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

Italy Small Flag Italy

See answer to Question 3.

Spain Small Flag Spain

Directors have a duty to be diligent and loyal to the company, regardless of the company’s financial situation.

The main criterion governing directors’ performance is that they must act in the company’s best interests. In this case, this means choosing the course that will produce the least damage to the company’s assets. In other words, seeking ways to refinance the company’s debt and obtain write-offs and grace periods, and avoid the company entering into insolvency proceedings. Some scholars argue that this refers to the directors’ obligation of responsible management, protecting the company’s interests in a reasonable manner, that is, maximizing, in the medium- and long-term, the value of the company, its sustainability, its reputation, and ensuring that its adverse economic situation does not worsen, thus affecting the company’s interests.

However, directors should also to take into account all the interest at stake, even more when managing distressed debtors. If such is the case, they need to take a cautious approach in the decision-making process, considering the creditors’ interests so that, without focusing on the payment of the remaining debts, they can ensure the debts do not increase and avoid any risky transactions that could prevent subsequent payment to creditors.

In addition, it’s worth stressing that directors may incur in civil liability within the insolvency proceedings when:

  1. the categorisation phase of the insolvency proceedings is opened; and
  2. it is proved that directors’ negligent or culpable behavior is what has triggered or worsened the insolvency situation.

Said civil liability could consist on (i) being those directors disqualified between two to fifteen years, (ii) losing any claim they may have before the insolvent debtor, and (iii) a condemn to indemnify the insolvent debtor for damages.

Japan Small Flag Japan

There is no specific provision of law that places enhanced duties on directors of a distressed debtor. However, directors owe obligations under general provisions of the Companies Act, such as the duty of diligence and duty of loyalty. Thus, directors could, for example, be held liable for damages to the company or creditors if they have acted in breach of their duty of diligence. In addition, certain acts (such as a gratuitous act) by an insolvent company are vulnerable to being set aside.

In addition, if a director or officer has engaged in fraudulent conduct before filing of a company’s bankruptcy proceedings, he/she may be held liable for such a conduct under criminal law and/or tort law.

Denmark Small Flag Denmark

The board of directors and the executive board (the ”management”) of a business that suffer from cash unavailability must pay particular attention to the so-called ”time of no avail”.

The time of no avail cannot be fixed in advance but it defines the time at which the management ought to have realised that the business could not continue operations properly without any further losses for the creditors.

If the management continues operations beyond the time of no avail, the trustee of the subsequent insolvent estate and creditors that believe that operation beyond the time of no avail has caused losses for the business and/or the creditors may at a later time raise a claim for damages against the former management.

If the business has passed the time of no avail, the management is also obliged to ensure that payment of creditors in an insolvent business takes place in a manner that complies with the ranking of creditors so that some creditors are not given preference over others.

In addition, the management must ensure that the business fulfills the general bookkeeping and tax obligations as these factors are decisive in a later assessment of any management liability.

The management may incur liability, see above, but may also be disqualified by the insolvency court if up to the insolvency the management has not fulfilled its management obligations. Disqualification means that each management member cannot participate in the management of a limited liability company without being personally liable for claims against the company.

Australia Small Flag Australia

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.

Cayman Islands Small Flag Cayman Islands

See 3 above.

Switzerland Small Flag Switzerland

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.

Germany Small Flag Germany

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).

Mexico Small Flag Mexico

Pursuant to the Insolvency Law, the managers and relevant employees shall be liable for damages and lost profits (daños y perjuicios) caused to the insolvent entity in certain specific cases provided by the Insolvency Law. In addition, they would be liable when acting in breach of their duties of care and loyalty, and when acting with willful misconduct (dolosamente), bad faith (mala fe) or illegally.

The Insolvency Law also contemplates that Directors could be criminally liable.

British Virgin Islands Small Flag British Virgin Islands

Directors in the BVI have a range of fiduciary and common-law duties to their companies, and these duties do not terminate with the appointment of a liquidator, though directors cease to have any role in the management of the company save to the extent permitted by the IA and/or the liquidator.

As stated above, when a company nears insolvency, the focus of the directors’ duty to act in the company’s best interests shifts from the members to the creditors. As such, the directors must be mindful of the effect their conduct of the company’s affairs may have on creditors’ likelihood of being repaid what they are owed. Directors are sometimes given indemnities for liability they may incur for negligence, default, breach of duty, or breach of trust.

Part IX of the IA deals with malpractice and the principal ways in which a director may be ordered to contribute assets to an insolvent company, including liability for misfeasance, fraudulent trading and insolvent trading. An application pursuant to Part IX can only be brought by a liquidator, but the provisions are not limited territorially.

In the event that a director or officer of the company has misapplied or retained or become accountable for any money of the company, or if the director’s actions could be described as ‘guilty of any misfeasance or breach of any fiduciary or other duty in relation to the company’, then the court has broad powers to make an order that such director or officer repays, restores, or accounts for money or assets or any part of it to the company as compensation for the misfeasance or breach of duty. The IA misfeasance action merely puts on a statutory footing the powers at common law, but this statutory provision does not preclude any parallel liability arising under general directors’ duties at common law or otherwise.

The court can make an order against a company’s directors if it is satisfied that, at any time before the commencement of the liquidation of the company, any of its business has been carried on ‘with the intent to defraud creditors of the company or creditors of any other person; or for any fraudulent purpose’. In such cases, the court can declare that the director is liable to make a contribution that the court considers proper towards the company’s assets. This is not limited to directors and officers, but applies to anyone who has been involved in carrying on the business in a fraudulent manner. There is no statutory defence to fraudulent trading, but it is necessary that actual dishonesty be proved.

Directors’ liability for insolvent trading has been summarised above, and as stated in that context any contribution that the court orders under Part IX is compensatory and not penal, and will be used to swell the assets available for distribution to the company’s general body of creditors. The section 81 Conveyancing Ordinance claim is also a relevant consideration.

Bermuda Small Flag Bermuda

The fiduciary duties owed by directors of a Bermuda company are prescribed by statute (section 97 Companies Law 1981) and by the common law. In essence, such duties reflect the contemporary English position and require directors to act honestly and in good faith with a view to the best interests of the company, and to exercise the care, diligence and skill of a reasonably prudent person. When a company is in the “zone of insolvency”, the interests of the company will be reflected by creditor interests.

Directors can be liable for the debts of an insolvent company if, during the course of the winding-up of a company, the company has carried on its business with the intention of defrauding its creditors (section 241 Companies Act 1981). The court has the power to summon persons suspected of involvement in the fraud for examination under oath or through written interrogatories. Importantly in the context of a director’s obligations, the Companies Act 1981 not recognise the concept of “wrongful trading” (i.e. directors potentially being liable for a company’s debts if they permit the company to trade while insolvent).

Companies may, and generally do, indemnify their directors against liability for negligence, default, breach of duty or breach of trust (section 98 Companies Act 1981) but any indemnity which extends to liability for fraud or dishonesty will be void. A director shall be deemed not to be acting honestly and in good faith if he fails to disclose at the first opportunity his interest (whether direct or indirect) in any material contract or proposed material contract with the company or any of its subsidiaries.

Shadow directors, and probably de facto directors, are in the same position as de jure directors for these purposes, all being officers of the company.

There is a paucity of case law on claims for breach of directors’ duties in Bermuda since, even where there is no indemnity given by the company, culpable directors are invariably sued in the jurisdiction where they reside so as to aid in the enforcement of any judgment.

Claims for breach of fiduciary duty or in negligence can be brought by an insolvent company against directors, and in this respect, there are statutory provisions dealing with the duties owed by directors (see section 97 Companies Act 1981). Monies recovered would increase the assets available for distribution to creditors.

Updated: April 27, 2017