What is the test for insolvency? Is there any obligation on directors or officers of the debtor to open insolvency procedures upon the debtor becoming distressed or insolvent? Are there any consequences for failure to do so?
Restructuring & Insolvency
Before opening liquidation, the court investigates the debtor's financial position. Upon the request of the debtor the court may allow a maximum period of 45 days for the debtor to settle its debts. The court orders liquidation within 60 days of receiving the petition for liquidation if it finds that the debtor is insolvent. The court will declare the debtor insolvent in the following cases:
- upon the debtor’s failure to settle or contest its previously uncontested and acknowledged contractual debts within 20 days of the due date, and failure to satisfy such debt upon receipt of the creditor’s written payment notice;
- upon the debtor’s failure to settle its debt within the deadline specified in a final court decision or an order for payment;
- if an enforcement procedure against the debtor was unsuccessful;
- if the debtor did not fulfil its payment obligation as stipulated in the debt restructuring agreement concluded in bankruptcy or liquidation proceedings;
- if the court has declared the previous bankruptcy proceedings terminated; or
- if − in proceedings initiated by the debtor or the receiver (appointed in case of the solvent winding-up of the company) − the debtor’s liabilities exceed the debtor’s assets, or the debtor was unable, and presumably will not be able, to settle its debt on the date on which they are due, and − in proceedings initiated by the receiver − the members (shareholders) of the debtor fail to provide a statement of commitment, following due notice, to guarantee the funds necessary to cover such debts when due.
In the first two cases, liquidation proceedings may not be initiated if the amount of the claim against a debtor (not including interest and other similar charges) does not exceed HUF 200,000 [approx. EUR 658 / USD 785 based on the official daily exchange rates of the Central Bank of Hungary (CBH) as of 28 August 2017].
The debtor shall not be liquidated in connection with any claim that the creditor failed to register in previous bankruptcy proceedings.
Executive officers are not under the duty to commence liquidation proceedings upon the debtor becoming distressed or insolvent, however, they shall without delay convene the debtor’s supreme body, or initiate its decision-making process without having to hold a meeting in order to provide for the necessary measures whenever it comes to their attention that, inter alia:
- the debtor is on the brink of insolvency or has stopped making payments; or
- the debtor’s assets do not cover its debts.
Regarding their liability for failure to do so, please refer to Question 11.
Furthermore, executives can only file for bankruptcy or liquidation if they are in possession of the prior consent of the supreme body of the debtor.
The existence of a non-reversible state of insolvency (i.e. a debtor’s inability to regularly fulfill its obligations as they fall due) is a requirement for insolvency proceedings.
When a company is in the vicinity of insolvency with no reasonable chances to continue as a going concern, its directors are under the obligations to: (i) take appropriate actions to monitor the financial situation and minimize potential losses to creditors, (ii) file for insolvency proceedings if no other solution is viable, or (iii) attempt a good faith effort to rescue the business or achieve an out-of-court composition with the creditors (or with some of them) using, as much as possible, the new instruments recently introduced by the Italian Bankruptcy Law (IBL) (see answer to Question 7). Should these obligations fail to be timely fulfilled and the distressed company be declared bankrupt, the directors of the companies subsequently found to be or to have become insolvent are liable for such losses as may be suffered by creditors as a result of the unnecessary delay in the commencement of insolvency proceedings, without the possibility of relying on the honest business judgment defense.
Additionally, should the debtor delay the filing of a petition for bankruptcy, its directors may incur criminal liability where such delay has worsened the debtor’s distress. The criminal consequences for directors are more severe if the debtor has undertaken seriously incautious transactions with the purpose of delaying the declaration of bankruptcy or made preferential payments and/or created securities in favour of a particular creditor to the detriment of the others.
Insolvency can be defined as the situation in which a company or a natural person cannot meet its payable obligations consistently and on time. At that moment, the two-month period to file for voluntary insolvency begins.
As provided under article 5 of the Spanish Insolvency Act 22/2003 (the “Spanish Insolvency Act”), directors should file for insolvency with the competent commercial court within two months of when they became aware, or should have become aware, of the company’s state of insolvency. There is an exception to this rule, which consists of filing, within the two-month period, a so-called “5 bis notice” with the same competent commercial court, claiming that the directors are negotiating with the creditors to reach an out-of-court refinancing agreement or obtain their support to file a pre-pack or advanced composition agreement. The filing of the 5 bis notice extends by four months the deadline for filing for insolvency.
If the petition is filed once the two-month period has elapsed and it is proved that the delay in filing for insolvency has exacerbated the debtor’s situation, the directors (and even other affected persons) could be penalized under the Spanish Insolvency Act and be obliged to compensate for damages.
A petition for commencement of bankruptcy proceedings may be filed by a debtor, a director of a debtor company or a creditor in the following circumstances:
- where the debtor is characterised as being ‘unable to pay its debts’ – that is, where a debtor is generally and continuously unable to pay its debts as they become due; or
- in cases where the debtor is a company, where the debtor is characterised as ‘insolvent’ – that is, where the debtor’s debts exceed its assets.
The court must order commencement of the proceedings if it is satisfied that one of the above circumstances (as applicable) exists.
There is no specific statute providing obligations on directors or officers of the debtor to open insolvency procedures. Directors and officers, however, owe general duties of care and loyalty to the company. It is theoretically possible that failure to open insolvency procedures may be a violation of such duties. In such situations, directors and officers are liable for damages of the company, creditors and shareholders.
Under Danish law, the test for insolvency for the debtor’s insolvency is whether the debtor is able to fulfill its obligation as they fall due. If the debtor cannot do this, it is assumed that the debtor is insolvent, unless the inability to pay is temporary.
Individuals are not obliged to file their own petition.
Under Danish law, the management of a distressed company (the debtor) is not obliged to file a petition in bankruptcy. Under the Danish Companies Act the management of a company must ensure that the debtor’s capital reserves are sufficient at any time so that the debtor is able to fulfill its present and future obligations as they fall due.
As a starting point, the management of a company does not incur liability if insolvency proceedings are commenced against the debtor. However, the trustee or a third party may raise a claim for civil management liability or criminal management liability against the management if it is discovered that the management has carried out transactions in a manner that has contributed decisively to the debtor’s insolvency or if the operation has continued after the time at which the management could establish that further operation was to no avail.
The trustee may also institute disqualification proceedings against the management. If the management is disqualified, the management must not participate in the management of a limited liability company without being personally liable for the company’s obligations.
In Australia, the definition of insolvency is contained in section 95A of the Corporations Act which states,
- A company is solvent if, and only if, the company is able to pay all the company’s debts, as and when they become due and payable.
- A company which is not solvent is insolvent.
Case law in Australia has indicated that the focus of the insolvency test for companies approaching financial distress is the ‘cash flow’ position of the business rather than its balance sheet.
Company directors are burdened by a positive duty to prevent insolvent trading. This duty prevents directors from incurring any debt on behalf of the company if the company is insolvent or the director has reasonable grounds for suspecting that it is likely to become insolvent. Directors will be personally liable for any debts that are incurred thereafter in these circumstances.
To guard against the risk of an insolvent trading claim, directors are required to consider the solvency of the company regularly and to place the company into voluntary administration if, in their opinion, the company is, or is likely to become, insolvent.
A company may be wound up on the ground of insolvency if it is unable to pay its debts as they fall due (i.e. the cash flow insolvency test). A company will be deemed to be unable to pay its debts if:
- It fails to satisfy a statutory demand (provided that the debt claimed in the demand is not disputed by the debtor company in good faith and on substantial grounds);
- Execution of a judgment is returned wholly or partly unsatisfied; or
- It is proved to the satisfaction of the Court that the company is unable to pay its debts.
There is no statutory obligation on a company's directors to commence liquidation proceedings. However, in circumstances in which the company is insolvent or of doubtful solvency, the directors' duty to act in the best interests of the company requires them to have regard to the interests of its creditors. Directors may incur personal liability to the company for any losses which they cause to the company if they act in breach of that duty, for example, by causing the company to incur further obligations when they knew or should have known that there was no reasonable prospect of the company avoiding an insolvent liquidation.
Under Swiss law, the following terms must be distinguished:
- Illiquidity (Zahlungsunfähigkeit): A Swiss corporate is illiquid pursuant to Art. 191 of the Swiss Federal Act on Debt Enforcement and Bankruptcy (DEBA) if it is no longer in a position to pay its debts as and when they fall due. Hence, this test focuses on the solvency of the corporation.
- Over-indebtedness (Überschuldung): A Swiss corporate is over-indebted within the meaning of Art. 725 par. 2 (CO) if its assets are no longer sufficient to cover its liabilities. This test is balance sheet based. That said, over-indebtedness may result from illiquidity where, as a result, the going concern assumption is no longer sustainable and, thus, accounting will have to be made at liquidation values.
The highest executive body of a Swiss corporate is generally obliged to file for bankruptcy proceedings in case of over-indebtedness within the meaning of Art. 725 DEBA. Certain exceptions apply where a deep subordination exists (cf. section 5 below) or where a restructuring can be implemented without delay. The general assembly of a Swiss corporate may further resolve to apply for the liquidation of the Swiss corporate through a bankruptcy proceeding if the company is illiquid pursuant to Art. 191 DEBA but no general obligation to initiate such proceedings in case of illiquidity currently exists under Swiss corporate law. Furthermore, a creditor may directly apply for the opening of bankruptcy proceedings if the corporation has ceased to make payments pursuant to article 190 DEBA.
There is no specific trigger event for a debtor to request the opening of composition proceedings although (looming) illiquidity and/or over-indebtedness will often exist. In addition, both creditors entitled to request the opening of bankruptcy proceedings and the bankruptcy court may request the opening of composition instead of bankruptcy proceedings.
It is currently being proposed within the context of a general revision of Swiss corporate law to extend the duties of the highest executive bodies of a Swiss corporate in case of (looming) illiquidity. Such rules are not currently expected to enter into force before 2019. It is not proposed to make (looming) illiquidity an automatic trigger for insolvency proceedings.
Please refer to section 11 below for the consequences of a breach of obligations by the highest executive body of a Swiss corporate.
There are three independent tests for insolvency:
- Illiquidity (Zahlungsunfähigkeit) is the debtor's inability to meet its payment obligations as and when due. A debtor is generally assumed to be illiquid if he has ceased to make payments. Illiquidity cannot be presumed if there is only a temporary delay in payments. Only debt that is being seriously pursued by the creditor (ernstliches Einfordern) must be considered for the purposes of determining illiquidity.
- A company is overindebted (überschuldet) if its assets (on market value basis) no longer cover its liabilities, unless the continuation of the company’s business is predominantly likely, which requires sufficient funds to carry on its business within the present and the following business year. If this prognosis is negative, overindebtedness is determined solely on the basis of a special balance sheet (Überschuldungsstatus).
- Impending illiquidity (drohende Zahlungsunfähigkeit) which is defined as the debtor not being able to meet its payment obligations as and when they will become due in the future.
In case of illiquidity or overindebtedness, managing directors of limited liability companies, corporations and partnerships ultimately having limited liability must file for insolvency at the latest within three weeks. This three-week period, may only be fully used, if there is a well-founded expectation that within it illiquidity and overindebtedness can be cured. Managing directors who intentionally or negligently breach this duty face civil liability to the company and its creditors for any losses which these have incurred due to the delayed petition and criminal liability. These severe consequences are a serious threat for managing directors in distressed situations.
In case of impending illiquidity, management has a right, but not a duty, to file for insolvency.
As a general rule (the “Insolvency Standard”), a company may be declared insolvent (in “Concurso Mercantil”) when it has defaulted in its payment obligations to two or more creditors, and on the date of filing of the insolvency petition:
- its due obligations that have been delinquent for more than 30 days represent 35% or more of its total outstanding obligations; and/or
- it does not have sufficient liquid assets to pay for at least 80% of its obligations that are due and payable on such date (the “General Default”).
Once the company has defaulted in its payment obligations to two or more creditors, it may file a voluntary insolvency petition when only one of the conditions described in items (a) and (b) above has been satisfied. In contrast, creditors of the company or the attorney general’s office may also file an insolvency claim against the company, but only if it satisfies both such conditions.
There is no obligation on directors or officers of the debtor to open insolvency procedures upon the debtor becoming distressed or insolvent.
British Virgin Islands
A company is insolvent if—
- it fails to comply with the requirements of a statutory demand that has not been set aside,
- execution or other process issued on a judgment, decree, or order of a BVI court in favour of a creditor of the company is returned wholly or partly unsatisfied, or
(i) the value of the company’s liabilities exceed its assets, or
(ii) the company is unable to pay its debts as they fall due: see section 8(1) IA.
In the BVI, there is no express duty on the directors of a company to commence insolvency proceedings at any particular time; however, there is a substantial body of case law from a variety of common-law jurisdictions that suggests that in certain circumstances the directors’ duty to act in the best interests of the company as a whole (and not to any individual person or class of persons) will require them to take account of the interests of the company’s creditors rather than those of the company’s members. In such circumstances, the directors must take those interests into account when deciding how to act until such time as solvency is restored, the company’s debts are restructured, or the company goes into liquidation. In some cases, therefore, acting in the best interests of the company will mean recommending that the members put the company into liquidation or causing the company to apply for the appointment of a liquidator (if the power exists).
In addition, if a company goes into insolvent liquidation and the court is satisfied that a director ‘at any time before the commencement of the liquidation of the company, knew or ought to have concluded that there was no reasonable prospect that the company could avoid going into liquidation’, then it can order any director to make such contribution to the assets of the company as it considers proper: section 256 IA.
The court cannot make an order against a director if it is satisfied that the director knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation, but that the director ‘took every step reasonably open to him to minimise the loss to the company’s creditors’.
Any contribution that the court orders will be compensatory rather than penal, and the money recovered will be pooled with the general assets of the company for distribution by the liquidator. The court has broad powers to order such person to repay, restore or account for the money or assets, or pay compensation for such misfeasance.
A company will be insolvent if it is “unable to pay its debts” (section 161(e) Companies Act 1981). There are two tests for insolvency: the cash flow test and the balance sheet test (section 162(c) Companies Act 1981; In the matter of LAEP Investment Ltd  Bda LR 35). In making a determination of insolvency, the concept of liabilities is extended and will include contingent liabilities.
In the event that there may be some doubt as to whether or not a company is insolvent, or if proving insolvency may be difficult or costly, a creditor may issue a statutory demand for payment. If the demand has not been satisfied or set aside within 21 days, the company will be deemed to be insolvent.
Directors are not required to file liquidation proceedings where a company becomes insolvent. However, if they do not, they risk personal liability for breach of fiduciary duties, fraudulent trading and/or misfeasance.
Insolvency may be declared when a debtor is unable to fulfill its overdue financial obligations in a general and permanent way (cessation of payments) or when the debtor foresees an imminent inability to fulfill its financial obligations when they become due and payable and requests to be declared bankrupt (threatened cessation of payments).
Bankruptcy proceedings are initiated only through the issuance of a court decision upon application of the insolvent debtor, its creditor(s) or, for public interest purposes, of the public prosecutor. The debtor is obliged to apply for bankruptcy anytime before the cessation of payments but within thirty (30) days from its occurrence. To this effect, the directors and corporate administrators of the debtor have an obligation to take every individually possible action or measure for the purposes of the adoption and implementation of the necessary corporate resolutions in order to file for bankruptcy in a timely manner.
In case the application for bankruptcy is not filed by a company in a timely manner, the members of the board of directors or the administrators are jointly liable for the decrease of the bankruptcy estate to be distributed to the creditors as a result of the delay. The same liability is attached to any party, such as a controlling shareholder, that instigated the members of the board of directors or the administrators to delay filing.
Moreover if the bankruptcy of a company is caused by willful misconduct or gross negligence of the directors or administrators, they are jointly liable for compensation of the creditors. The same applies to any party who instigated the willful or negligent actions that caused the bankruptcy.
In addition there are certain potential criminal liabilities of directors, administrators and other executives in case of bankruptcy, (i) if they have undertaken certain actions that lead to a misrepresentation of the true financial position of the company or presented fictitious creditors; (ii) if they undertake loss-making or risky transactions in a manner which is contrary to prudent financial management; (iii) if they purchase merchandise or securities through credit and then resell them at prices materially below their value in a manner which is contrary to prudent financial management. A separate criminal liability is provided for if the company, while in a status of cessation of payments or in a condition in which the normal satisfaction of its due obligations risks is to become impossible, discharges the obligations of a creditor or provides security to a creditor, knowing that this will be to the detriment of other creditors.
Even though no one single test is conclusive as a measure of solvency, it is commonly accepted that the two primary indicia of a company’s inability to pay debts are an inability to meet a demand for a debt which has become due (the “cash flow” test) and an excess of liabilities over assets (the “balance sheet” test). For most purposes, it is the present inability to pay debts that is the crucial factor. Ultimately, the determination of whether a company is insolvent is a fact specific inquiry.
Usually, the directors will seek to place a company into formal insolvency proceedings where there is the likelihood that the directors may be held personally liable for wrongful or fraudulent trading if the company were to continue business. Wrongful and fraudulent trading can attract both civil and criminal liability. This is explored in greater detail in the answer to Question 11 below.
Insolvency is not expressly defined under English law but can generally be demonstrated if (1) it is unable to pay its debts as they fall due (the “cash flow” test); or (2) its liabilities (including contingent and prospective liabilities) exceed its assets (the “balance sheet” test). A company will also be insolvent if it fails to comply with a statutory demand for a debt of over £750 or it fails to satisfy enforcement of a judgment debt.
If a company is insolvent under any of these tests, it may be placed into administration or liquidation.
There is no obligation on directors to commence insolvency proceedings but directors may be personally liable if they breach certain duties as set out in Question 10 below. Civil penalties against directors can be for wrongful trading if they fail to take all steps to minimize potential losses to creditors. However, if they intentionally fail to do this, a criminal penalty for fraudulent trading may be imposed.
The insolvency tests above are also used to determine if a transaction occurred in the zone of insolvency. Such transactions may be challenged by an administrator or liquidator or other creditors in certain circumstances.
In Indonesia, the insolvency procedure means the bankruptcy procedure. Under Law No. 37 of 2004 regarding Bankruptcy and Delay of Payment (the “Bankruptcy Law”), the petition for bankruptcy will be approved by the relevant Commercial Court (“Court”) if it satisfies the following requirements:
- The debtor has at least two creditors; and
- At least one of the debts is due and payable.
The above requirements should be proved in a simple way. Otherwise, the Court may reject the petition.
The directors of the creditors have no obligation to initiate insolvency procedures against the distressed company/debtor with the Court. If the bankruptcy involves its own company, the directors can submit the bankruptcy petition upon obtaining approval from the General Meeting of Shareholders in accordance with its Articles of Association. Therefore, bankruptcy proceedings can to be commenced by the debtor itself voluntarily or by the creditors. However, certain conditions apply if the bankruptcy petition involves a financial institution.
The French insolvency test is a pure cash flow test, defined as the debtor’s inability to pay its debts as they fall due with its immediately available assets (cessation des paiements), taking into account available credit lines and moratoria. Within 45 days from the insolvency date, the legal representative of the insolvent company is required to file for reorganization proceedings or liquidation proceedings.
In the event directors of the debtor knew of the insolvency and failed to file the appropriate proceeding within this required time period, they will be held personally liable in tort for an act of mismanagement (“faute de gestion”).
Article 258 of the Companies Ordinance provides as follows: “The court will deem a insolvent upon any of the following: (i) a creditor to whom the company owes an amount that exceeds NIS 5 at the time payment thereof falls due, delivers to the company, at its registered office, a notice signed by the creditor requesting payment of the debt, and during a period of three weeks following such notice, the company fails to pay the debt, does not furnish a guarantee and fails to reach an arrangement to the reasonable satisfaction of the creditor; (ii) an execution order or some other legal process issued pursuant to a court judgment or court order granted in favor of a creditor of a company, is not satisfied in whole or in part; or (iii) it has been proven, to the satisfaction of the court, after taking into account the company’s conditional and future liabilities, that the company is unable to pay its debts.
There are no specific obligations imposed on directors or officers of the debtor to open insolvency procedures when the debtor becomes distressed or insolvent.
A debtor who has ceased to pay may be declared bankrupt by a court order at his own application or at the request of one or more of his creditors. The basis for a bankruptcy adjudication is that the debtor has at least two creditors (one of them being the filing creditor, if the filing is involuntary) and that at least one of these two debts is currently due and payable. Dutch insolvency law does not have the concept of “balance sheet insolvency” as exists in other jurisdictions. The test instead is whether a debtor has ceased to pay.
Pursuant to the Dutch Bankruptcy Code a debtor who foresees that he will be unable to continue to pay his payable debts may apply for suspension of payments. Suspension of payments can also be requested by a debtor who foresees that he will not be able to pay off debts which will become payable in the future.
Dutch law does not contain a provision pursuant to which management of a debtor is obliged to file for insolvency. However, based on Dutch case law, management may be held liable if it continues the business and assumes new obligations on behalf of the debtor company knowing that the company will not be able to (timely) fulfil its obligations (and where there is insufficient recourse for creditors). More generally, a director may be held liable in case he continues the debtor company’s business while it is clear that such continuation serves no reasonable purpose anymore and only prejudices creditors’ possibilities to take recourse against the debtor company.
The substantive test for insolvency is where the commercial entity has both:
- ceased payments and is unable to meet its commitments (cessation des paiements), i.e., the company cannot, or does not, fully pay its due, certain and liquid debts as they fall due; and
- lost its creditworthiness (ébranlement de crédit), i.e., the company is unable to obtain credit from any source.
If the court considers that these two criteria are met, it declares the company bankrupt and opens a bankruptcy procedure. Luxembourg law does not have the balance sheet or cash flow tests.
The management of a company is required to file for bankruptcy (faillite) within one month from the date of cessation of payments. Otherwise, it could be held criminally and civilly liable.
The conditions for bankruptcy are (i) the company faces a durable cessation of payments and (ii) it is unable to obtain further credit (cumulative conditions). A durable cessation of payments exists when a company constantly is unable to repay its (some of its) debts as they fall due. If the company can still be redressed or still has access to sufficient credit, the company is not in a state of bankruptcy.
The directors of the debtor have a legal obligation to file for bankruptcy, within one month of the date on which the bankruptcy conditions are met. Failure to do so may lead to personal liability of the directors. In addition, criminal penalties may apply, if it was the director’s intention to postpone the bankruptcy.
The test for insolvency or the prerequisite for filing for insolvency proceedings is what the law calls the “cessation of payments”, which is understood as when the debtor is not able to regularly meet their obligations when due.
The law provides the following facts that evidence the “cessation of payments”:
- Debtor’s acknowledgement of their insolvency.
- Debtor’s default in complying with any obligation due.
- The absence or self-hiding of the debtor or its board members.
- Closing of the headquarters or the place where the company works.
- Selling goods at a vile price or paying with goods.
- The judicial revocation of certain fraud acts committed by the debtor against the creditors.
- Any kind of fraud committed by the debtor in order to obtain resources.
The directors of a company facing financial difficulties do not have any special duty and continue having the general law fiduciary duties. However, they are required to adopt any available measure to overcome financial crisis or reduce losses. Otherwise, although they are not obliged by the law to file for bankruptcy or reorganization procedures, they might be found liable for delaying such filing and deepening the crisis.
There are two solvency tests commonly employed: (a) the balance sheet test; and (b) the equity or cash flow test. Recent case law indicates that either test may demonstrate (in)solvency, although the issue is not free from doubt.
Under the law of the State of Delaware, which is the leading jurisdiction for U.S. corporate law jurisprudence, a company is considered insolvent under the balance sheet test if: (a) the sum of its debts exceeds the aggregate value of its assets; and (b) there is no reasonable prospect that the business can be successfully continued in the face of that insolvency.
The valuation of assets must be included at “fair market value.” Neither book value nor GAAP accounting principles are controlling. Courts have provided limited guidance on whether the balance sheet test is determined on a going concern or liquidation value basis. However, there appears to be general support for either an individual asset valuation or a business enterprise valuation. Certain decisions have placed weight on the market’s perception of value, by reference to the trading price of a company’s securities and ability to raise debt or equity financing. While all liabilities must be included in the balance sheet test analysis, regardless of whether or not they are matured, contingent or unliquidated, it may be possible under certain circumstances to discount the present value of certain contingent liabilities.
A company is considered insolvent under the equity or cash flow test if it is unable to pay its obligations as and when they come due. The key consideration is whether the company has the ability to produce sufficient cash to pay its debts as they mature. The source of cash may be from continuing operations, the disposition of assets, or other reasonably achievable capital raising activities. The caselaw is unclear as to how far in the future—or under how many different contingencies—a company’s ability to pay its debts must be assessed. Just because a company may be engaging in reasonable, ordinary course liquidity management (for example, by timing certain payables and receipts to “smooth out” cash flows and cash balances, as distinct from the inability to make any payables whatsoever) does not necessarily put the company in the zone of insolvency.
The United States—unlike Germany and certain jurisdictions in Europe and elsewhere—does not obligate a debtor to commence insolvency proceedings if the debtor becomes insolvent or believes that it may be insolvent. Furthermore, while many, if not all, debtors in the United States are insolvent when they commence bankruptcy case, the U.S. Bankruptcy Code does not have an insolvency requirement.
The import of solvency is key in a restructuring. Under the laws of the State of Delaware, where most U.S. corporations are formed, directors and officers generally owe their fiduciary duties to the company but not to creditors. While shareholders rely on directors and officers acting as fiduciaries to protect their interests, creditors are afforded protection through creditor rights (contracts, general commercial law, etc). Previously, Delaware cases implied that those fiduciary duties might shift to creditors when the company is insolvent, meaning that creditors may have the ability to sue officers and directors for breaches of fiduciary duties or for “deepening insolvency” when the company is insolvent or in the “zone of insolvency.” Recently, Delaware courts have partially clarified the law on this issue and limited the ability of creditors to bring direct actions against directors and officers.
A bankruptcy is declared with regard to a debtor which has become insolvent.
A debtor is insolvent if it has lost its ability to pay its due and payable pecuniary obligations. A debtor is presumed to have lost such ability if the delay in payment of its debts exceeds 3 months. A debtor is also insolvent if the value of its assets is lower than the value of its pecuniary obligations and this state of affairs persists for more than 24 months.
A bankruptcy motion must be filed by each person who is authorised to represent a debtor either individually or jointly with other persons (i.e. in practice, each management board member) no later than within 30 days from the day when the grounds for the declaration of bankruptcy described above arose.
The persons who are responsible for making the timely bankruptcy filing are also responsible for any damage caused to the creditors as a result of their failure to do so in time. However, such a person may be discharged from such liability if they are not at fault including, in particular, if they prove that restructuring proceedings were initiated or approval in proceedings for approval of an arrangement was given within the 30-day time frame.
Also, the management board members of a limited liability company are jointly and severally liable with the company for the company’s liabilities if enforcement proceedings against the company prove ineffective. However, such a person may be discharged from such liability if it is proven that either: (i) a motion for a declaration of bankruptcy or initiation of applicable restructuring proceedings was timely filed; (ii) the failure to make the bankruptcy filing occurred through no fault on the part of such person; or (iii) despite the failure to make the bankruptcy filing, the creditor suffered no damage. Similarly, management board members of a limited liability company are jointly and severally liable with the company for tax arrears, subject to certain exclusions and limitations.
Moreover, a court may ban a person from conducting an economic activity or holding the position of a member of a management or supervisory board or being a representative or a proxy of a company for a period from one to ten years if such person failed to make a timely bankruptcy filing.
A company will be deemed insolvent where it is unable to pay its debts. The Companies Act 2014 provides that a company shall be deemed to be unable to pay its debts where (a) a debt of the requisite size has been demanded and the company has failed to make payment within 21 days or (b) it is proved to the satisfaction of the Court that the company is unable to pay its debts, taking into account the actual as well as contingent and prospective liabilities of the company.
The directors are not obliged to commence insolvency proceedings in respect of an insolvent company and the directors of a company do not have locus standi to present a petition for the winding up, or commence a voluntary liquidation. However, they have the standing, but not the obligation, to present a petition for the appointment of an examiner to a company that is insolvent or at risk of insolvency.
Where the directors of a company are aware (or ought to be aware) that there is no reasonable prospect of the company avoiding an insolvent liquidation, they have a duty to take steps to minimise any loss to the company's creditors i.e. to preserve, or at least not dissipate, the company’s assets. Depending on the circumstances, the directors may decide to cease trading or to recommend to the shareholders that the company be wound up by means of a voluntary liquidation. Alternatively, if the company’s business has a reasonable prospect of survival, the directors may decide to file a petition with the Court for the appointment of an examiner which will impose a moratorium on creditor action for a period to enable the examiner to formulate a scheme of arrangement that would facilitate a restructuring of the company’s debts.
Where it is reasonable to continue to trade, for example where efforts are continuing to secure investment or financing that would allow the business to survive, the directors will not necessarily be required to cease trading, particularly where to do so would cause material value destruction, which is contrary to the interests of creditors. Nevertheless, a director of a potentially insolvent company must be careful to avoid a scenario where the company continues to trade, and to incur liabilities to creditors, unless he or she has an honest and reasonable belief that those liabilities would be discharged. In those circumstances there is a risk that the directors will be found to have engaged in reckless trading, and could be fixed with personal liability for losses suffered by creditors. There is also a risk that a liquidator would subsequently apply to the Court for an order restricting the directors from acting in that capacity for companies that do not satisfy certain minimum capital requirements, and in cases of serious misconduct the Court may disqualify the directors from holding office in any company for a period of up to five years.