The duty to declare bankruptcy in light of Covid-19 – is the scope of the Board of Directors leeway wider?
Covid-19 has significantly affected the financial situation for many companies both nationally and internationally. Board members in a company in financial crisis have a stricter responsibility to ensure that the business is financially sound and that the company does not undertake any debt, which the company is unable to service. When does the Board of Directors of a company have a duty to dissolve the company? Violation of the duty to dissolve the company can result in both liability for damages and, ultimately, criminal charges. In the following, we will address the Board of Director’s leeway against the duty to dissolve the company in light of the Covid-19 virus. In some of the Board of Directors’ assessments, does it now have wider leeway than in a normal situation?
Pursuant to the Companies Act sections 3-4, cf. 3-5, a company shall at all times have «an equity and a liquidity» which is «adequate on the basis of the risk and scope of the business», and if the equity is lesser than adequate, the board is obliged to take measures to strengthen the equity. If it is not possible to strengthen the equity, the Board of Directors is obliged to propose the company dissolved, either through a managed liquidation if the company have the funds for it, or through bankruptcy. The Board of Directors’ duty to secure that the company has an adequate equity applies fully in the current crisis.
Pursuant to section 17-1 of the Companies Act and case law, a negligent or intentional violation of section 3-5 of the Companies Act entails a possible liability for the members of the board and/or the CEO.
Liability can be claimed if «the company, shareholder or others» have been financially injured as a result of a failure to dissolve the company. In practice, this will usually be the company’s creditors either individually or a bankruptcy estate on behalf of all of the creditors. Creditors who suffer losses as a result of the company failing to dissolve the company and continues the business after the Board of Directors should be aware that the company does not have an adequate equity will be able to file claims directly against the Board of Directors and the CEO.
The question further is when does a company have a duty to dissolve the company?
This will always have to depend on a concrete and complex assessment. If the company continues its work after the company is insolvent, the company’s Board of Directors may be held liable for losses creditors may suffer for credit given to the company in the period after the insolvency occurred.
A company is insolvent under Section 61 of the Bankruptcy Act when the company «cannot fulfill its obligations as they fall due, unless the ability to pay is assumed to be temporary» and the value of the company’s assets is less than the company’s debt.
The company is not insolvent even though the value of the company’s debt is higher than the value of the company’s assets. The crucial point is that the company is also unable to pay its bills as they become due and payment problems are not temporary.
The latter is of particular relevance in today’s situation where companies face liquidity problems as a result of the Covid-19 virus. The virus is inherently transient and the inability to pay directly due to the Corona virus will in itself be temporary. This could be an element that can justify extending the term «temporary» somewhat further than case law and legal literature have suggested (1-3 months). How far this is applicable will in any case have to depend on a specific assessment. Factors in this assessment will be for example how secure the company’s outstanding accounts receivable are, how profitable the business is and what prospects the business has. The safer the basis for the aforementioned factors, the longer can it be expected that a court will accept that the payment inability is «temporary». If however, there is a high uncertainty about outstanding accounts receivable and the profitability of the business in the future, the courts might not be willing to extend the period further.
At the core of the Board of Directors’ evaluation is whether the company has the financial resources to resume operations when everything is back to normal, without meanwhile undertaking more unsecured claims, which the company is unable to service. Crucial for the Board of Directors’ evaluation is that the Board of Directors has realistic and updated liquidity budgets for the months ahead and realistic expectations for the profitability of the company’s business operations in the times ahead. If, after such a review, the board finds that the company also after «normalization» is unable to settle its debts as they fall due after the situation has normalized, the board will soon have an obligation to dissolve the company. This unless the Board of Directors is unable to enter into agreements with the individual creditors and/or is provided with additional equity which makes it reasonable to continue the business without inflicting further losses on the creditors. Agreements with individual creditors (payment deferral, repayment plan) will allow the Board of Directors greater discretion in their assessments.
The Government’s help packages, both in the form of loan packages and cash support, also help to give the Board of Directors greater leeway in its assessments. The remedial measures are undoubtedly relevant elements in the Board of Directors’ assessments of whether it has a duty to declare bankruptcy or not. The Government has stated that one of the main purposes of the packages is to avoid «an explosion of bankruptcies as a result of the Covid-19 virus». For companies that did not struggle before the Covid-19 virus paralyzed Norwegian business, will the packages undoubtedly contribute to fewer bankruptcies. On the other hand, for companies that already struggled before the Covid-19 crisis, the help packages will have less significance. Companies with negative equity from the time before the crisis occurred will be exempt from several of the relief measures.