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Directors in the twilight zone. Neil Cooper Partner, Kroll Corporate Advisory & Restructuring Past President, INSOL International. The “Twilight Zone”. The period when the future of the company is uncertain - Is it solvent or insolvent? Is it profitable or loss-making?

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Directors in the twilight zone l.jpg

Directors in the twilight zone

Neil Cooper

Partner, Kroll Corporate Advisory & Restructuring

Past President, INSOL International


The twilight zone l.jpg

The “Twilight Zone”

  • The period when the future of the company is uncertain -

  • Is it solvent or insolvent?

  • Is it profitable or loss-making?

  • In essence,

    will it survive or fail?


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Introduction

  • considerable advances in corporate governance generally

  • insufficient consideration of liability in the twilight zone

  • two publications by INSOL International

  • In essence, it is the time when directors’ responsibilities change from protecting shareholders to protecting creditors


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Main issues

  • On what does “twilight zone” depend

  • Actions giving rise to liability

  • Who may be liable

  • Orders available to the court

  • Impact on counterparties

  • Enforcement

  • Remedies

  • Duty to cooperate


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On what does the “twilight zone” depend?

  • whether formal proceedings commenced

  • actual or assumed knowledge of insolvency

  • nature of transaction

  • whether other party connected or associated

  • any other factors?


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Actions giving rise to liability

  • Breach of general & common law liabilities

  • Insolvency specific liabilities


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Actions giving rise to liability – early stage

  • falsification of company's books

  • transactions defrauding creditors

  • extortionate credit transactions

  • fraud in anticipation of winding-up

  • false representations to company's creditors – overtly or covertly


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Actions giving rise to liability -later stage

  • fraudulent (or dishonest) trading

  • wrongful (or negligent) trading

  • preferences

  • transactions at undervalue

  • incurring further credit during the twilight period


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What defences are permitted?

  • lack of actual knowledge of insolvency

  • reasonable belief of solvency of companyafter transaction

  • benefit to company or group of related companies from transaction

  • Acting on professional advice

  • other (e.g. technical defence no intention to prefer)


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Who may be liable?

  • Directors

  • Shadow directors

  • De facto directors

  • Former directors

  • Lenders/financiers

  • Third parties dealing with directors with or without knowledge of insolvency


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Orders available to the court

  • pay compensation to company

  • liability to creditors

  • disqualified from acting as director

  • imprisonment or fine

  • setting aside "tainted" transaction

  • postponing any debt owed by company to director


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Duty to co-operate

  • who has duty to co-operate with the office holder?

  • defence of privilege against self-incrimination?

  • court sanction to enforce duty by fine and/or imprisonment

  • statutory presumptions reversing burden of proof where connected parties concerned


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Sundry issues

  • Time limits for actions

  • Appeal periods

  • Foreign application as well as domestic?

  • D & O insurance

  • Ability to incur further credit in twilight period as part of reorganisation


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Pros and cons

Pros

  • Stop recklessness before too late

  • Encourages responsible management

  • Incentive to hire professionals

    Cons

  • Accelerates collapse

  • Inhibits workouts

  • Weakens enterprise initiative

  • Increases risk to lenders & introduces uncertainty


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In practice

  • Most directors start out honest

  • Poor results encourage little lies

  • which leads to bigger deception

  • and need to falsify

  • coupled with self-justification

  • and eventually little left to lose

  • And they can’t work out how it ended that way


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International best practice

  • Need for positive encouragement for improved corporate governance

  • Financing consequences

  • Increased penalties for abuse

  • Wrongful trading test is most workable – the stick

  • Improved rescue laws provide viable alternatives to directors – the carrot


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