Forefront by TSMP: Directors’ Duties – When Red Is the New Black

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Forefront by TSMP

7 June 2016

Directors’ Duties – When Red Is the New Black

p>As companies across the world increasingly report dismal results, Forefront: By TSMP discusses some timely lessons on Directors’ Duties when the company is in financial trouble, and stares into the crystal ball on the growth of creditor-funded litigation.

By Thio Shen Yi, SC

Cover photo credit: Unsplash.com

Living the Link, the brainchild of Singapore fashion celebrity and pioneer Tina Tan-Leo (“Ms Tan-Leo”), was incorporated in 2007 with the bold vision that it would be a fashion and lifestyle concept store, combining the retail of high fashion brands with food and beverage outlets. For many years, the Link chain of boutiques was Singapore’s arbiter of fashion and the purveyor of all things you need for the ultimate in elegant living. Living the Link, Ms Tan-Leo’s latest foray, was set to be another surefire success.

Sadly, the global financial crisis in 2008 sounded the death knell for many a hopeful enterprise and Living the Link was one of many casualties. Its business “never really took off” and it ultimately went into creditors’ voluntary liquidation in May 2010, with its main creditors being its related companies (that Ms Tan-Leo was the owner of) and its landlord, to whom it owed arrears in rent and was liable to for premature termination of its lease at One Nassim Road.

Although Living the Link’s liquidation had been ongoing for almost 6 years, it was only in April this year that the Singapore High Court gave a judgment pertaining to improper payments to its creditors. The decision serves as a timely reminder of what a director’s duties to an insolvent company are and the consequences of breaching those duties. It also points to the growing trend of creditor-funded litigation.

Directors’ Duties When Red is the New Black

Directors owe a fiduciary duty to act in the company’s best interests. When the company is profitable, this means that the board needs to keep its shareholders’ interests front and centre.

However, when the company becomes insolvent, the interests of the company’s creditors become paramount. This means that directors must look out for the best interests of the company’s creditors collectively. To this end, they must ensure that the company’s assets are not dissipated and that the company does not take on fresh liability which it does not expect to be able to repay. In addition, the company may not selectively repay certain creditors to the detriment of others. Where such payments are made, particularly to related parties, they may constitute unfair preferences which may subsequently be set aside by the Singapore Court upon the application of the company’s liquidator.

Where a director is complicit in or has procured the making of such preferential payments, this may also constitute a breach of that director’s fiduciary duty rendering the director liable for damages.

These issues were central in the Singapore High Court case of Living the Link Pte Ltd (in creditors’ voluntary liquidation) and Ors v Tan Lay Tin Tina [2016] SGHC 67. The liquidators of Living the Link took out proceedings against both the related-party creditors of the insolvent company as well as Ms Tan-Leo in her capacity as a director. For the first time in a reported case, a director was held personally liable for the preferential payments made by the insolvent company to its related entities. All in all, the director was jointly and severally liable to return more than S$2 million to the company.

The Growing Trend of Creditor-Funded Litigation

This case also highlights the issue of growing creditor-funded litigation, which for better or worse, appears here to stay.

In prior winding ups, the liquidator would often struggle to find adequate financial resources to fund its claims. In the Living the Link case, it was the landlord, aggrieved by the preferred payments, that funded the liquidator’s court action. In fact, it appears from the judgment that it was the landlord who actively took steps to have Living the Link’s original liquidators replaced by liquidators of the landlord’s choosing (and funding), who aggressively prosecuted the insolvent company’s claims against Ms Tan-Leo and the associated entities.

Whilst creditor-funded insolvency litigation is not novel, it has not been a common occurrence in small to medium scale liquidations where the majority of creditors’ claims are usually in respect of trade debts and operational expenses. But in the present economic climate, where an upswing in the number of corporate insolvencies is coupled with the growing willingness of creditor groups to invest in recovery action, many more creditor-driven investigations and recovery proceedings can be expected.

In fact, creditors who fund the liquidator’s recovery efforts may also stand to improve their position in the liquidator’s distribution of the company’s assets, as the Singapore courts have a statutory power to give such funding creditors an advantage over other creditors in the distribution of the insolvent company’s assets, in consideration of the risks run by those creditors in funding the recovery proceedings.

Taking another step down what directors may consider a slippery slope, the High Court (in the case of Re Vanguard Energy Pte Ltd [2015] 4 SLR 597) has recently held that liquidators can validly assign (for a purchase consideration) causes of action belonging to the company. This effectively means that liquidators can now “sell” the company’s right to prosecute the company’s debtors and parties who potentially have a liability to the company (such as an errant director) to third parties. This potentially opens the door for a great deal more litigation, and hapless directors could be facing down civil suits brought by unrelated, opportunistic “inventors” intent on cultivating litigation in search of financial returns.

These new legal developments in today’s financial headwinds suggest increased risks for directors. One key takeaway is that when the company’s books start sporting red ink, the duties of directors take on a different gloss and it is worth stopping, and taking stock of what restrictions the company should observe. Different rules apply when managing a company facing insolvency, and directors must walk a much thinner line when Red is the new Black.