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Directors Duties in Insolvency and its Vicinity- An Alternative Approach for Creditors to Recover

 

Cyprus: Directors Duties in Insolvency and its Vicinity- An Alternative Approach for Creditors to Recover

 

When a company enters insolvency or its ‘’vicinity’’[1], the fiduciary duties of directors are no longer owed to the company as a whole, and instead their duties shift towards the creditors. [Kinsela & Anor v Russell Kinsela Pty Ltd [1986] 4 NSWLR 722; West Mercia Safetywear Ltd v Dodd (1988) 4 BCC 30]

 

Pursuant to section 212 of Cap 113, under Cyprus law a company is deemed to be insolvent:

 

" a) If a statutory demand for an undisputed and liquidated amount, exceeding (€5.000), is left unpaid for more than three weeks; or

 

b) …; or

 

c) If it is proved to the Court’s satisfaction that the company is unable to pay its debts as they fall due, having in mind its contingent and prospective liabilities (‘’the cash flow test’’) ; or

 

d) If it is proved to the Court’s satisfaction that the liabilities of the company exceed the company’s assets, having in mind its contingent and prospective liabilities; (‘’the balance sheet test’’) "

 

According to the decision in Yukong Line Ltd v Rendesburg Investments Corpn (No 2) [1998] 1 WLR 294, despite this duty shift a director cannot be sued by individual creditors because he does not owe direct fiduciary duties towards them. Therefore, actions against them are brought by the liquidator on behalf of the company, which at this point is synonymous to the creditors and not the shareholders.

 

Cyprus law, in contrast with English law does not have a wrongful trading provision similar to section 214 of the Insolvency Act 1986 (IA 1986). In summary, pursuant to s. 214 a director may be found liable for contribution to the company’s assets, if the company has gone into insolvent liquidation, and at some time before the commencement of the winding up proceedings, the director knew or ought to have known that there was no reasonable prospect of avoiding insolvency, and if he did not take every step to minimize the potential loss.

 

Even though Cyprus law does not provide a similar statutory provision, it is very likely that a similar result with that of s. 214 of IA 1986 can be achieved through the use of the West Mercia rule as a remedy. This function of the West Mercia rule is similar to that of the wrongful trading provision, but due to the fact that it is triggered earlier than the duty in s. 214, it manages to encompass managerial conduct committed at a much earlier point, and thus provides for an even more extensive application. Additionally, it is not limited to a compensatory remedy and it is not confined to winding-up proceedings. In general, when using the West Mercia rule as a remedy, to be able to recover against a director, the director must have received a benefit from the misapplication of the funds or his breach of duties.

 

An even more extensive application of the West Mercia rule as a remedy can be seen in the Australian case of Westpac Banking Corporation v Bell Group Ltd [2012] WASCA 157; (2012) 89 ACSR 1, which was concerned with the validity of transactions with creditors before formal insolvency proceedings were initiated. In short, there was a refinancing of some sort which disadvantaged some creditors over others, and the court even though it concluded that it amounted to preferences, it found that it was not susceptible to an attack under the Australian law preference rules, because it took place outside the period of six months prior to the commencement of the formal insolvency proceedings. Since no successful claim for recovery could be based on the preferences provisions, it was contended that the Bell Group’s directors in going through with the refinancing were in violation of their fiduciary duties to the creditors, based on the Australian corresponding rule with that in West Mercia.

 

Unlike other cases which applied the West Mercia rule as a remedy, the Westpac v Bell Group decision is particularly important for the fact that it did not require as a condition, evidence that the directors had received an advantage from this scheme. Even though under this formulation of the West Mercia rule there can be no compensation order against the directors since the corporation does not suffer a loss and the directors have not benefited personally, it may nevertheless leave them vulnerable for disqualification and it also opens a route for recovery from creditors who dishonestly assisted in the breach.

 

In summary, the West Mercia rule can allow creditors to recover debt owed to them despite the lack of provisions like s. 214 IA 1986, statutory limitations and difficulties surrounding the area of insolvency. Its function as a remedy can allow a creditor to recover from the directors for breach of their duties, or even provide a way to claim against other creditors for dishonest assistance.

 

For now, this function of the West Mercia rule does not seem to have come for examination before the court, but the fact that authoritative cases like West Mercia v Dodd and Kinsela v Russell Kinsela have been cited with acceptance by Cyprus courts, shows promise that such an approach can be adopted.

 

* [1] The terms ‘’vicinity of insolvency’’ or ‘’twilight zone’’ are used interchangeably to refer to the gap that exists between the period when a company is regarded as doubtful solvent and up to the point it is found to be insolvent under section 212.

 

For further information on this topic please contact

Mr. Kyriakos Pittas( kpittas@pittaslegal.com) at SOTERIS PITTAS & CO LLC,

by telephone (+357 25 028460) or by fax (+357 25 028461)

 

 

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

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