COVID-19 | Liability of the company management
Even prior to the government-imposed restrictions on our freedom of movement, the coronavirus had already left its mark on the economy on the vast majority of businesses. The Government has adopted several measures to help the companies, but despite the postponement of deadlines for the payment of VAT and salary taxes, salary guarantee for employees and others, many companies will face economic difficulties and maybe even bankruptcy.
Any manager with responsibility in a company in distress, whether due to failed investments or failing turnover due to COVID-19, must be extra careful when the liquidity is challenged. What may initially seem harmless can end up disastrously and result in financial liability for the management of the company.
Obtaining new debt
A frequent problem for distressed companies is purchases on credit. Basically, there is nothing wrong with purchases on credit. It happens every single day and without such purchases it would be difficult to do business in a modern society. The problem arises on the day on which the seller of an item is reimbursement of the credit provided at the sale. If as the management of a distressed company, you directly or indirectly authorize purchases on credit, there is a significant risk that you could become financially liable for the loss suffered by the seller by not receiving payment.
The problem arises not only with credit purchases. It can also occur in the opposite situation. The director who authorizes sales on credit without making sure that the buyer actually can perform his obligation to pay, may also be liable for the business of which he is the director. Especially in a crisis situation during which many companies are experiencing economic difficulties the obligation for the seller to make sure the buyer can actually pay the credit is enhanced.
A special subcategory hereof is engaging in additional activities of obtaining new debt through bank loans. This applies both to further withdrawal of a revolving facility and the obtaining of new loans.
The Government and Parliament have just introduced a guarantee scheme according to which companies that experience a loss of revenue of at least 30 % as a result of the coronavirus can obtain bank loans with a guarantee from the Danish state’s investment fund, ‘Vækstfonden’, of 70 % of the loan. It has taken some time to get the scheme in place, since it contains an element of state aid, which had to be approved by the EU prior to implementation. The scheme was introduced on the 18th of March 2020 for large companies and 23rd of March for small and medium-sized companies respectively.
It is presumed that many companies will apply for a government-guaranteed loan through their usual bank. The loan will typically be used for the continued operation of the company, and if the company despite the loan does not survive the corona crisis, the company is left with increased debt but no additional assets to outweigh the increased debt.
Therefore, it would be detrimental to the existing creditors that new debt is obtained to continue operations rather than shutting down and allow the company to go bankrupt and taken into insolvency proceedings. One may therefore wonder whether obtaining new debt should be subject to the approval of the existing creditors or a majority hereof.
In addition, the company may have different covenants in its existing loan agreements, which could prohibit obtaining of further loan debts, and they could also in themselves cause the existing loan to default by the fact that the company is economically distressed.
Continuation of the operation
Even though the distressed company does not obtain new debt, the management may well be liable for losses suffered by the creditors of the company. If a company has continued the business beyond the ‘time of hopelessness’, that is, when the financial problems of the company have become so comprehensive that a recovery is no longer realistic, the management can become liable to the creditors for the loss they may suffer, due to the management not stopping operations in the company and filing for bankruptcy.
Of course, this does not mean that, as the managing director of a distressed company you should immediately file for bankruptcy, but professional advice from an insolvency lawyer should to sought before making any decisions.
Germany has very strict rules regarding responsibility of the management of distressed companies, including criminal liability. The management is required by law to file a bankruptcy petition against the company within three weeks of the management finding that the company is overindebted or is in fact insolvent. If the management fails to comply with this obligation, it may not only be economically liable to the company’s creditors, but may also be prosecuted according to the Penal Code.
The rules in Denmark are not as strict as in Germany, but if the management takes up new debt in the company with the knowledge that the company will not be able to repay the debt, the management in more extreme cases can be pursued according to the provisions of the Danish Penal Code.
Further to the financial liability of the company management, there is also a risk in Denmark of being imposed with a ‘bankruptcy quarantine’ lasting up to three years. This requires that it is subsequently assumed that the management has acted grossly through unjustifiable business conduct in the previous year leading up to the company being subject to bankruptcy proceedings.
The consequence of a bankruptcy quarantine is that you are not allowed to be a director or part of the board of directors of a capital company (i.e. for instance an ApS or A/S) during the quarantine period.
If the management of a bankrupt company continues to operate the business beyond the point of hopelessness or undertakes irresponsible obtaining of debt, it may result in the members of the management being imposed a bankruptcy quarantine.
If you are in the management of a distressed company, LEAD Rödl & Partner is ready to advise you on how to act.
Contact our legal expert in insolvency law:
Tlf.: +45 40534583