Overriding provisions of Guernsey law affecting third parties contracting with Guernsey companies
07 February 2013
Guernsey companies are utilised for significant structuring and offshore transactions including captive insurance, investment funds and special project vehicles owning property. Generally, contractual relations with banks, insurers, reinsurers and investment companies are governed by the law of England and Wales or other foreign jurisdictions. In such cases, the law governing those contracts (and jurisdiction clauses choosing another forum as the forum for resolution of disputes by arbitration or litigation) will be applied in the absence of fraud or some matter which is contrary to public policy in Guernsey.
However, the rules of conflicts of laws mean that certain Guernsey statutes relating to, for example, capacity of companies to do certain acts, enforcement of judgments and security over Guernsey situs intangible and tangible property remain governed by Guernsey law. The consideration of those overriding provisions are therefore important for any third party considering entering into a contract with Guernsey company.
Generally the rules are as follows:
- real property: prior ranking security over real property situated in the Island of Guernsey is taken by way of a charge over real property, consented to by the property owner before the conveyancing Court, which sits on Tuesdays and Thursdays. A document (the "bond") is registered on the public records at Her Majesty’s Greffe. Duty is payable to the States of Guernsey (the Island Government) on the amount secured at the rate of 0.5%.
- moveable property: security is often required over shares, bank accounts or investment portfolios situate in Guernsey as a result of commercial transactions involving Guernsey companies. English law or other forms of legal charge over moveable property are not effective prior ranking security over Guernsey situs intangible assets. Only an agreement which complies with the provisions of the Security Interests (Guernsey) Law, 1993, is capable of providing such security. It is not possible to charge a lease in Guernsey. When charging the shares of a Guernsey company, it should be noted, in particular that the standard articles of Guernsey companies provide the directors with an absolute discretion to refuse a share transfer. It will often be necessary to have the members of the company approve the amendment of the articles of the company so that they may not refuse a transfer arising from the provisions of a security interest agreement over shares.
A Guernsey company may provide financial assistance (whether directly or indirectly) for the purchase of its own shares provided that;
- the memorandum/articles allow for the company to provide such financial assistance; and
- immediately after the giving of such financial assistance, the company will satisfy the solvency test set out in the Companies (Guernsey) Law, 2008, as amended (the "Companies Law").
There is no requirement under Guernsey law to perform a "white wash" procedure similar to that known under English Company law before the 2008 changes. There is no requirement that the members of a Guernsey company sanction financial assistance by ordinary or special resolution.
A company may provide financial assistance in many ways, both direct and indirect, including granting security, waiving or making loans or guarantees, discharging debts or the debts of third parties. In practice, where relevant it is dealt with by special minutes of the board of directors providing sanction for such financial assistance, having considered the company’s solvency position and approved a solvency certificate (the "Solvency Certificate").
A distribution made to a member at a time when the company did not immediately after the distribution satisfy the solvency test, may be recovered except to the extent that the member received the distribution in good faith without knowledge of the company’s failure to satisfy the solvency test and has altered their position in reliance on the validity of the distribution.
A director who has failed to take reasonable steps to ensure the correct procedures were followed and has approved the Solvency Certificate even though reasonable grounds for believing that the company would satisfy the solvency test did not exist at the time, may be personally liable to repay the company so much of the distribution as is not recoverable from members.
Borrowing powers and power of the directors to bind a Guernsey company
A company’s borrowing, security or guarantee powers may be limited by the terms of its memorandum and articles and Guernsey counsel are frequently asked to opine on the corporate powers of companies and whether a contemplated transaction might be ultra vires. Third parties are protected by statute.
Section 114 of the Companies Law provides that the validity of an act by a company shall not be called into question on the grounds of lack of capacity by virtue of anything contained in or omitted from:
- the company’s memorandum and articles;
- any resolution of the company;
- any agreement between the company’s members or any of them.
Further, section 115 of the Companies Law provides that in favour of a person dealing with a company in good faith, the power of the directors to bind it, or authorise others to do so is deemed to be free of any limitation imposed or deriving from:
- the company’s memorandum and articles;
- any resolution of the company;
- any agreement between the company’s members or any of them.
A transaction entered into by a Guernsey company in which a director is interested is voidable by the company at any time within three months after the date the transaction is disclosed to the board of directors unless:
- the director's interest was disclosed to the board in accordance with section 162 of the Companies Law prior to the company entering into the transaction or was not required to be disclosed under section 162 of the Companies Law; or
- the transaction is ratified in accordance with section 160 of the Companies Law; or
- the company received fair value for the transaction (in this regard, the Companies Law provides that (a) a determination as to whether a company receives fair value for a transaction shall be made on the basis of the information known to the company and the interested director at the time that the transaction was entered into, (b) if a transaction is entered into by the company in the ordinary course of its business and on usual terms and conditions, the company is presumed to receive fair value under the transaction, (c) a person seeking to uphold a transaction and who knew or ought to have known of the director's interest at the time the transaction is entered into has the burden of establishing fair value, and (d) in any other case, the company has the burden of establishing that it did not receive fair value).
Third parties are protected: the avoidance of a transaction does not affect the title or interest of a person in or to property which that person has acquired if the property was acquired from a person other than the company, for valuable consideration and without the knowledge of the circumstances of the transaction under which the seller acquired the property from the company.
The Control of Borrowing Ordinances, 1959, as amended ("COBO") require that a company must have the permission of the States of Guernsey Policy Council, whose executive functions are delegated to the Guernsey Financial Services Commission by statute, in order to borrow money. Where a company borrows more than £500,000 in any one year (not from a bank in the ordinary course of business) or proposes to raise more than this amount by the issue of shares to founder members on incorporation, then it must obtain consent of the Guernsey Financial Services Commission. This ordinance is out of date and is now being utilised for purposes probably not intended in its original form (being intended primarily for exchange control purposes in the aftermath of World War II). Permission may not be given after the event. The sanction for failing to follow these provisions includes fines for summary conviction and on indictment to a prison sentence not exceeding two years together with a fine which may be up to the amount of any unapproved borrowing or the nominal value of shares issued without consent. Failure to observe these requirements are likely to lead to regulatory investigation in the case of regulated companies (i.e. fiduciary, insurance, investment funds). It is common for consent to be sought in all cases where it is believed there is any likelihood of application of the legislation. It should be noted that COBO will shortly be repeated.
Guernsey common law contains rights known as the "droit de division" and "droit de discussion" which allow a guarantor to require a creditor to prove a debt against a debtor (or to action co-guarantors) before enforcing the provisions of a guarantee. These rights may be waived by express terms in a contractual relationship, and it is common practice for such rights to be waived, even in contracts governed by laws other than that of Guernsey.
The "Ordonnance Donnant Pouvoir à La Cour de Réduire Les Intérêts Ecessifs", 1930 provides that the Royal Court has powers to reduce interest at a rate exceeding 10 per cent per annum where, taking into account all the circumstances, that rate is considered unreasonable. The Royal Court also has powers to reduce interest rates on hire purchase agreements where it considers that the interest rate is excessive taking into account the value of the goods acquired by the relevant agreement. This ordinance is rarely pleaded in proceedings in Guernsey. There is also some doubt as to whether the ordinance could apply to commercial transactions between companies, as the ordinance refers to "interest which is impossible to pay and which by virtue of judicial proceedings exposes them and their families to misery", and therefore is likely only apply to individual persons rather than companies subject to such interest. Indeed, it is a fundamental provision of Guernsey law that "entre les parties le contrat fait loi", similar to that of English law that parties are free (within of course the bounds of public policy and immorality and in the absence of fraud), to conclude and agree whatever terms they wish in a contract. The effect of these potentially conflicting provisions of Guernsey law have not been resolved conclusively.
Enforcement of foreign judgments and arbitration awards
Irrespective of the choice of governing law of a contract or the forum for resolution of any dispute between parties, if the assets which a third party is trying to obtain to satisfy a judgment are present in Guernsey it will be inevitable that a judgment (in personam) must be brought to, recognised and enforced under Guernsey law in order to recover sums due. (This does not apply to prior ranking security interests granted under a security interest agreement described above, for example over shares or bank accounts).
No judgment (in personam) of a jurisdiction other than Guernsey is directly enforceable in Guernsey without an order of the Guernsey court. English Bailiffs have no jurisdiction, for example, to come to Guernsey and arrest goods. The Judgments (Reciprocal Enforcement)(Guernsey) Law, 1957, as amended (the "1957 Law") provides that judgments from the courts of certain jurisdictions may be recognised and registered upon application to the Royal Court in Guernsey and then enforced according to Guernsey procedures. Enforcement of orders of the Royal Court are the responsibility of Her Majesty’s Sheriff.
The enforcement legislation allows for judgments from the following jurisdictions to be directly enforceable in Guernsey:
- England & Wales in the Supreme Court or the Senior Courts of England and Wales, excluding the Crown Court.
- Isle of Man The High Court of Justice of the Isle of Man.
- Israel The Supreme Court, The District Courts, Rabbinical Courts, Moslem Religious Courts, Christian Religious Courts and Druze Religious Courts.
- Kingdom of the Netherlands The Hoge Raad der Nederlanden, the Gerechtshoven and Arrondissement-srechtbanken.
- Netherlands Antilles The Hoge Raad der Nederlanden, the Hof van Justitie der Nederlandse Antillen and the Gerecht in Eerste Aanleg.
- Northern Ireland The Supreme Court of Judicature.
- Republic Of Italy The Corte d’Apello and the Tribunale.
- Scotland The Court of Session and the Sheriff Court.
- Surinam the Hof Van Justitie van Suriname, the Kantongerecht in het Eerste Kanton and the Kantongerecht in het Derde Kanton.
Within six years of any final foreign judgment, application may be brought for registration and enforcement provided that the judgment concerned:
- has not been fully satisfied;
- could not be enforced by execution in the country of the original court.
- only judgments satisfying the following conditions may be recognised:
- there is a final and conclusive judgment between the parties thereto;
- there is payable under the judgment a sum of money, not being a sum payable in respect of taxes or other charges of a like nature or in respect of a fine or penalty; and
- the judgment is given after the coming into operation of the ordinance directing that the law apply to the relevant country.
The effect of registration is that the judgment concerned may be enforced according to Guernsey procedures as if it were a judgment of the Royal Court, and the Royal Court has powers over execution in a similar manner. The judgment also carries judgment interest from the date of registration in the same manner as a Guernsey judgment.
An application for registration will be set aside if the Royal Court is satisfied by the judgment debtor that:
- that the judgment is not a judgment to which the law applies or was registered in contravention of the law; or
- that the courts of the country of the original court had no jurisdiction in the circumstances of the case; or
- that the judgment debtor, being the defendant in the proceedings in the original court, did not (notwithstanding that process may have been duly served according to the law of the country of the original court) receive notice of those proceedings in sufficient time to enable him to defend the proceedings and did not appear; or
- that the judgment was obtained by fraud; or
- that enforcement of the judgment would be contrary to public policy in Guernsey; or
- that the rights under the judgment are not vested in the person by whom the application for registration was made.
A judgment may be set aside if the Royal Court is satisfied that the matter in dispute has already been the subject of final and conclusive judgment in another court having jurisdiction in the matter (the principle known as res judicata).
It is therefore most important that contractual relations with Guernsey companies include submission to the jurisdiction of the foreign court where appropriate and that there be agreed provisions as regards service of notices (and proceedings), which can be referred to the court upon application for registration of a foreign judgment. Failure to do so could give rise to grounds to set aside an application for registration.
It is also important to note that only judgments for liquidated sums are capable of recognition and enforcement - it is not possible to plead damages on assessment.
Foreign judgments from other jurisdictions (or courts)
Under common law rules and the provisions of section 9 of the 1957 Law, a judgment creditor may bring a new action in the Royal Court against the judgment debtor based on the existence of a foreign judgment. In such cases the existence of the foreign judgment is itself the cause of action rather than the original subject matter of the agreement and provided it satisfies the rules set out above is deemed to be final and conclusive as to the subject matter. It should not therefore be necessary to reopen any arguments relating to the original subject matter. The same rules as regards public policy, notice, proper jurisdiction and submission to jurisdiction apply to the question of whether a foreign judgment is enforceable by way of fresh proceedings.
It should be noted, particularly as regards the jurisdiction of foreign courts in cases involving the law of contract and tort, that the Brussels & Lugano conventions (Private International Law Act) do not extend to Guernsey and the rules of jurisdiction relating to them may not apply (or be recognised by the Guernsey courts) in all circumstances. This can lead to conflicts between the rules of jurisdiction of foreign courts in certain circumstances unless proper provision has been made within a contract for submission to a foreign jurisdiction by a Guernsey party to that contract.
The enforcement of arbitration awards is governed by Guernsey law (the Arbitration (Guernsey) Law, 1982), as well as by extension of orders in council of UK legislation to Guernsey (such as the Arbitration (International Investment Disputes) Act, 1966).
Whilst, for example, Guernsey is not recognised as a signatory to the New York Convention, extending legislation allows its provisions to be recognised under Guernsey law.
The Guernsey courts therefore have wide powers to recognise and enforce arbitration awards obtained under the New York Convention, Geneva Convention and 1965 Washington Conventions. The convention countries (of which there is a substantial international list) include most substantial nations and many offshore jurisdictions.
Most substantial contracts include arbitration provisions. In complex cross-jurisdiction contracts, where the assets which might comprise the subject matter of a dispute are present in or controlled in Guernsey, it is advisable to examine in detail the mechanics and enforcement of any arbitration hearing process.
Important peculiarities - the protected cell company or "PCC"
Guernsey was the first jurisdiction to introduce modern PCC legislation under the Protected Cell Companies Ordinance 1997, as amended and now incorporated into Part XXVII of the Companies Law. This legislation has been copied in many offshore jurisdictions worldwide.
Under the provisions of the Companies Law, a company may (with permission of the Guernsey Financial Services Commission) create one or more cells for separating the assets and liabilities of a company. Prior to 2006 these companies could only be used for regulated purposes, but may now be used for private wealth structures.
Cells may be formed with or without cell capital and where cell capital is issued, the profits relating to any particular cell are payable to the owners of the shares of the cell concerned.
The relevant sections of the Companies Law and operation and administration of a PCC is an esoteric legal concept which can be difficult to understand. There are a number of very important concepts, the prime one being that a PCC is a single legal entity and cannot therefore contract with itself.
The second important provision is that relating to assets and liabilities. It is the duty of the directors of a PCC to keep assets of each cell separate from one another and separately attributable to the cell to which they relate.
It is a common misconception that it is a duty of the directors of a PCC to attribute liability between cells. This is not the case. It is the duty of the directors to state clearly to any third party that;
- the company is a PCC; and
- where the contract relates to a cell, to state the cell on behalf of which the company is contracting.
It is this requirement to state the name of a contracting cell which creates the contractual nexus allowing attribution of assets to a cell’s business, and which limits the rights of third parties to the assets when bringing a claim only against the assets of the contracting cell.
A creditor with a contractual "link" to a cell may not, under the provisions of the Companies Law, attach a claim to the assets of other cells, or the core of the PCC – assets in these sections of the PCC are "protected assets" for the purposes of the law.
Most importantly for directors and third parties, in the absence of proper naming of a PCC or the relevant cell, the directors are personally liable for the transaction concerned but have an indemnity in the absence of fraud, negligence or wilful misconduct against the assets of the "core" (the non-cellular assets). In many cases the core assets of a PCC are minimal.
This provision of the law is much misunderstood and we have observed considerable errors in its application, mainly by the directors of a PCC "attributing" liability after the event to a cell or cells to which they believe liability should arise. There is no power under the law to allow such "reattribution" of liabilities, indeed they could be highly prejudicial to the members of PCC cells if liabilities can be attributed without proper contractual nexus, as they could erode the inter-cellular protections provided under the PCC Law generally. The proper forum for resolution of a dispute relating to whether a liability is that of one cell or another is to the Royal Court, not by the actions of the directors attributing liability after the event. Since negligence is an exception under which the directors of a PCC cannot claim an indemnity against core assets, a third party contracting with a PCC might have to recover assets from the directors themselves in such circumstances.
It is therefore an essential requirement when contracting with a PCC to ensure that the contract correctly narrates the cell to which the contract relates.
A PCC cannot transfer assets between cells without an order of the court unless such a transfer is either an "arrangement" or "in the ordinary course of business". There is no definition available in the Companies Law of "ordinary course of business", and there is some disagreement amongst Guernsey Advocates as to what the phrase means and therefore when assets can be properly transferred without reference to the courts. The most prudent and cautious advice, particularly when taking into account that declaring a cellular dividend in order to recapitalise assets in another cell may have unwanted tax consequences for a cell owner, is that unless there is certainty that the "ordinary course of business" exception applies, an application for the approval of a transfer of assets between cells should be made to the Royal Court.
It is also most important to recognise that the approval of the GFSC for a particular transaction does not grant immunity from action by a third party to whom prejudice may have been caused. The grant of permission by the GFSC, for example, to amend the business plan of a PCC by transfer of assets does not grant civil immunity from suit against the directors of a PCC, or the company as a whole.
Third parties seeking security over the assets of a PCC should examine in detail any structure whereby a guarantee or financial security is provided from a cell within a PCC other than the cell to which the main contractual liability arises. This is because the guarantee cell may be owned by different members of the company, the guarantee may be invalid for reasons of lack of corporate benefit, or that the securing of assets may prejudice the creditors of the guarantee cell concerned. In all these cases the effectiveness of the guarantee or security may be compromised, or challenged by third parties.
A conventional company can also convert to become a PCC following a relatively simple procedure. Upon conversion, the pre-existing contractual relations of the ordinary company become liabilities of the "core" of the converted PCC. Share capital of the ordinary company also becomes the share capital of the "core". The points raised concerning "naming" of a cell and attribution of liabilities above also apply to conversion of an ordinary company to a PCC. Often, an ordinary company will convert to enable it to separate and manage a portfolio of risks or investments to ring fence the assets associated with them from being attacked by creditors as a whole. We have seen a number of examples where contracts have not been amended or novated to the new cells of a PCC following conversion. Without novation of such contracts it is arguable whether any of the protections of the PCC ordinance are available. It is not possible for the directors of a newly converted PCC to simply assume that the liabilities (and benefits) of a particular contract automatically apply and can be "transferred" to a newly formed cell rather than the core without being properly approved by all the parties to the contract, and the usual process would be to enter a form of novation for this purpose
In the event, for example, of a contractual breach or a contract being called upon (such as a contract of reinsurance), unless the relevant contracts have been properly novated to the relevant cells, then liability is likely to fall directly on the core of a PCC with obvious unintended consequences.
The same is true of the conversion of share capital in a PCC. Often it will be advantageous for the majority of capital in a PCC to be held in the cells rather than the core. Upon conversion, the existing capital becomes core capital of the new PCC.
A PCC may, in the ordinary course of business or the business attributable to any of its cells transfer assets between any of the company’s cells or between the core and any of its cells and make such adjustments to its accounting records as are necessary, which is known as an "arrangement". A third party who is directly or indirectly interested in or otherwise affected by the arrangement may apply to the Court to make, vary, rescind, replace or confirm an order in respect of such an arrangement.
The law which governs the insolvency (and the ranking of creditors claims) in respect of a Guernsey company is the Companies Law. This is only a brief discourse of the provisions of insolvency law in Guernsey. Further details are available on this subject from our website at www.bedellcristin.com.
In essence, the Companies Law contains provisions for the administration of companies and PCC cells by an application to the Court for the appointment of an administrator. During the administration process, any function conferred on the company or a protected cell of a PCC by the Companies’ Law or by the memorandum or articles or otherwise, which could interfere with the performance by the administrator of his functions, may not be performed except with the consent of the administrator. The appointment of an administrator in respect of a protected cell may not be made if a liquidator has already been appointed, an application made for the winding up of the PCC or the PCC has passed a resolution for voluntary winding up.
In addition, Guernsey companies and PCC’s may be placed into voluntary liquidation with the appointment of a liquidator subject to a special resolution of the members, or by a creditor, the company or other interested party in a compulsory liquidation. Compulsory liquidation is a more formal process usually reserved for insolvency (although there are no rules in this regard) and requires an application to the Royal Court. A Jurat (permanent juror of the Royal Court) is thereafter appointed commissioner to examine the accounts prepared by the liquidator. It is often the case in substantial insolvencies with a cross border element that a foreign liquidator is appointed in addition to a Guernsey based practitioner.
The Companies Law provides that preferences made in the six months prior to winding up a company (or two years prior to a winding up where the person to whom the preference is given is connected to the company) may be reversed by the court upon application of a liquidator, but bona fide third parties contracting with a company in this regard without knowledge of the circumstances are protected from having their contractual rights prejudiced.
The Companies Law also contains provision for directors’ liability in the case of wrongful or fraudulent trading, and for the disqualification of directors similar to those applicable under the UK Companies Act. These provisions allow for potential directors’ liability when a company or a protected cell of a PCC has knowingly traded whilst insolvent or defrauded creditors and gone into insolvent liquidation. The wrongful and fraudulent trading provisions in Guernsey law are rarely utilised. Directors have been disqualified on a number of occasions by proceedings brought by the Guernsey Financial Services Commission and others.
There is no mechanism for the voluntary liquidation of a cell of a PCC without following the complex receivership procedure set out in the Companies’ Law which involves applications to the Royal Court and therefore entails additional costs to the simple voluntary procedure. Generally PCC cells are wound up outside the liquidation process by payment of creditors and distribution of assets to members. The distribution of assets of a PCC cell to members is not classified as a distribution subject to the statutory solvency test in the Companies Law.
In all cases involving regulated companies (particularly collective investment schemes and insurance companies) there are regulations made under the Protection of Investors (Bailiwick of Guernsey) Law, 1987 as amended and the Insurance Business (Bailiwick of Guernsey) Law, 2002 as amended which apply to the operation of regulated businesses. These regulations are comprehensive, and in some areas, prescriptive, as to the powers and obligations of regulated companies to carry out certain types of transaction. For example, a licensed insurer is required to seek approval for the change of a business plan. Entering into any form of contractual arrangement which alters the type of assets in which it invests, its insurance or reinsurance programme constitutes a change of a company’s business plan. The creditworthiness of reinsurers is also a matter which is of concern to the regulator. Despite the binding nature of contractual arrangements with third parties, the Guernsey Financial Services Commission has substantial powers (which are used) to suspend licences of insurers, or to suspend specific activities by the imposition of conditions, which can have significant effects upon the ability of Guernsey licensed insurers to conduct their normal business.
There are a number of areas of Guernsey law which, even when contracts are carefully considered and jurisdiction and proper law requirements are correctly drafted, require detailed consideration, particularly in the case of cross-border contracts involving numerous jurisdictions. The PCC, in particular, being a concept with which many overseas practitioners are not familiar, requires special care.