By Aurelio Gurrea-Martínez (Singapore Management University)
When a company becomes factually insolvent but it is not yet subject to a formal insolvency proceeding, the shareholders—or the directors acting on their behalf—may engage, even in good faith, in various forms of behaviour that can divert or destroy value at the expense of the creditors. For this reason, most jurisdictions around the world provide a variety of legal strategies to respond to this form of shareholder opportunism. One of these strategies is the imposition of special directors’ duties in the zone of insolvency.
In a recent article, I analyse the primary regulatory models of directors’ duties in the zone of insolvency observed internationally. From a sample of more than 20 countries from Asia, Australia, Europe, Latin America, Africa, and North America, I distinguish six primary regulatory models: (i) the imposition of a duty to initiate insolvency proceedings, generally found in Europe; (ii) the imposition of a duty to recapitalise or liquidate the company, typically existing in Europe and Latin America; (iii) the imposition of duties towards the company’s creditors, including the duty to minimise losses for the creditors existing in the United Kingdom; (iv) the imposition of a duty to prevent the company from incurring new debts, existing in countries like Australia and South Africa; (v) the imposition of a duty to prevent the company from incurring new debts that cannot be paid in full, existing in Singapore and New Zealand; and (vi) the imposition of a duty to keep maximising the interest of the corporation, as it exists in Canada and the United States.
After analysing the features, advantages, and weaknesses of these models, my paper argues that the desirability of each regulatory model of directors’ duties in the zone of insolvency depends on a variety of country-specific factors including divergences in corporate ownership structures, debt structures, level of financial development, efficiency of the insolvency framework, and sophistication of the judiciary. For instance, in small and medium-sized enterprises (SMEs) as well as large controlled firms, there is a greater alignment of incentives between directors and shareholders. Therefore, in the event of insolvency, the directors will have more incentives to engage in a series of opportunistic behaviour that will advance the shareholders’ interests even if it is at the expense of the creditors. As a result, a more interventionist approach to protect the creditors, such as the duty to initiate insolvency proceedings, may make more sense in countries with a significant presence of SMEs and large controlled firms, as it happens in most jurisdictions around the world. By contrast, in countries like the United Kingdom and the United States, where large companies usually have dispersed ownership structures and therefore the directors are less influenced by the shareholders, a more flexible approach for the regulation of directors’ duties in the zone of insolvency may be more justified. Therefore, a duty to keep maximising the interest of the company or a duty to take steps to minimise potential losses for the creditors may make sense.
Nonetheless, country-specific factors other than corporate ownership structures can also affect the desirability of each regulatory model of directors’ duties in the zone of insolvency. For example, in countries without sophisticated courts, the discretion of courts should be reduced. Therefore, the imposition of clear rules (e.g., duty to initiate insolvency proceedings) may be more desirable than the use of standards (e.g., duty to minimise losses for the creditors or duty to keep maximising the interest of the corporation). Similarly, in countries with inefficient insolvency frameworks, initiating an insolvency proceeding can do more harm than good for both debtors and creditors. Therefore, these countries should not impose a duty to initiate insolvency proceedings even if, as it happens in many jurisdictions with inefficient frameworks (e.g., emerging economies), this solution makes more sense from the perspective of the corporate ownership structure prevailing in the country.
Based on a comparative, interdisciplinary, and country-specific analysis, my articles provides various policy recommendations to enhance the regulatory framework of directors’ duties in the zone of insolvency across jurisdictions taking into account international divergences in corporate ownership structures, debt structures, level of financial development, efficiency of the insolvency framework, and sophistication of the judiciary.
The full article is available here.
A modified version of this post was published on the Singapore Global Restructuring Initiative Blog.