In the modern legal regime for corporate

insolvency there are two basic routes which

can be followed in dealing with a company that
is failing: liquidation and corporate rescue.
Both provide a collective way of set tling the
fate of the company when the claimants can
not resolve the company's financial troubles
through private negotiations. Yet they provide
two distinct paths to address the financial
difficulties of a business. Liquidation serves the
basic purpose of winding up an ailing company
through an orderly collection and real isation
of assets for the benefit of the claimants. The
net value that is gathered through this
collective debt collection process is then
distributed among claimants according to a
statutory system of priorities. On the other
hand, corporate rescue procedures provide an
al ternative to the immediate liquidation of the
ailing company, seeking to provide companies
in financial difficulty with a period of respite in
which compromises and rescue arrangements
can be made.
But, what ex actly do we mean when we use
the term 'corporate rescue'? What values and
purposes does it serve? How can a rescue be
achieved? What conceptual, legal and practical
problems arise in relation to corporate rescue?
THE CONCEPT OF CORPORATE RESCUE

The term 'corporate rescue' is understood in

very differ ent ways by policy-makers, judges
and scholars. These differences often stem
from the divergent standpoints regarding the
approaches and purposes of rescue ac tions in
response to companies' financial troubles.
First, corporate rescue can be premised on
(contractually agreed) informal mechanisms as
well as on formal collective legal proceedings.
Professor Belcher defined the term 'corporate
rescue' as 'a major intervention necessary to
avert eventual failure of the company'. Such a
broad definition encompasses any drastic
remedial action to a company at a time of cor
porate crisis, including both the informal and
formal strategic rescue responses. In contrast,
a narrow definition of the term uses it to cover
only the opera tion of legal proceedings, which
offer facilitating mech anisms for rescuing
financially distressed companies. Furthermore,
the term may be defined differently as a way to
reflect the various outcomes of rescue
activities. Corporate rescue, or corporate
reorganisation' in North American terminology,
may be regarded as an alternative to
immediate liquidation of the company, with
the aim to prevent the death of the company.
In the UK, the scope of rescue is wider, in
cluding both a turnaround of the company and
alternat ively preserving the core of a
company's business. Un derlining such
differences is the distinction between
'company rescue' and 'business rescue.
Company rescue works towards the restoration of a
company in difficulty, which leads to the
preservation of the legal entity itself so that the
Company rescue works towards the restoration of a
company in
difficulty, which leads to the preservation of the legal
entity itself so that the company can continue
operations after reorganisation. In contrast, business
rescue implies the termination of the old company,
but the actual business and its activities will remain
as
a cohesive, productive unit under new ownership.
This happens where a company is insolvent but
successful steps are taken to retain the business as
an operational enterprise, to sustain the employment
of groups of workers and to ensure the survival of
some economic activity. Company rescue often
involves changes in the management of the company
and is usually achieved through reorganising
methods such as refinancing, debt composition or
rescheduling, downsizing activities, and making
redundant part of the workforce to offer temporary
relief. Business rescue is commonly achieved through
the sale of the company's assets and business as a
going concern, which, as commonly believed, could
generate more value than assets being sold in a
piecemeal fashion. For the purposes of this book, the
term 'corporate rescue' will refer to collective
strategic rescue proceedings under a legal
framework designed to facilitate either the
preservation of the distressed company itself or the
rescue of its underlying business by transferring it to
a new owner. It should be clarified that rescue out
comes can be achieved not only through rescue-
oriented proceedings but also through a
liquidation procedure. As mentioned earlier, the
liquidation procedure is oriented to the winding-up
of the company by ceasing its operations, realising its
assets and paying off its debts and liabilities. In the
process of realising off its debts and liabilities. In the
process of realising its assets, a result that amounts
to a rescue may be achieved where the company's
assets are sold in the form of a
complete takeover or a bulk sale of the assets, which
involves the sale of the entire business, including
goodwill and other intangibles. Nevertheless, despite
the rescue outcomes, the liquida tion procedure is
not recognised as part of corporate rescue
proceedings in the sense used here since its goal is
different. The distinctive feature of a rescue pro
cedure is that it is designed to capture the going-con
cern surplus in corporate restructurings and
insolvency, in general. The going-concern surplus can
be obtained if the business and assets are preserved
as an operating unit, surviving either through a suc
cessful company turnaround or reorganisation, or
through a going-concern sale, where the whole or
sub stantial business and assets of the ailing
company are. preserved.

THE SURPLUS OF GOING-CONCERN

VALUE
It is commonly acknowledged that the
rationale of cor porate rescue is to capture the
surplus of going-con cern value of the assets of
the ailing company, in that the value of a
company's business operations is likely to be
far greater than the scrap value of its assets. As
has been noted: [wle have a going-concern
surplus (the thing the law of corporate
reorganisations exists to preserve) only to the
extent that there are assets that are worth
more if located within an existing firm. If all the
assets
can be used as well elsewhere, the firm has no
value as a going concern. The expression 'going-
concern value is contrasted with piecemeal
liquidation value, which is referred to as the value
realised when the parts of the business and assets
are broken up and sold off separately. The
goingconcern value could be measured by
estimating the income stream that the assets would
generate if they were kept together, taking into
account the risk of reorganisation failure and
comparing it to the amount that the assets would
realise if they were sold off separately.But what are
the sources of goingconcern surplus that exceed
their piecemeal liquidation value? In other words,
where does the additional value come from?
Traditional thinking places the source of going-
concern surplus in the intangibles associated with
the running of the business, such as goodwill and
intellectual property. It follows that salvaging a
company's going concern value can be achieved by
holding together a 'bundle of intangible assets
(patents, accounts receivable, customer lists and
orders, etc.) and employees, and outsourcing most
manufacturing activities. Nevertheless, this assertion
has been challenged in the wake of the tremendous
change in fundamental forces at work in the
economy, brought on especially by the decline of
heavy industry, technological advances, easier
access to capital and credit markets, globalisation
and the birth of a service-based economy. The
premise of the going-concern value in the traditional
sense has also been questioned by the argument
that if the intangible assets are the only source of
the going-concern surplus, most failed companies
may be said to have no going-concern surplus, as
their failure is usually due to their lack of valuable
intangible assets, having neither a sound business
Formal rescue-oriented proceedings have their ad
vantages in providing a forum for structured negoti
ations among competing and diverse interests to
avoid the unnecessary collapse of businesses in the
chaos of financial distress. Nevertheless, the role of
insolv ency law is primarily, although not merely, a
response to the problem of collecting debts. The
formal rules in this context impose considerable
limits on departing from the pre-insolvency
entitlements of claimholders and on how far they
can go in response to the substan tial obstacles
caused by the inherent uncertainty in the
progression of rescue work. Pre-pack restructuring is
a hybrid form of corporate rescue and it does
present an innovative approach to overcome the
holdout problem in informal workouts by providing a
formal procedure to solidify the outcome of private
negotiations. Yet pre-pack rescue also face
challenges in capturing the going concern surplus in
an uncertain state of corporate distress. In
particular, how should the competing interests and
various goals that underlie the insolvency system
(e.g. fairness or justice and wealth creation) be
prioritised when a trade-off is inevitable? This
problem could be more acute in a pre pack
restructuring, where trade-offs are often prede
termined and market-led, but not always in line with
the statutory objectives of a particular insolvency
law. These challenges are key to the successful use
and completion of pre-pack arrangements and they
are ex tensively discussed in subsequent chapters. It
is the duty of the directors of a company to run the
business of the company in the best interests of the
company and its shareholders. In principle, the
company.
alone, is responsible for the debts incurred in the
running of the company and the creditors are, in
principle. precluded from looking to the directors or
shareholders for payment of any shortfall arising as a
result of the company's insolvency. This principle has,
in a number of jurisdictions undergone statutory
change such that in certain circumstances, the
directors and others who were concerned with the
management of the company may be made liable to
contribute, personally, to meet the payment in part
or entirely of the company's debts. This paper aims
to explore this statutory jurisdiction. It also seeks to
describe succinctly the process by which the shift
from unlimited to limited liability trading was
achieved. It will end by examining briefly a
comparatively new phenomenon, namely that of a
shift in the focus of the directors' duties from
company and shareholders to the creditors as the
company becomes insolvent and nears the stage of a
formal declaration of its insolvent status i the so-
called zone of insolvency

1.Introduction

It is a generally accepted proposition that the

duty of the directors of a company is to run the
business of the company in the best interests
of the company. Some, who are perhaps les
pedantic about the separation in legal terms of
the company from its shareholders, would
extend the beneficiary of these duties to
include the shareholders Nevertheless, this
separation is of crucial importance, in
particular in shifting the primary liability for the
debts incurred in running the business, from
the individual entrepreneur, to the company
which, in law owns and carries on the business.
The company is the primary debtor and the
legal status of the entrepreneur is that of being
a director of, and a shareholder with limited
liability in the company. Thus, in principle, the
company, alone, is responsible for the debts
incurred in the running of the company and the
creditors are, in principle, precluded from
looking to the entrepreneur for payment of any
shortfall arising as a result of the company's
Insolvency
It is also the case that in a number of jurisdictions
statutory changes have sought, in certain
circumstances. to render the directors and others
who were concerned with the management of the
company prior to the insolvent liquidation, liable to
contribute to the assets of the company so as to
assist the insolvent estate in meeting the companya
debts to its creditors. This paper aima to explore this
statutory jurisdiction. Before this, however, it will
seek to describe briefly the process by which the shift
from unlimited to limited liability trading was
achieved Thereafter it will look at the common law
response to this changed dispensation. It will end by
examining briefly a comparatively new phenomenon,
namely that of a shift in the focus of the directors
duties from company and shareholders to creditors
as the company becomes insolvent and nears the
stage of a formal declaration of its insolvent status.
As we will discover, this new phenomenon seems to
have struck a chord in many different jurisdictions,
but is, on the other hand elusive and not without
controversy it, as this principle would have it, the
focus of the duty of director and officers shifts to
creditors when the company enters the zone of
insolvency, the creditors should be able to enforce
that duty before the formal declaration of insolvency
Arguably, they should also be entitled to seek
information about the proposed actions of the
company Insolvency Arguably they should also be
entitled to seek information about the proposed
actions of the company and they should be able to
apply to court to prohibit any action which they
perceive to be against their interests.
The notion of the zone of insolvency may have a
distinctly modern ring about it, but I hope to show
that it has a long pedigree. I hope also to illustrate
that it encompasses a clash between two
fundamental principles in the conception and
operation of limited. liability companies, namely the
protection of the company's creditors and the right
and the duty of the directors and officers of the
company to run the business of the company in the
best interests of the shareholders. Thus the first part
of this paper locks forward to formal insolvency, the
second looks back from farmnal insolvency to the
actions of the directors as the company approaches
its downfall. Each part is distinctive. Yet, there is an
obvious link between these two parts. If the legal
system does provide for the personal liability of the
directors and officers who led the company into
formal insolvency, this is likely to influence the
conduct of those directors and officers when they
perceive this to be the likely fate of the company.
The threat of such personal liability may encourage
decisions and conduct which further the creditors
interests and thus, informally, bring about this shift in
the focus of the duty of directors and officers.
I take the case of Salomon v Salomon & Co Ltd as the
starting point for the exploration of these ideas in its
result, this decision greatly strengthened the position
of directors and shareholders (whom I will
sometimes refer to, collectively, as the entrepreneur
or the entrepreneurial interest) at the expense of the
creditors. Much of the post Salomon history has been
the digesting of the dispensation which was created
by the decision, and the seeking to restore, or at
least maintain the balance between these competing
interests. Salomon's case was one of the great
exports of the British Empire and justifiably can claim
the title of father or grandfather, or maybe
Godfather, of company law for colonials and
colorists alike in South Africa, where I first studied
company law under the great Professor HR (Bobby)
Hahlo later the Director of the Institute of
Comparative Law at McGili University, Montreal
Salomonis case had pride of place at the start of the
course and was on the first substantive page of
Hahlo's "Company Law Through the Cases, the first
company law casebook of the English-inspired
common law world.
To law students, Salomon's case meant the authority
for the proposition that the company was a separate
legal entity from that of the people who constituted
the company, as well as the beginning of the process
of wrestling with the vell of incorporation and its
piercing or in more genteel discussions its lifting. The
first of these propositions is at the root of the shift in
the balance of t power from creditor to
entrepreneur, the second in our continuing attempt
to ensure that we have achieved the right balance
between these two opposing commercial forces.
2.The period leading up to Salomon

Until the middle of the nineteenth century, the

overwhelming mass of commercial trading in
Great Britain was undertaken by single traders
or by partnerships of traders, without any limit
of personal liability.la Occasional attempts to
provide for limited liability by contract were
eithet too cumbersome or were rejected by
the courts, 12 This was changed, or rather the
process of change from unlimited to limited
liability trading was started, with the passage
of the Limited Liability Actin 1855 The latter act
was only achieved after a spirited public
debate, and was grafted on to the Joint Stock
Companies Act of 1844, and together these
and other acts were consolidated in 1862 as
Britain's first Companies Act.
When the comparison was drawn between, on the
one hand, a registered company which offered
limited liability to its investors and directors, and, on
the other, the partners of a partnership, it is hardly
surprising that there were misgivings in this new
dispensation. While there could be no rational
objection to seeking an escape from the labyrinthine
problems which arose from the unincorporated
status of the partnership compounded as they were
by the much criticised procedures of the Courts of
Equity, permitting small time entrepreneurial activity
without personal liability was something else. There
was a heady mix of emotions and position in this
debate. High Torles were opposed to limited liability
and subscribed to the view expressed in the famous
decision of Waugh v Carver that he who feels the
benefit should also feel the burden, itself a
restatement of Chief Justice Grey's dictum some 18
years earler "that every man who has the share of
the profite of a trade, ought to bear his share of the
loss Support for limited liability on the other hand,
came from the radical Whigs (the predecessors of
today's UK Liberaln) and the utilitarian economists
such as Jeremy Bentham) and John Stuart Mill
Human nature and religion were also pressed in aid
by the respective protagonists, Robert Lowe, the vice
president of the Board of Trade, who is considered
largely responsible for the pioneering Limited
Liability Act of 1855. denounced the evangelical
fervour of his opponents unless we deal with each
other upon some presumption of confidence the
disruption of human society must necessarily follow
Fraud and wickedness are not to be presumed in
individuals.
This evangelical opposition came from men like John
Ramsay McCulloch a prolific Scottish journalist, who
was editor of both The Scotsman and the Edibagh
Review an ardent disciple of classical Ricardo
economics and a lecturer on political economy at
University College London in the early 1830s. There
was no separation of human nature and economics
for McCulloch in the scheme laid down by Providence
for the government of the world, there is no shifting
of narrowing of responsibilities, every man being
personally answerable to the utmost extent for all his
actions. But the advocates of limited liability proclaim
in their superior wisdom that the scheme of
Providence may be advantageously modified, and
that debts and contracts may be contracted which
the detitors though they have the means, shall not
be bound to discharge.11
One of McCullough's best known pupils was Lord
Overstone, a top flight political economist of the day
who described the Limited Liability Act as a fraud on
creditors, and harbinger.

3.Directors duties and the zone of insolvency the

early period
Salomon's case made more urgent the need for some
vigilance on the part of creditors as to the solvency of
their debtors who were registered companies. They
had, after all, been told so by the House of Lords
that* [e]very creditor is entitled to get and to hold
the best security the law allows him to take 1221
And, as we shall see shortly. those who could
essentially lenders as opposed to trade
creditors.123.1 did. But as for those who could not,
well, it was a brave new world and at least they knew
the score
The unsecured creditors of A Salomon and Company
Limited, may be entitled to sympathy, but they have
only themselves to blame for their misfortunes. They
trusted the company, I suppose, because they had
long dealt with Mr Salomon, and he had always paid
his way, but they had full notice that they were no
longer dealing with an individual and they must be
taken to have been cognisant of the memorandum
and of the articles of association 1241
Having notice was all very well, but the only real
protection for most traders was to abstain from
dealing with a limited liability company, hardly an
option for most. Investigating and monitoring
the solvency of the company was equally
illusory. But some lenders, on the other hand, could
and did take full advantage of two significant
instruments of credit and security the floating
charge and receivership. The latter was of ancient
vintage as a means of managing leased real
property, but emerged in the late nineteenth
century as a vital adjunct to the floating charge,
which itself dated from about 1870.125.1
Salomon, himself, had loaned money to the
company and had secured his loan by means of a
floating charge. The only one of the nine judgments
in all courts to make this clear is that of Lord Justice
Kay.1261 Others speak only of the debenture issued
to Salomon so it can be safely assumed that at that
stage, anyway, a debenture was taken to include a
floating charge. 1271 Indeed, it was this aspect of the
Salomon case which, commercially speaking, was the
most crucial. Not only was Salomon not obliged to
indemnify the company's creditors, but the floating
charge enabled him to be first in the queue of
creditors. This must have added insult to the injury
evinced by the four judges below and there is a
somewhat lame recognition of this in the House of
Lords: