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
Pursuant to the Civil Code, executive officers of business associations must act in the best interest of the company they are managing, and in due compliance with the relevant legislation, the instrument of constitution and the resolutions of the company’s supreme body. However, they must also ensure the protection of creditors’ interests when managing a distressed debtor.
In the event of a business association’s dissolution without succession, creditors may bring action for damages up to their claims outstanding against the company’s executive officers on the grounds of non-contractual liability, if the executive officer have failed to take the creditors’ interests into account in the event of an imminent threat to the business association’s solvency.
Executive officers, inter alia, must comply with the following creditor protection rules:
In case of private limited liability companies (kft.), the managing director shall without delay convene the members’ meeting, or initiate its decision-making process without having to hold a meeting in order to provide for the necessary measures, whenever it comes to his attention that:
- the company’s equity dropped to half of the initial capital due to losses;
- the company’s equity dropped below the statutory minimum amount of the initial capital;
- the company is on the brink of insolvency or has stopped making payments; or
- the company’s assets do not cover its debts.
In case of limited companies (rt.) the management board shall, with simultaneous notice to the supervisory board, call a general meeting within a period of eight days in order to provide for the necessary measures, or initiate a decision-making process without having to hold a meeting, whenever it comes to the notice of any member that:
- the limited company’s equity has dropped to two-thirds of the share capital due to losses;
- the limited company’s equity dropped below statutory minimum amount of the share capital;
- the limited company is on the brink of insolvency or has stopped making payments; or
- the limited company’s assets do not cover its debts.
Further provisions related to liquidation proceedings
Pursuant to the Insolvency Act, any creditor or on behalf the debtor, the liquidator, may bring an action during the liquidation proceedings before the court to establish that the former executives of the debtor failed to exercise their management functions in the interests of creditors in the three years prior to opening liquidation proceedings in the wake of any situation carrying potential danger of insolvency, in direct consequence of which the debtor’s assets have diminished, or providing full satisfaction for the creditors’ claims may be frustrated for other reasons. If damage is caused by several executives together, their liability shall be joint and several.
Any person with power to influence the decision-making mechanisms of the debtor shall also be considered as a manager of the debtor (shadow directors).
A situation is considered to carry potential danger of insolvency as of the day when the executives of the debtor were able to foresee, or a person in such position should have foreseen, that the debtor will not be able to satisfy its liabilities when due.
The executive officer shall not be held responsible if he can prove that he has not undertaken any business risk that may be considered unreasonable in light of the debtor’s financial position. Similarly, he shall not be held responsible if he proves that he has taken all measures, within reason, that are expected of persons in such positions, upon the occurrence of a situation carrying potential danger of insolvency, so as to prevent and mitigate the losses of creditors, and to prompt the supreme body (decision-making body) of the debtor economic operator to take action.
Where an executive failed to perform or improperly performed – for reasons within his control – the requirement, prior to opening liquidation proceedings, of having to deposit and publish the economic operator’s annual accounts (consolidated annual accounts), or failed to comply with the obligations to draw up the reports and accounts in the Insolvency Act [e.g. the final statement of accounts (tevékenységet lezáró mérleg)], and to have the relevant documents and assets delivered, and – furthermore – to provide information, the burden of proof that no situation carrying potential danger of insolvency has occurred during his tenure as an executive, or if such situation has in fact occurred, he has performed his management functions in due consideration of the interests of creditors, lies with such executive.
If the court establishes the liability of a former executive, any creditor may bring an action within a 90-day forfeit deadline following the publication of the resolution on the final conclusion of liquidation proceedings. The court will order the debtor’s former executive to satisfy the creditor’s registered claims, which were not recovered in such proceedings, up to the extent of loss suffered.
In addition to duties arising out of creditor protection provisions, the Insolvency Act imposes further obligations on executive officers in connection with the proper conduct of the liquidation proceedings. The executive officer may be subject to a fine of up to 50% of his income received from the company in the year preceding the time of opening liquidation proceedings, or up to HUF 2,000,000 [approx. EUR 6,576 / USD 7,846 based on the official daily exchange rates of the Central Bank of Hungary (CBH) as of 28 August 2017] if his income cannot be determined:
- for any breach of such obligations;
- for any failure to comply with such obligations in due time;
- for providing any false information; or
- for his failure to cooperate with the appointed liquidator.
The executive officer shall also cover the costs arising out of his non-compliance with the above duties.
According to Section 404 of the Act C of 2012 on the Criminal Code (the “Criminal Code”) any person who has powers to control the assets, or any part thereof, of the debtor, or has the opportunity to do so, and who, in connection with the imminent insolvency of the debtor covered by the Insolvency Act, actually or fictitiously, diminishes the debtor’s assets:
- by concealing, disguising, damaging, deteriorating or destroying, or by making unusable such assets or any part thereof;
- by concluding a fictitious transaction, or recognizing a doubtful claim; or
- by other means, in contradiction to the requirements of prudent management;
and thereby prevents the satisfaction of his creditor or creditors in part or in whole shall be found guilty of a felony punishable by imprisonment between one to five years.
Any person who, in connection with a debtor covered by the Insolvency Act:
- engages in either of the conducts referred to in the previous paragraph to artificially induce the debtor’s insolvency, or to cause the perception of insolvency; or
- in the case of the debtor’s insolvency, engages in either of the conducts referred to in previous paragraph;
with intent to prevent the satisfaction of his creditor or creditors in part or in whole is punishable in accordance with the previous paragraph (i.e. by imprisonment between one to five years).
The penalty may be imprisonment between two to eight years in qualified cases, based on the debtor’s preferential status for strategic considerations (please refer to Question 18), or if the dimunition of assets, actually or fictitiously, is particularly substantial:
Any person who, following the order of liquidation, provides preferential treatment to any creditor in violation of the sequence of satisfaction specified in the Insolvency Act (please refer to Question 5) shall be found guilty of a misdemeanor punishable by imprisonment not exceeding two years.
See answer to Question 3.
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:
- the categorisation phase of the insolvency proceedings is opened; and
- 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.
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.
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.
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).
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
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.
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 does 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.
The general rule is that the Directors and officers are liable towards the company for every damage or loss of profit suffered by the company as a result of their acts or omissions which do not comply with their duties in accordance with the articles of association of the company, the law and, most importantly, the best interests of the company. The duty of loyalty is an obligation of the directors and officers to exercise their duties in such a manner that he will promote the corporate interest and the accomplishment of the objective of the company. In addition to the above obligation, the directors and officers have the negative duty to refrain from any act that may harm the interests of the company and not to pursue own interests that conflict with the interests of the company. In this regard, we also note that the directors and officers have an obligation to timely reveal to the Board of Directors their personal interests that may arise from transactions of the company which are associated with their duties. In case of breach of duty, directors and officers are liable for any direct losses suffered by the company.
As regards companies facing financial distress please refer to question 3 above regarding the obligation of the directors and officers to file timely for bankruptcy in case of inability or threatened inability of the company to meet their obligations.
There are various duties and liabilities concerned with increasing directors’ accountability to a company’s creditors, particularly during the twilight period of financial difficulty where such company is insolvent or imminently so. Once a company is of doubtful solvency, the interests of the creditors take precedence over that of the shareholders.
Fraudulent trading occurs where, in the course of winding up or any proceedings against a company, it appears that any business of the company has been carried on with an intent to defraud creditors of the company or creditors of any other person or for any fraudulent purpose. On the application of the liquidator or any creditor or contributory of the company, the Court may, if it thinks proper to do so, declare that any person, who was knowingly a party to the carrying on of the business in that manner, shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company. Such a person may also be guilty of the commission of an offence.
Wrongful Trading occurs if, in the course of the winding up of a company or in any proceedings against a company, it appears that an officer of the company who was knowingly a party to the contracting of a debt had, at the time the debt was contracted and after taking into consideration the other liabilities (if any) of the company, no reasonable or probable ground of expectation of the company being able to pay the debt, such officer shall be guilty of an offence. If found guilty, that person can also be made personally liable for the whole or part of the debt.
Breach of directors’ duties affecting creditors
If a company has become insolvent, the directors may be in breach of their duties to the company if they prejudice the interests of the creditors. This is so even if the shareholders of the company have no objections to their actions or where the shareholders may actually have benefited.
Statutory directors’ duties can be found in sections 171-177 of the Companies Act 2006. These duties are owed to the company itself (which, in good times, means its shareholders, but in the zone of insolvency, this shifts to the creditors or potential creditors of the company).
The main heads of liability for directors in the zone of insolvency are wrongful trading and misfeasance. Note that other forms of liability may be found in relation to publicly traded companies. Misfeasance relates to the breach of fiduciary duties and, specifically, the misapplication of the debtor’s funds.
Directors are generally most cognizant of the wrongful trading offence, which is designed to force directors to take all steps to minimise losses to creditors. Wrongful trading is established where a director knew or ought to have known that there was no reasonable prospect that the company would avoid insolvent liquidation and the director failed to take every step to minimize potential losses for creditors.
Apart from financial penalties, any one of these offences can lead to a disqualification order for future directorships or criminal penalties including fines.
The liabilities of directors to the bankrupt company are basically the same as their liabilities to the company when it is not bankrupt. They are principally not personally liable for any action that they have taken under the company’s name in accordance with their duties and authorities. However, there are certain circumstances in which directors may be held personally liable under Law No. 40 of 2007 on Limited Liability Companies (“Company Law”), ie the bankruptcy is the fault of or due to the negligence of the Board of Directors (“BOD”) and the bankruptcy estate is not sufficient to settle all of the company’s debts. In this case, the members of the BOD may be held jointly responsible for all the unpaid debts. This also applies to members of the BOD who served as directors within the 5 years before the declaration of bankruptcy found at a fault or negligent. The company’s shareholders can also file a lawsuit against the members of the BOD because of the breach of their fiduciary duty,
If a lawsuit is filed by the company’s shareholders, the members of the BOD will not be held responsible for the company’s bankruptcy if they can prove that:
- the bankruptcy was not caused by their fault or negligence;
- they have performed the administration of the company in a good faith, prudently, and with full responsibility for the interests of the company and for the purposes and objectives of the company;
- they have no conflict of interest, either directly or indirectly, in the administration of the company they have performed;
- they took action to prevent the bankruptcy.
Directors, while managing the distressed business, need to act in the ordinary course of business.
As a matter of corporate law, directors have fiduciary duties towards the company first and as such need to preserve it as a going concern and act in accordance with its corporate interest.
Within the scope of a liquidation proceeding, directors may be personally liable in committing an act of mismanagement that would contribute to an insufficiency of assets in accordance with Article L. 651-2 of the French Commercial Code. Therefore, the liability of directors is only retained for having increased the financial difficulties of the company.
Directors may also incur criminal liability for criminal bankruptcy (“banqueroute”) or other criminal offences set out in Articles L. 654-8 et seq. of the French Commercial Code.
Under the Companies Law, and regardless of the company’s financial situation, officers (including directors) owe a duty of care and a fiduciary duty to the company, and not to shareholders or third parties, such as creditors. However, because of these duties, officers are permitted to also take into account the impact on shareholders and creditors. The law specifically stipulates that the duties toward the company do not limit an officer's duty of care toward "other persons", which may include employees, creditors, customers and the public, in accordance with the general torts principles.
The fiduciary duty consists primarily of the duty to act in good faith and in only the best interest of the company. Consequently, an officer must:
- Refrain from any action that creates a conflict of interest between performance of the officer's function in the company and the officer's personal interests;
- Refrain from any activity that competes with the business of the company;
- Refrain from exploiting a business opportunity of the company in order to obtain a benefit for himself or another person;
- Disclose to the company any information that the officer received due to his position with the company.
With respect to the duty of care, officers are required to exercise the level of skill that a "reasonable officer" in the same capacity and circumstances would exercise. As part of such duty, an officer must, after taking into account the circumstances of the case, take reasonable measures to obtain all required information related to the decision he is to take, including information regarding the credit risks of an action that is submitted to his approval.
Consequences of breach of duty:
Directors may, under certain circumstances, be held liable for breach of duty (see below, question 12).
Directors and officers of a company must act in the company’s best interest (taking into account stakeholder interest). If a company enters into a state of financial distress, its directors should attach more importance to the interests of the creditors with a view to ensure the availability of recourse of their claims.
The starting point is that only the company is liable for its obligations. However, there are various grounds on which a director can be held (personally) liable (see below).
- Liability towards company – In general, a director is liable for improper performance of his duties only in case of serious negligence. Improper performance of duties can consist of (refraining from) acting in violation of statutory provisions, the articles of association or if he has acted in a way which is obviously unreasonable/improper;
- Liability towards third parties – A director can be held liable on the basis of tort if it can be held he has acted seriously negligent and in particular if he has prejudiced creditors of the company;
- Liability in bankruptcy – Each director is jointly and severally liable for the shortfall of the bankruptcy estate if the management board has evidently improperly performed its duties and the improper management was an important cause of the bankruptcy. Special importance is attached to the duty of bookkeeping and the duty to timely publish the annual accounts.
Under Luxembourg law, the directors of a company may generally be liable for (i) the non-execution of their mandate, (ii) any misconduct in the management of the company's affair and (iii) any damages caused by their fault or negligence (torts).
Not filing for bankruptcy within this timeframe constitutes serious misconduct, which could lead the court to recognize the director’s civil or criminal liability and to order the directors to bear all or part of the debts of the company.
The directors of a debtor should respect the duty of due care and diligence in the performance of their tasks (criterion: a reasonable, cautious and diligent director), and act in the corporate interest of the debtor. Besides the contractual, tort and criminal liability, there are also specific grounds for director’s liability in case of bankruptcy:
- Any (former) (shadow) director can be held liable for all or part of the company’s debts up to the shortfall if that person committed a gross and manifest negligence that contributed to the bankruptcy.
- Any (former) (shadow) director may be held liable for (part of) the social security contributions and related costs due at the time of the bankruptcy if (i) he committed a gross fault which caused the bankruptcy, or (ii) during the period of five years before the bankruptcy, he was involved in at least two bankruptcies, settlements or similar operations, with debts towards the Social Security Institute.
- Directors of companies are jointly liable for failure to pay the company tax prepayments or VAT if this is due to a fault in the performance of their management tasks. Not only the managing director, but also other (shadow) directors may be held liable if it is proven that they committed a fault that contributed to the failure.
Directors or any kind of representative of a company who have fraudulently produced, facilitated, allowed or aggravated the debtor’s financial situation shall be liable for the damages caused.
Likewise, any third party who in some way helped to reduce the debtor’s assets or increase its liabilities at any time before or after the bankruptcy declaration shall be liable and must reinstate any asset that it may have and also compensate for the damages caused.
These acts must have been performed up to one year before the cessation of payments date declared by the court. Related actions should be started by the liquidator with the authorization and thus consent of a majority of unsecured creditors. Also, if the liquidator does not file the action, any creditor can do it on their own.
Having said that, directors and representatives of the companies in distressed situation keep their duties and responsibilities under the Commercial Companies Act and the Bankruptcy Law does not ban filing claims against them. The only difference is that those claims must be filed by the liquidator and, although it is not required, asking for the approval of a majority of creditors seems to be the correct way of doing it.
Fiduciary duties of directors and officers are typically governed by the state’s law where the entity is formed or incorporated. These duties include the duty of care and the duty of loyalty. The duty of care requires that directors and officers be informed and exercise the care of a prudent person under similar circumstances. This duty is slightly mechanical in nature and requires fiduciaries to establish and follow a decision-making process and maintain good records. The duty of loyalty requires directors and officers to act in good faith and in a manner they reasonably believe to be in the best interests of the company. This duty prohibits fiduciaries from engaging in bad faith or self-dealing, or making decisions that would be a conflict of interest with the company.
In analyzing duty of care and loyalty, the business judgment rule generally applies, which creates a presumption that the directors and officers acted on an informed basis, in good faith, and with the honest belief that the action was in the best interests of the company and its shareholders. The business judgment rule applies regardless of whether a company is solvent or insolvent. As a practical matter, however, a heightened level of scrutiny based on hindsight may be applied to directors and officers of an insolvent or near-insolvent company.
A number of cases in the United States have addressed to what extent directors may be sued for failure to maintain proper oversight over a corporation. Many cases in the Delaware courts have generally, though not exclusively, been favorable to directors. Because a breach of the duty of due care is difficult to prove, and because a corporation may exculpate a director from paying money damages for breaching the duty of due care, plaintiffs have generally asserted claims based on a failure to act in good faith. Directors, on the other hand, defend many of these cases for failure to act in good faith or lack of oversight with the business judgment rule. Directors and officers of solvent companies generally owe fiduciary duties to shareholders. Delaware cases have previously indicated that these fiduciary duties may shift to to creditors when a company is insolvent. Recently, however, Delaware courts have partially clarified the law and limited the ability of creditors to sue directors and officers.
Once a company files for bankruptcy, however, there is additional oversight over a company’s affairs, even though the board of directors is typically still making decisions in the best interest of all stakeholders. The United States Trustee, an official of the United States Department of Justice, performs a variety of administrative functions, as well as oversight. Bankruptcy courts often heavily rely on the advice of the United States Trustee and although the United States Trustee does not make decisions for the board, it can inquire about, or object to, a decision made by the company through its board.
As regards the duty of timely filing motions for bankruptcy or restructuring proceedings, the key issues were briefly described in the response to question no. 3 above.
In addition to such duty, directors have fiduciary duties, the consequences of a breach of which by directors managing a distressed debtor are no different from those in respect of non-distressed companies, except for potential criminal responsibility for deliberate actions relating to assets of the debtor which decrease the value of the distressed business to the detriment of creditors.
The duties of the directors of an insolvent, or potentially insolvent, company are primarily owed to the company’s creditors. Where the directors are aware of the insolvency they are deemed to hold the assets on trust for the creditors of the company and are obliged to preserve the assets for the benefit of the creditors.
A director of an insolvent company that acts in breach of his or her fiduciary duties to the creditors can be sued for damages, and a purchaser with knowledge of the insolvency that attempts to acquire assets at an undervalue can be required to return or compensate the company and its creditors.
Directors that are found by the Court to have knowingly engaged in reckless trading (ie allowing a company to incur liabilities that the director knows the company cannot or is unlikely to be able to discharge) can become personally liable for the debts of the company, in whole or in part, and without limitation in amount. A director is deemed to have acted knowingly where he or she (a) ought to have known that their actions or those of the company would cause loss to creditors or (b) allowed a company to contract a debt without honestly believing on reasonable grounds that the company would be able to discharge that debt.
The Court may relieve an officer of personal liability for the debts of the company where it is satisfied that the officer acted honestly and responsibly in relation to the conduct of the affairs of the company.
Directors can be found guilty of fraudulent trading if, in the course of an examinership or the winding up of a company, it is proven that the director was knowingly a party to the carrying on of any business of the company with intent to defraud creditors of the company or creditors of any other person or for any fraudulent purpose. A person found guilty of fraudulent trading may be exposed to criminal liability as well as personal liability for all or any part of the debts or other liabilities of the company.
Duty to keep adequate accounting records
Directors are responsible for the company’s due administration, including keeping proper accounting records, minutes of meetings and filing information at the Companies Registration Office.
Where a company is wound up, and was unable to pay all of its debts, and it is shown that the failure to keep adequate accounting records contributed to this, or resulted in substantial uncertainty concerning its assets and liabilities, or substantially impeded its orderly winding-up, the company and every director or other officer in default shall be guilty of a criminal offence and moreover a court may declare that any such director or other officer in default shall be personally liable for all or any part of the liabilities of the company.
Restriction and Disqualification orders
A liquidator of an insolvent company is obliged to make an application to the Court for an Order restricting the directors from acting as directors of another company for a period of up to five years, unless the liquidator directed otherwise by the Director of Corporate Enforcement (the “ODCE”). A defence to such an order exists where the director can demonstrate that he or she acted honestly and reasonably in the conduct of the affairs of the company. In addition the directors must demonstrate that they have when requested to do by the liquidator, cooperated as far as could reasonably be expected in relation to the conduct of the winding up. A restricted director can only act be appointed or act in any way, whether directly or indirectly, as a director or secretary or be concerned or take part in the promotion or formation of any company where the company has a paid up share capital of €500,000 in the case of a PLC or €100,000 in the case of a private company.
An application can also be brought by a wide range of parties including shareholders, directors, employees, receivers, liquidators, examiners and creditors, for a disqualification order in respect of a director who has been guilty of fraud, a breach of his duties, reckless or fraudulent trading or conduct which makes him unfit to be concerned in the management of a company. A disqualification order will prevent the offender from acting as an auditor, director, receiver, liquidator or examiner or other officer of a company for a period of five years, or such other period as the court may order.
Disqualification and restriction orders can be obtained against any person who is a director of a company on the date of, or within 12 months of, the commencement of the winding up.