is on the brink of insolvency; (iii) when the company is likely to become insolvent; or (iv) where there is a “real risk of insolvency, as opposed to a remote risk”.
The UK Court of Appeal has found that the duty to consider the interests of creditors can be triggered when the directors know or ought to know that the company is or is likely to become insolvent. Therefore, under this test, circumstances other than actual insolvency trigger the obligation. The UK Court of Appeal dismissed an argument Sequana that the transfer of obligation from shareholders to creditors occurs at the time of option (iv) above, on the basis of a lower threshold, would be too uncertain and would be contrary to political considerations.
In Sequana, the UK Court of Appeal has admitted that it can be difficult for directors to determine the exact moment when the company becomes insolvent. However, he also suggested that there could be circumstances leading to actual insolvency where it should be clear to administrators that a particular transaction or event may expose creditors.
In addition to case law in this area, the Supreme Court of New Zealand has also heard an appeal of the decision of the New Zealand Court of Appeal in Yan v Mainzeal Real Estate and Construction earlier this year. Similar to Sequanathe question in mainzeal is whether the manner in which the directors conducted the affairs of the company fell within the sphere of legitimate business risk-taking, or whether they exceeded acceptable limits of business risk-taking and should be held accountable of all or part of the losses suffered by Mainzeal’s creditors. In finding that the directors were liable to some degree, the New Zealand Court of Appeal held that it was “wishful thinking“for the administrators to continue trading as usual while Mainzeal was in a very vulnerable state.
In its judgment, underlining the unsatisfactory state of the law in this area, the New Zealand Court of Appeal called for a broad review of the duties of administrators applicable in the insolvency zone.
Implications of the obligation to act in the best interests of creditors
Once the obligation is triggered, the following principles will apply: first, the interest of the creditors takes precedence over that of the shareholders. This is the case because the company is likely to be unable to pay its debts and it is the creditors who are likely to be exposed in this scenario.
Second, shareholders of an insolvent corporation cannot ratify acts of directors that affect the interests of creditors (West Mercia Safetywear vs. Dodd). Likewise, the principle of Re Duomaticwhich allows shareholders to approve the acts of a company even if the required formalities have not been followed, is not applicable when the company is insolvent (see a recent example in Re Mobigo).
Third, although directors must consider the interests of creditors when the company is in the insolvency zone, the duties of directors are still owed to the company and can be sued by it; and fourth, the burden of proof in directors’ duty cases (and/or in cases alleging an undervalued transaction) rests with the plaintiff (Re City Build (London) Ltd (in liquidation)).
As the Cayman Islands is set to introduce a new rescue and recovery regime for distressed businesses, recent common law decisions are a timely reminder to directors to be aware of the threshold tests applicable to each of the fiduciary duties and non-fiduciary that they owe to the companies they oversee.
The reasoning of recent judgments such as Sequana and mainzeal, although both currently on appeal, are likely to be very persuasive in the Cayman Islands and point out that administrators have a limited time, before actual insolvency, to act to protect the interests of creditors. New and existing restructuring tools are expected to become increasingly valuable to directors (and advisors) of distressed companies over the next few years.
Re Emmadart Ltd  1 ea. 540
Prospect Properties vs. McNeill [1990-91 CILR 171]
BTI 2014 LLC v Sequana SA and others and Bat Industries plc and others v Sequana SA  EWCA Civil 112
Yan v Mainzeal Property and Construction Ltd  NZCA 99
West Mercia Safetywear Ltd (in Liq) v Dodd  BCCL 250
Re Duomatic Ltd  2 way 365
Re Mobigo Ltd (In liquidation)  EWHC 1349 (Ch)
Re City Build (London) Ltd (in liquidation)  EWHC 364 (Ch)
This article was originally published by Global Restructuring Review.