Sunday, 18 October 2015

Liability of the Board of Directors in a Company Facing Economic Difficulties


TRUST's Parties' getting Closer 12 November 2015
Splendid autumn for everyone! At Trust, everything is going well and our house-warming parties are getting closer. If you have not received an invitation, do not panic, just check all your mail bozes and if you still do not find it, send me an e-mail (jan.lindberg@thetrust.fi) and I will send to you an invitation. We have awesome artist playing like Anssi Kela,  Italian wines and good food - you do not want to miss this! 
To our real topic, as we have been advising some Boards lately in companies facing economic difficulties, I thought that I share a few words about this governance topic from director's liability point of few if it could also help others. Naturally this topic is requires further attention to details depending on the particular case, but at least this gives to you an overview of the different options. At the same time I must say that while my M&A blog has been on hold, but we have actually written a few additional posts so I will also publish those shortly.
Background
If a company is going through economical difficulties, it has, in practice, three options: 1) to file for restructuring 2) to file for bankruptcy or 3) to continue its business operations. If the company has lost its equity, the company must notify this to the trade register without undue delay, and the management of the company has an emphasized duty of care. Failure to file the notification has not been deemed a very significant matter in the court praxis regarding directors’ liability, but it is more important what actions the board takes, if the company is in economic difficulties and whether such actions lead to an increased debt burden or weaken the position of the creditors. Consequently, the management is under an obligation to take active measures to correct the situation or to improve the financial position of the company. If they fail to do so, they should generally file for insolvency proceedings. This is important, as continuing the business without corrective actions may lead to personal liability of the members of the Board of Directors of the company as well as that of its other management (including the CEO). Therefore, the management of a distressed company should be extremely alert in the event of loss of equity and other financial difficulties.
The purpose of this memorandum is to outline, at the general level, these possible liabilities under the Finnish law, and the different options a company not having adequate financing or capital could have, without providing an overall understanding of the matter or going too much into detail.
Liability of the Board
According to Section 23 of Chapter 20 of Limited Liability Companies Act (the “Act”), if the Board of Directors of a company notices that the company has negative equity, the Board shall at once make a register notification to the trade register on the loss of share capital. The purpose of such notification is to bring the economic situation of the company to the attention of the company’s debtors. If the Board neglects the notification, this might lead to the personal liability of the company’s Board of Directors and management under Section 1 of Chapter 22 of the Act, if a debtor or another contracting party suffering credit loss can show that it would not have given credit to the company had it known of the loss of equity. The referred Chapter stipulates the following:
“Liability of the management
(1) A Member of the Board of Directors, a Member of the Supervisory Board and the Managing Director shall be liable in damages for the loss that he or she, in violation of the duty of care referred to in chapter 1, section 8, has in office deliberately or negligently caused to the company.
(2) A Member of the Board of Directors, a Member of the Supervisory Board and the Managing Director shall likewise be liable in damages for the loss that he or she, in violation of other provisions of this Act or the Articles of Association, has in office deliberately or negligently caused to the company, a shareholder or a third party.
(3) If the loss has been caused by a violation of this Act other than a violation merely of the principles referred to in chapter 1, or if the loss has been caused by a breach of the provisions of the Articles of Association, it shall be deemed to have been caused negligently, in so far as the person liable does not prove that he or she has acted with due care. The same provision applies to loss that has been caused by an act to the benefit of a related party, as referred to in chapter 8, section 6(2).”
Furthermore, in order to prevent inappropriate and damaging business and to maintain confidence in the business, among others, a person involved in the management of a company (for example as a member of its board) may be imposed a ban on business operations under the Finnish Act on Ban on Business Operations. This requires that the person in question has essentially failed in performing his statutory obligations related to the business, or if he is found guilty of criminal procedure that cannot be considered minor. It is also required that his activities as a whole are regarded as detrimental to the creditors, contractors, public finance, or sound and effective economic competition. The ban prevents its subject from, e.g., engaging in business activities for which the Accounting Act provides for an accounting obligation, being a partner of a general partner or a limited partnership's general partner or a member of the board of a company, as well as establishing a limited liability company, or otherwise to acting in a comparable business operations position. The duration of the ban varies between 3 to 7 years.
Bankruptcy
If a company’s financial difficulties turn into permanent insolvency, then the company should file for bankruptcy. Some pressure to make the appropriate filings is created by the fact that continuing to run the business of an insolvent company may be deemed as debtor’s dishonesty under Section 1 of Chapter 39 of the Criminal Code, in relation to which the punishment varies between a fine and 2 years of imprisonment. Therefore, it is not recommended to wait that a creditor files for the bankruptcy of the debtor company – at least not for a very long time. The decision on filing for bankruptcy is made by the Board of Directors with simple majority.
Also, according to Section 12 of Chapter 4 of the Credit Data Act, which is applied to registers to which credit data companies enter credit data, which they then provide to others (usually against payment), the credit data registers are entitled to enter information regarding a person’s participation in companies, as well as these companies’ payment default situation, bankruptcy, and similar economic situations. The entry regarding bankruptcy may be in the register for a period of five years. Furthermore, as stipulated in Section 27 of Chapter 6 of the same act, this information may, subject to the fulfillment of specified requirements, be used in the credit rating of a company in which that person is involved. It is our estimation, however, that these requirements would not be fulfilled in the case at hand with the assumption that the company has been up and running for several years and its accounting has been made and filed appropriately. On another note, it is possible that this information be used also in other relations, such as when establishing a new company, or when applying for a personal loan, etc. as the information is publicly available to any interested party.
Restructuring of Enterprises
To the extent the company is in a position to be rehabilitated and it fulfills the requirements under the Restructuring of Enterprises Act, the company could, instead of bankruptcy, file for restructuring. This could be recommended if the debtor company’s business is profitable, but it has so much debt that it cannot pay them in the agreed schedule. The restructuring proceedings creates costs, and thus is not recommended if the company is for example very small.
Conclusions
A member of the Board of Directors of a company going through economical difficulties should pay special attention to the company making the appropriate filings an taking the necessary actions in accordance with the above and also otherwise actively act with due care in fulfilling his or her obligations as outlined above. Continuing the business without corrective actions and/or otherwise not acting as required by the law may lead to personal liability of the members of the Board of Directors of the company as well as that of its other management (including the CEO). Next we continue with M&A themes, but hopefully we meet in our parties so see you there!
Regards,
Limppu