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 (2nd Edition)
(a) Insolvency is defined by the Act XLIX of 1991 on Bankruptcy Proceedings and Liquidation Proceedings (the “Insolvency Act”). According to the Insolvency Act the court shall declare the debtor insolvent:
- if the debtor fails to settle or contest his previously uncontested and acknowledged contractual debts within 20 days of the due date, and fails to satisfy such debt upon receipt of the creditor’s written payment notice;
- if the debtor fails to settle his debt within the deadline specified in a final court decision or order for payment;
- if the enforcement procedure against the debtor was unsuccessful;
- if the debtor did not fulfil his payment obligation as stipulated in the agreement concluded in bankruptcy or liquidation proceedings;
- if it has declared the previous bankruptcy proceedings terminated; or
- if the debtor's liabilities in proceedings initiated by the debtor or by the receiver exceed the debtor’s assets, or the debtor is unable and presumably will not be able to settle its debts on the date they are due and, in proceedings opened by the receiver, the members (shareholders) of the debtor economic operator fail to provide a statement of commitment following due notice, in order to guarantee the funds necessary to cover such debts when due.
(b) If the statutory auditor detects any changes in the legal person’s assets that are likely to jeopardise its ability to satisfy any claims filed against the legal person, or learns of any circumstance that entails the liability of the executive officers or supervisory board members with respect to their activities performed in that capacity, he shall forthwith request management to take immediate action to the extent required for enabling the members – or the persons exercising founders' rights in the case of non-membership legal persons – to take the necessary decisions. In the event of non-compliance with his request, the auditor shall inform the court of registry that is exercising judicial oversight over the legal person concerning the situation at hand. The court of registry has a right to commence liquidation proceedings.
(c) The management of a company has the obligation to monitor the solvency of the company managed by it. If the management becomes aware of a situation which is threatening to lead to the insolvency of the company it shall act in the interest of the creditors. If the insolvency of the Company can be foreseen by the management, the management shall initiate liquidation of the company. Failure by the management to observe these provisions may lead to claims for damages by the creditors or even in extreme situations to criminal liability on the side of the management.
Under Indonesian law, the insolvency test for commencing insolvency proceedings within the meaning of either “cash flow test” to determine a company is unable to pay its debts as they fall due or “balance sheet test” to determine the value of a company's assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities, is not recognized.
The test for the relevant Indonesian commercial court (“Commercial Court”) to declare a company bankrupt responding a bankruptcy petition being filed under Law No. 37 of 2004 concerning Bankruptcy and Suspension of Payments (Kepailitan dan Penundaan Kewajiban Pembayaran Utang (PKPU)) (hereinafter shall be referred to as Indonesian Bankruptcy Law or “IBL”), is as follows:
- the debtor has one due and payable debt;
- the debtor has at least 2 (two) creditors (plurality of creditors); and
- the above conditions can be summarily proven in each of the relevant proceedings.
The bankruptcy petition can be filed by one or more creditor(s), the debtor itself or the Public Prosecutor, if it is in the public interest.
IBL further provides that:
a. debtor “who cannot or foresees that he will not be able to continue paying his due and payable debts” may petition for PKPU for the general purpose of submitting a composition plan covering the offer to pay a part of or the entire debts to its creditors; or
b. creditor who foresee that a debtor is unable to continue paying his due and payable debts may petition for the debtor to be granted with PKPU which enable the debtor to submit a composition plan covering the offer to pay a part of or the entire debts to its creditors.
In practice, the requirements for declaring a debtor bankrupt will be imposed by the Commercial Court to grant the PKPU petition.
IBL imposes restrictions on who or what type of entity can commence an insolvency proceedings. Only particular institutions can petition for the bankruptcy or PKPU of certain debtors. For example (i) banks, by Bank Indonesia (the Indonesian central bank), (ii) securities companies by Otoritas Jasa Keuangan (Financial Service Authority, previously known as BAPEPAM-LK or the Indonesian Capital Markets – Financial Institution Supervisory Board), and (iii) insurance and re-insurance companies, pension funds, state-owned companies operating for the public interest, by the Minister of Finance.
There is no mandatory obligation on directors or officers of the debtor to open insolvency procedures upon the debtor becoming distressed or insolvent, except for certain situation. In fact, the Company Law would only allow a voluntary bankruptcy petition of a debtor in a limited liability form to be submitted by the board of directors of the debtor after obtaining prior approval from the General Meeting of Shareholders of such debtor which is attended by at least ¾ of the total shares with valid voting rights and approved by at least ¾ of the total amount of votes being casted in such meeting.
The only exception is when a debtor in a limited liability company form is already in the dissolution and liquidation process and the appointed liquidator estimates that the debts of such company are greater than the assets of the company. In this situation, the liquidator must file a bankruptcy petition against such company in liquidation. The Company Law that regulates this matter does not provide any clear legal consequences on the appointed liquidator that failed to do so, except that upon the request of the interested party or the district attorney, the chairman of the relevant district court may appoint new liquidator and dismiss the previous liquidator.
Please however note that the term insolvency under Indonesian law has a meaning that differs from those in many other legal systems: it does not constitute the test for bankruptcy declaration. The general meaning of the term ‘Insolvency” under the IBL refers to the specific concept of ‘the state of being insolvent at law’ which occurs (a) during the bankruptcy proceedings after the bankruptcy declaration has been rendered or during the PKPU proceedings after the decision granting the PKPU has been rendered and :
(i) no composition plan is submitted in the creditors meeting for the verification of claims, or
(ii) the composition plan is rejected in the voting process by the creditors, or
(iii) the composition plan is approved by the creditors but not ratified by the Commercial Court, or
(b) the final and binding ratified composition plan is nullified by the Commercial Court due to it is proven that the debtor is negligent in performing its obligations under the ratified composition plan.
Pursuant to section 2 of the BIA, an insolvent person means a person who is not bankrupt and who resides, carries on business or has property in Canada, whose liabilities to creditors provable as claims under the BIA amount to Cdn$1,000, and
- who is for any reason unable to meet his obligations as they generally become due;
- who has ceased paying his current obligations in the ordinary course of business as they generally become due; or
- the aggregate of whose property is not, at a fair valuation, sufficient, or, if disposed of at a fairly conducted sale under legal process, would not be sufficient to enable payment of all his obligations, due and accruing due.
While there are no formal or express obligations imposed on directors or officers of debtors to open insolvency procedures under Canadian law, they are required to govern themselves in accordance with the corporate duties imposed on them and discussed at greater length in Question 14 (see below). While directors may consider other stakeholders (including creditors) when executing their duties, their obligations to act reasonably and in the best interests of the corporation are owed solely to the corporation.
There are three independent tests that determine whether a debtor can file for the opening of insolvency proceedings:
- Illiquidity (Zahlungsunfähigkeit): A debtor is illiquid if it is unable to honor its due payment obligations. According to exceptions set out by the Federal Court, a debtor shall not be regarded as illiquid (i) when it is unable to pay less than 10% of his aggregate liabilities unless it is foreseeable that the shortfall will exceed 10% in the near future, or (ii) if the debtor’s illiquidity can with some certainty be cured within a very short period of time (three weeks).
- Over-indebtedness (Überschuldung – only applicable to legal entities / partnerships as debtors): A debtor is over-indebted if its assets (at liquidation value) no longer cover its existing payment obligations, unless it is predominantly likely, considering the circumstances, that the enterprise will continue to exist. Hence, even if the balance sheet test is negative, a debtor is not obligated to file for insolvency as long as the continuation of the company’s main business is predominantly likely (positive going concern prognosis/positive Fortführungsprognose). The prognosis is mainly based on (i) a sound liquidity plan for the current and following fiscal year and (ii) the existence of a conclusive business plan.
- Impending illiquidity (drohende Zahlungsunfähigkeit): A debtor is considered to be facing impending illiquidity if it is likely to be unable to meet its existing payment obligations on the date of their maturity.
Managing directors have a personal duty to file for insolvency within three weeks at the latest, if the entity/partnership (which has no natural person as personally liable shareholder) is illiquid or over-indebted, in accordance with the criteria set forth above. A breach of this obligation results in severe personal civil and criminal liability risks (see Question 14).
Note: In case of impending illiquidity, management has the option, but not an obligation to file for the opening of insolvency proceedings.
In is important to understand that the term “sequestration” refers to the insolvency process relating to natural persons and partnerships whereas “winding-up” and “liquidation” refers to the insolvency process relating to companies and other legal entities. For a sequestration to be initiated, the test is whether the debtor’s liabilities exceeds its assets (known as factual insolvency). For the winding-up of a company, it is sufficient to show that the entity is unable to pay its debts (commercial insolvency).
Directors’ obligations regarding financial distress:
Financial distress in reference to a company, means that it appears to be reasonably:
- unlikely that the company will be able to pay its debts as they fall due and payable within the immediately ensuing six months; or
- likely that the company will become factually insolvent within the immediately ensuing six months.
If a company is financially distressed the directors may put it into business rescue (see below) and if the directors decide not to place it into business rescue, directors are under a statutory obligation to deliver a written notice to each affected person (i.e. creditor, shareholder, registered trade unions and employees), confirming that the company is financially distressed and is not being placed into business rescue and providing reasons for this.
Directors’ obligations regarding insolvency:
If a debtor is insolvent and unable to pay its debts, the company cannot continue to trade and the director may have to wind the company up or place it into business rescue. The Companies Act provides that a company may not carry on its business recklessly, with gross negligence, or with the with intent to defraud creditors. If the directors incur debt when there is no reasonable prospect of creditors receiving payment when due, the company will be trading recklessly. If a company trades recklessly, the following consequences may follow:
- directors may be:
- guilty of a criminal offence and liable to a fine or imprisonment for a period not exceeding 10 years, or both;
- held civilly liable for damages to any person as a result of trading recklessly;
- held liable for any loss, damages or costs of the company; and/or
- declared delinquent;
- the Companies and Intellectual Property Commission may issue a compliance notice requiring the company to cease carrying on its business. Failing to comply with the notice, entitles the Companies and Intellectual Property Commission to apply to court for the imposition of an administrative fine or refer the matter for prosecution as an offence.
Considering the prohibition on reckless trading, a director has a duty to pass a resolution for a company’s business rescue or alternatively resolve to liquidate the company as soon as he becomes aware that the company is either financially distressed or is trading in insolvent circumstances (factually and commercially).
To be eligible for voluntary liquidation proceeding, the debtor whose business is no longer economically available may file for its judicial liquidation attaching certain documents set forth in Article 105 of the Brazilian Reorganization and Bankruptcy Law (Federal Law 11,101, dated 9 February 2005 – “BRBL”), as follows:
- “accounting statements for the last three financial years and those specially drawn up to support the petition, prepared in strict accordance with applicable corporation law and consisting necessarily of (i) the balance sheet, (ii) accrued income statement, (iii) income statement as from the last financial year, (iv) cash flow report;
- a nominal list of creditors, stating their address and the amount, kind and rating of the respective claims;
- a list of properties and rights constituting the assets, with the respective estimate of the amount and documents evidencing ownership;
- evidence of his status as businessman, articles of association or by-laws, or, if there are none, a list of all partners, their addresses and their personal assets;
- the mandatory books and accounting documents required by law;
- a list of officers during the last five years, with their respective addresses, offices and corporate holdings.”
Although advisable, when the debtor cannot overcome its financially distressed situation, the debtor is not obliged to file for an insolvency proceeding in any event as the insolvency judicial proceeding is a prerogative that can be exercised at the debtor’s convenience. Therefore, no penalties can be applied if the debtor fails to do so.
However, pursuant Article 94 of the BRBL, any creditor may file for the debtor’s liquidation, if the debtor (i) without relevant reason, does not pay on the due date a liquid obligation, the amount of which exceeds the equivalent of 40 minimum wages; (ii) being demanded on a collection action for any net and certain amount, does not pay, does not deposit and does not appoint sufficient assets for attachment; and (iii) performs any of the following acts, unless they are part of a judicial reorganization plan:
- liquidates its assets precipitately or resorts to ruinous or fraudulent means to make payments;
- carries out, or by unequivocal acts attempts to carry out, with the object of delaying payments or defrauding creditors, a simulated transaction or the disposal of part or all of its assets to a third party, whether or not a creditor;
- transfers as security to a third party, whether or not a creditor, without the consent of all the creditors and without retaining sufficient assets to settle its liabilities;
- simulates the transfer of its principal establishment with the object of circumventing the law or inspection or to harm a creditor;
- gives or increases a guarantee to a creditor for a debt previously contracted without keeping sufficient assets free and clear to settle its liabilities;
- absents itself without leaving a qualified representative with sufficient funds to pay creditors, abandons an establishment or attempts to hide its place of domicile, the locality of its headquarters or principal establishment; or
- fails to perform, within the established term, an obligation assumed under the judicial reorganization plan.
Insolvency is tested by means of balance sheet and liquidity tests. If the debtor passes either of them, it is deemed insolvent.
The liquidity test requires the debtor:
a) to have multiple creditors,
b) to have due and payable debts which have been past maturity for more than 30 days, and
c) to be unable to satisfy such debts.
For the purposes of the liquidity test, the debtor is deemed unable to satisfy its monetary obligations if the debtor:
a) has suspended payments with respect to a substantial portion of its payment obligations, or
b) has been in default with such payments for more than three months past the due date, or
c) it is impossible to satisfy certain due and payable obligations of the debtor by the enforcement of a decision or by foreclosure, or
d) the debtor failed to submit a list of assets and liabilities as required by the insolvency court.
The balance sheet test requires the debtor:
a) to have multiple creditors, and
b) the sum of its liabilities exceeds the value of its assets (whereas the further management of such assets, or the further operation of its business, is being taken into account).
In 2017, a new instrument for assessing and evaluating the debtor’s insolvency was implemented into the Insolvency Act. A liquidity gap (in Czech: mezera krytí) is an instrument used for the solvency evaluation of a debtor which indicates whether the debtor is in fact insolvent or whether there has only been a temporary decline in the debtor’s operations which can be surpassed within a short period of time. The liquidity gap may be used as a negative presumption by which the debtor can prove its ability to fulfill its liabilities and as a matter of fact avoid to become subject to insolvency proceedings, i.e., to be deemed insolvent. The liquidity gap assessment may further help to determine (i) the date as of which the debtor was in an insolvency situation or (ii) whether certain decisions made by the statutory body of the debtor are going to cause a liquidity gap.
Directors are obliged to promptly initiate insolvency proceedings with the competent court as soon as they learn of the insolvency (or should have learned of it, had they exercised due care).
If the directors fail to comply with the above obligation, they are liable for any loss suffered by the creditors. It is presumed that the loss is equal to the portion of the claims that was duly registered but was not satisfied in the insolvency proceedings.
A director may be exculpated if they can prove that the breach of duty to file the insolvency petition had no impact on the amount intended for satisfaction of the claim lodged by the creditors in the insolvency proceeding, or that the duty was not fulfilled due to facts that occurred independently of their will and that could not have been averted even if the director had exerted their best efforts.
A grave violation of a director’s duties may amount to a criminal offense punishable by imprisonment.
A company may be wound up on the ground of insolvency if it is unable to pay its debts (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 Cayman 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.
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.
There is no conclusive test as a measure of solvency. Generally, the two most common tests are whether a company is unable to pay its debts as it falls due (the “cash flow” test), or whether its total liabilities is in excess of its assets (the “balance sheet” test).
There is no statutory obligation for directors of a company to commence insolvency procedures upon the debtor becoming financially distressed. However, where a company is insolvent, there is a common law duty on the directors to run the company in the best interests of its creditors (as opposed to its shareholders).
Directors who fail to take creditors’ interests into account may be found personally liable for a breach of their duties, fraudulent trading, or other statutory offenses. It is not unusual for liquidators to look into the dealings of former directors, as it offers a potential avenue to obtain recovery for creditors.
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 put the interests of the company’s creditors ahead of 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).
Section 162 IA provides that the court may appoint a liquidator because of the company’s insolvency, on the just and equitable ground, or if it is in the public interest. The same section states that such an application may be brought by the company, a creditor, or a member (among others). It does not expressly state that directors may apply; similarly, directors do not have a power to put a company into voluntary liquidation without a resolution of the members. It is clear, therefore, that the directors of a company registered in the BVI have no standing under BVI legislation to apply for the appointment a liquidator in their own names, whether individually or as a board.
It is not immediately clear how the company may apply for the appointment of a liquidator other than by its directors: although it may be necessary that the company’s members resolve (by the relevant majority) to put the company into liquidation by application to the court (rather than by members’ voluntary liquidation), the members have no executive powers and their resolution can only be effected by the acts of the directors. If this is correct, the directors must a priori have power to cause the company to apply for an order, even if that power is only exercisable with the members’ authorisation or ratification.
But in some cases, the directors’ duty to act in good faith in the best interests of the company may require them to seek the liquidation of the company. As stated above, when a company enters the ‘zone of insolvency’, the directors’ duties to the company shift in focus from being concerned with the interests of members to being aligned with the interests of creditors. The directors may, therefore, find that it is in the interests of the company to go into insolvent liquidation, notwithstanding that this is against the wishes of the members. In such a situation, it is difficult to see why directors should not be able to comply with that duty by causing the company to apply to the court, especially given that they have an obligation not to permit the company to trade if it has become insolvent and may become personally liable to compensate the company for losses sustained if they do so (section 256 IA).
Additionally, 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.
In the English case of Smith v Duke of Manchester (1883) 24 Ch D 611, the court held that although a company’s right to apply for a liquidation order was independent of the members’ individual rights so to apply, the directors could only cause the company to exercise this right after a meeting of shareholders at which there had been a vote in favour of taking this step. One of the reasons for this was that the directors’ powers of management and administration did not extent to a power to bring about the company’s dissolution.
This decision was followed in the subsequent English case of In re Emmadart Ltd  Ch 540, in which the court held that the directors could only bring an application in the name of the company if—
- the company’s articles of association expressly gave them such a power, or
- the members of the company authorised the application at a general meeting (or ratified an application after it had been filed, but presumably before it had been determined).
The position in England and Wales was altered by the introduction of a provision expressly permitting directors to apply for an order putting the company into liquidation in section 124 of the Insolvency Act 1986 (the 1986 Act). This suggests that there is a genuine need for directors to be able to put companies into liquidation in cases where it obtaining the members’ consent is not feasible because of time constraints, or where consent is unlikely to be forthcoming.
The question does not appear to have been determined by the BVI courts; it is not a foregone conclusion, however, that the position in the BVI is the same as the pre-1986-Act position in England and Wales: courts in other jurisdictions have declined to follow the Emmadart decision, finding instead that directors do not require the members’ approval where the company is insolvent.
In Australia, for example, an application to appoint liquidators on the ground of insolvency brought by the company on a directors’ resolution – in the face of opposition from two of the company’s members – was granted because there were strong practical and commercial reasons for allowing this practice: see Re Inkerman Grazing Pty Ltd  1 ACLR 102. These reasons included the need to preserve the value of the company’s assets and prevent a run on the company by its creditors. Inkerman Grazing was approved in Re Compaction Systems Pty Ltd  NSWLR 477, in which it was noted that the presentation of an application did not lead ineluctably to the company’s dissolution, so could come within the directors’ powers of management and administration.
It has also been held that a common provision in the company’s articles stating that the directors had every power not expressly reserved by the articles or legislation to the company’s members conferred upon the directors the power to bring an application for the appointment of a liquidator: see In Re Interchase Corp (1992) 111 ALR 561. These two cases were both followed in preference to Emmadart in Re New England Agricultural Corporation Ltd (1982) 7 ACLR 231.
In Bermuda, the courts have decided to follow the Australian rather than the pre-1986-Act English approach: in Re First Virginia Reinsurance Ltd  Bda LR 47, the court held that although if the company were solvent, members’ approval was likely to be needed, if the company were insolvent, the directors’ duty to act in the best interests of the company might require them to bring an application to apply for the appointment of a liquidator without the need for shareholder approval, which might be delayed by shareholders wishing to extract funds from the company or recklessly incur further debt and put the company further into insolvency. The decision in First Virginia was followed in In the matter of Energy XXI Ltd  SC (Bda) 79 Com, in which the court questioned whether or not the company’s articles of association could deprive management of the power to take steps to protect the interests of third-party creditors when the shareholders’ economic interests had been extinguished by insolvency.
It appears to be open to the BVI court to decide in which direction the common law should develop and there are compelling reasons why the current uncertainty should be resolved by declining to follow Emmadart.
If, however, directors of BVI companies cannot rely on an express provision in the company’s articles, and the company’s members will not give consent, they should, at the very least, ensure that the company does not trade if it has entered the ‘zone of insolvency’.
As stated above, if a director permits the company to continue trading while it is insolvent, the court may make a compensation order, requiring the director to compensate the company for any losses it has suffered because of that period of insolvent trading. If the court 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, they will have a defence if they can show that they ‘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.
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.
If a debtor is unable to repay its debts as they become due, and its assets are insufficient for the settlement of all its debts or it is obviously insolvent, this provides a ground for the debtor to be bankrupted. Chinese law is silent on any obligation on the part of the management of a debtor to initiate a bankruptcy procedure, but the person/team who is responsible to handle liquidation of the debtor pursuant to law is obliged to apply to a court of competent jurisdiction for bankruptcy liquidation when there is a ground for the debtor to be bankrupted, or else the person/team will be held accountable for the loss incurred to the creditors.
In Australia, the definition of insolvency is set out 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 that 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 can be held personally liable for debts that are incurred thereafter in these circumstances.
The Insolvency Law Reform Act 2016 (Cth) (ILRA) and its related instruments (the provisions of which are either in their infancy or still being rolled out) introduced a new concept of a ‘safe harbour’ protection for directors who might otherwise be exposed to insolvent trading. The safe harbour protection could, in certain circumstances, enable a company to delay a formal insolvency process where it seeks to pursue a turnaround plan that has a ‘better outcome’ for the company. If such a plan is being developed, the company must ensure it meets the relevant criteria to enliven the protection, because as a matter of practice, if the turnaround plan is unsucessful and a formal insolvency follows, the safe harbour protection will only operate as a defence to an insolvent trading claim rather than a positive exception to liability.
The conditions for bankruptcy are (i) the debtor 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 debtor continuously is unable to repay its (some of its) debts as they fall due. If the debtor can still be redressed or still has access to sufficient credit, the debtor 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.
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.
In the U.S., one of two insolvency tests is typically applied: (i) the equitable insolvency test, which is generally defined as the debtor’s inability to pay debts when due and (ii) the balance sheet insolvency test, which examines the balance sheet of the debtor to determine if the amount of the debtor’s liabilities exceeds the value of its assets. The United States, however, does not have an insolvency requirement; thus, a debtor need not be insolvent to commence proceedings.
The balance sheet test defines “insolvent” as a financial condition such that the sum of the debtor’s debts is greater than all of the debtor’s property at a fair valuation. Generally, the value of goods is assessed at “fair market value” and courts have adopted a rather flexible approach in analyzing a debtor’s insolvency. Courts tend to value companies that continue to operate day-to-day on a going concern basis. Under the equitable insolvency test (also referred to as the cash flow test), a debtor will be deemed insolvent if the company is unable to produce sufficient cash to pay debts as they become due. The cash may come from the disposition of assets, continuing operations, or other capital raises. Courts have not decidedly determined how far in the future the assessment should be made.
U.S. law does not impose an obligation on a company’s board to commence insolvency proceedings and provides the board with the latitude to pursue alternative strategies in good faith to maximize the value of the company. Generally, directors and officers of a company owe a fiduciary duty only to its shareholders, not to creditors. However, when a company is insolvent, some states’ laws expand the fiduciary duties of the directors and officers of a company to include creditors as well as shareholders. The State of Delaware, for example, has ruled that directors of a solvent debtor operating in the “zone of insolvency” must discharge their fiduciary duties to the corporation and its shareholders. Thus, only when the debtor actually becomes insolvent do such duties shift to creditors as well. Apart from having a fiduciary duty, so long as directors continue to operate the business in good faith, they cannot be held liable. Most courts adopt the view that creditors are sufficiently protected by virtue of the protections in their contractual arrangements and that additional protections are not necessary.
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”).
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 credit”), 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 legal requirements of bankruptcy (i.e., the substantive test for insolvency) are assessed on the day of the declaratory judgement of bankruptcy.
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 New Zealand Companies Act 1993 has two "solvency" tests concepts applied in different circumstances.
In the context of liquidation or voluntary administration the relevant question is whether the company "is able to pay its debts" when due. This is a cashflow solvency test having regard to a commercial assessment of overall liabilities measured against the resources available in order to meet those liabilities when due.
In the context of distributions to shareholders and amalgamations, there is a different "solvency test" which combines the same cashflow test as discussed above with a balance sheet test by reference to the value of assets being greater than the value of liabilities of the relevant entity.
Obligations and duties of directors
There are no circumstances in New Zealand which require a company or its directors to commence insolvency proceedings, nor is there any express prohibition on, or duty to avoid 'trading while insolvent'. However, there is a positive duty on directors in relation to reckless trading (as discussed further in Question 13 below), which can ‘force the hand’ of directors to place a company into voluntary administration or liquidation.
Directors owe their duties to the company to which they are appointed. Directors generally do not owe duties to creditors (or shareholders), and creditors and shareholders generally cannot take direct action against directors for a breach of duties. Remedy for a breach of duty by a director is to be sought by the company (or by a liquidator on behalf of the company under section 301 of the Companies Act 1993 as discussed below), or by a shareholder on behalf of the company (with the leave of the Court by a derivative action under section 165 of the Companies Act 1993.
Directors should, however, consider the interests of creditors when a company is or maybe operating in the ‘twilight zone’, namely, the time during which the company is or is nearing insolvency, as those interests are directly relevant to the interests of the company and are the subject of specific director's duties (as discussed in Question 13 below) regarding insolvent (reckless) trading and incurring obligations beyond a company's ability to perform. Not doing so does not, however, provide creditors with a directly enforceable right against directors for a breach of director’s duties or for the debt claimed by the creditor against the distressed company.
As discussed in the context of Question 13 below, post-liquidation of a New Zealand company, section 301 of the Companies Act 1993 can be invoked by a liquidator, a creditor or a shareholder of the company to bring actions against directors (and others) where, among other things, such directors (and/or others) have misapplied, retained, or become liable or accountable for money or property of the company, or been guilty of negligence, default, or breach of duty or trust in relation to the company. Many of the claims in New Zealand seeking redress for breaches of the relevant provisions relating to breach of director's duties in the twilight period prior to insolvency are brought by liquidators under section 301.
Any creditor having a certain, liquid and exigible receivable for more than 60 days and higher than Lei 40,000 may request the insolvency of a company. If these conditions are met, the law does not provide for other restrictions also in what regards the capacity of the creditor that may request the opening of a procedure of insolvency of a company. In the same situation the debtor also may request its own insolvency, and the directors must request the opening of an insolvency procedure in a term of maximum 6 months from the date when payments cease, and the sanction may be even a criminal one, the failure to declare the insolvency in the legal term being possible to be considered, in certain condition, the crime of simple bankruptcy. There is, of course, also the risk of a civil liability for the failure to fulfil this obligation.
Under Swiss law, the following terms must be distinguished:
- Illiquidity (Zahlungsunfähigkeit): A Swiss corporate debtor 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 debtor is over-indebted within the meaning of Art. 725 para. 2 of the Swiss Code of Obligations (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 debtor is generally obliged to file for bankruptcy proceedings in case of over-indebtedness within the meaning of Art. 725 CO. 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 debtor may further resolve to apply for the liquidation of the Swiss corporation 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 Art. 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 corporation in case of (looming) illiquidity. Such rules are not currently expected to enter into force before 2020. It is not proposed to make (looming) illiquidity an automatic trigger for insolvency proceedings.
Please refer to question 14 below for the consequences of a breach of obligations by the highest executive body of a Swiss corporation.
The Israeli case law recognizes two types of insolvency tests, and did not explicitly chose one over the other:
(a) The balance test – where the total obligations of a creditor exceeds the value of its assets.
(b) The cash flow test – examines the debtor ability to repay its obligation when becomes due and payable.
There is no explicit current legal provisions requiring directors and officers to open insolvency proceedings, however such obligations may be derived from case law and practice, under which in distressed circumstances the officers of the company are required to act in favor of the company creditors, and to take all precautionary measures for such purpose.
The new Insolvency Law adopts both tests for insolvency and set forth some factual presumptions of insolvency.
The new Insolvency Law imposes specific liability on directors and officer that knew or should have known that the company is insolvent and did not took reasonable measures to reduce its scope. A presumption of taking reasonable measures exists where such directors and officers acted in order get consultation from insolvency experts, negotiated a debt arrangement with the company creditors or commencing insolvency proceedings.
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.
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.
“Insolvency” is not expressly defined under English law but can generally be demonstrated if (1) a debtor 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 13 below. Civil penalties against directors can be for wrongful trading if they fail to take all steps to minimise 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.
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:
a) its due obligations that have been delinquent for more than 30 days represent 35% or more of its total outstanding obligations; and/or
b) 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.
As a subjective premise, natural persona, legal persons and inheritance pending to be accepted are able to apply for the DIP (art. 1 SIA).
On the other hand, as an objective premise, it is required that the debtor is insolvent and that the debtor will have this consideration when he is not able/ will not be able to fulfill (current or imminent insolvency) regular and punctually his enforceable obligations (art.2 SIA).
When the debtor is in this situation, directors or boards of directors must to apply for the DIP within the two months following the date of having known, or should have known his state of insolvency (art. 5 SIA). In addition, shareholders, partners, members or parties who are personally liable for the debtor are also entitled to apply for the DIP (art. 3 SIA) .
In case that the directors or boards of directors do not apply for the DIP, the insolvency proceeding could be qualified in the classification phase as tortious (art. 164 y 165 SIA). Consequently, the sentence of classification of the insolvency proceeding will determine the persons affected by the classification sentence. These persons could be condemned to the prohibition to administrate the assets of others for a period of two to fifteen years, as well as to act on behalf to any person during the same period (art. 172.2.2 SIA). Moreover, directors or boards directors could be condemned to pay totally o partially the credits that have not been satisfy by the liquidation of the assets (art. 171.2.3 SIA).
A debtor is deemed to be insolvent when its liabilities significantly exceed its assets or when it is unable to perform its obligations as they fall due.
The directors of a company must file for insolvency within 30 days of the date when they become aware of the insolvency or the date on which they should have been aware of it. When the debtor is the owner of a company, Portuguese law presumes that awareness of the insolvency occurs three months after the general failure to meet certain debts, such as taxes or social security contributions, debts arising from an employment contract or from the breach or termination of such contract, rentals for any type of hire, including financial leases.
If the directors fail to fulfil their obligation to file for insolvency proceeding, they can be considered culpable for having created or contributed for the situation of insolvency and, consequently, the Court may impose sanctions upon them, namely sentence them to indemnify creditors up to the amount of their unpaid credits – see question 13.