What duties and liabilities should directors and officers be mindful of when managing a distressed debtor? What are the consequences of breach of duty?
Restructuring & Insolvency
Directors owe a number of general and specific law duties to the company, its shareholders and creditors. These include:
- duties of good faith and due care and diligence;
- to not improperly use the position, or information obtained by virtue of the position, to gain personal advantage or cause detriment to the company;
- to keep adequate financial records;
- to take into account the interests of creditors; and
- to prevent insolvent trading.
Compliance with these duties means that directors should place a company into external administration at such time that the company is cash flow insolvent or there exists a less than reasonable prospect that the company will remain cash flow solvent.
When seeking to pursue an informal restructuring option care must be taken to ensure the duty to prevent insolvent trading is not breached. A breach of this duty exposes the director(s) to serious penalties such as personal liability for future debts incurred, including during any informal work-out period.
The Corporations Act provides a number of possible defences to an insolvent trading claim, including:
- if the director had reasonable grounds to expect that the company was solvent; and/or
- if the director took all reasonable steps to prevent the company from incurring the debt. In this context, the Corporations Act specifically states that matters to be taken into account when considering this defence include any action the director took with a view to appointing a voluntary administrator, when such action was taken and the results of that action.
Further, directors of a company in financial distress have a duty to the company to take into account the interests of creditors. In circumstances of financial distress, that duty supersedes the duty to shareholders.
See 3 above.
Under Swiss corporate law the highest executive body of a company is responsible for, inter alia, the overall management and strategic positioning of the company, the financial accounting and control, the overall supervision of the management and compliance with laws and regulations generally. Such duties become particularly relevant in a distress scenario in which case a certain shift of responsibilities from management to the highest executive body occurs. Duties and obligations will have to be interpreted in the light of the financial status of the company. In addition, the overarching duties (duty of care, fiduciary duty, equal treatment of shareholders) and certain specific obligations apply in a distress situation:
- If the latest annual financial statement shows that half of the share capital and the legal reserves of a company are no longer covered by its assets, the directors, inter alia, have to convene an extraordinary shareholders' meeting to which adequate restructuring measures must be proposed.
- If the board of directors of a Swiss corporate has reason to believe that the company is over-indebted, it must draw up an interim balance sheet without delay, which must be audited by the company's statutory auditors. Such interim balance sheet will have to be prepared on a stand-alone basis and the statutory accounting rules are pertinent. If such interim balance sheet shows that the company is over-indebted at both going concern values and liquidation values, the board of directors of the company must, as a rule, file for bankruptcy without delay.
Sound management may require the initiation of composition proceedings before an over-indebtedness situation exists in case the company is in the state of (looming) illiquidity. Such action may be warranted where an out-of-court restructuring does not appear to be viable and/or where creditor action is expected which may frustrate the attempts for an out-of-court restructuring.
If such duties are not complied with, executive bodies may be exposed to civil law director's liability where the wilful or negligent breach of the director's duties has caused damages to the company or, in certain constellations, the creditors and where there was a causal nexus between the breach and the damage. Where executive bodies failed to notify the court of an over-indebtedness situation, damages typically cover the increase of loss that occurred between the date the executive bodies failed to act and submit a notification of over-indebtedness with the competent court and the date bankruptcy proceedings were effectively opened. Further liability risks may arise in the context of transactions that are subject to avoidance (see section 6 above).
In addition, executive bodies may be exposed to the risk of criminal liability if they fail to adhere to their statutory duties and obligations. In particular, such risks exist in case of failure to properly keep corporate books and accounts, mismanagement, where bankruptcy proceedings were caused fraudulently, in case of a fraudulent reduction of assets to the detriment of creditors or in case of creditor preference.
If the annual or any interim balance sheet of a limited liability company shows that 50% or more of its registered share capital has been lost, the managing directors have to call an extraordinary shareholders’ meeting without undue delay.
Where a company becomes illiquid or overindebted (see question 3), the members of the board of directors or managing directors must file an insolvency petition without undue delay, at the latest within three weeks. Managing directors who negligently or intentionally breach those obligations commit a criminal offence and are liable for damages, which can be asserted by
- the insolvency administrator in case of damages suffered by creditors whose claim originated prior to the obligation to file for insolvency, or
- the creditors to the extent their claim originated thereafter.
Once the company has become illiquid or over-indebted, only payments which, also after this point in time, are compatible with the due care of a prudent businessman may be made. Otherwise, the directors are obligated to compensate the company for such payments. The same sanction applies to payments to shareholders if these led to the company becoming illiquid, unless this was not foreseeable observing due care (Sec. 64 Limited Liability Companies Act). Managing directors who negligently or intentionally breach those obligations commit a criminal offence and are liable for damages both to the company and its creditors.
The managing directors are liable where tax claims are not, or not in time, determined or satisfied (Section 69 Fiscal Code).
Withholding social security contributions of an employee is criminally sanctioned (Sec. 266a Criminal Code).
A debtor that, aware of its illiquidity, grants a creditor a preferential treatment over the other creditors is liable to criminal sanctions (Sec. 283c Criminal Code).
If a debtor diminishes its net assets or conceals the actual circumstances of its business in a manner which grossly violates regular business standards (such as buying goods on credit and selling them under their value, absence of bookkeeping, producing irregular balance-sheets) when in a state of insolvency or if such acts lead thereto, such actions are sanctioned as ‘bankruptcy’ by imprisonment up to five years, if
- the debtor has suspended payments,
- insolvency proceedings have been instituted or
- the insolvency petition has been rejected due to lack of available assets
(Sec. 283 Criminal Code).