The Board’s obligations during a global economic downturn – how to prevent personal liability

The Norwegian government has implemented temporary measures that have alleviated the negative economic effects of the Covid-19 pandemic. However, as the measures are phased out, the level of corporate distress will increase. In order to prevent personal liability towards the company’s stakeholders, Members of the Board should take certain measures.

Introduction:

The temporary measures from the government have alleviated the negative economic effects of the coronavirus. Nonetheless, the common view is that the level of corporate distress probably will increase when these measures are phased out. Thus, the role of the Board of Directors (the “Board”) and its individual directors (each a “Director”) is more important than ever. However, when the company’s survival is at stake, also the risk of director’s personal liability increases.

Summary:

In summary, Directors in a company that is or probably will suffer distress due to the coronavirus or other crises should as a minimum:

  • Frequently review the company’s financial situation and potential risks;
  • Get an overview of the company’s financial covenants and due dates;
  • If necessary; seek advice from third parties and implement the necessary measures;
  • Immediately inform the shareholders and creditors if it becomes evident that the company’s difficulties are severe and not temporary; and
  • Ensure that the minutes from all board meetings are correct, complete, dated and signed.

In order to prevent personal liability, each Director should be proactive and aware of its responsibility during a crisis. A passive approach could turn out to be costly for both the company and the Directors.

The Board’s essential obligations during a crisis:

Each Director can be held personally liable towards the company, shareholders and third parties, including the company’s creditors, for economic damage caused by negligent behaviour. An example of such negligent behaviour is to infringe or contribute to infringe the Board’s legal obligations.

The Board has a continuous obligation to keep itself informed of the company’s financial position and to overlook the actions of the management. This entails that the Board must ensure that the financials are subject to adequate control, inter alia that the company is compliant with financial covenants and applicable due dates. As it is normally insufficient to solely rely on the company’s official financial statements, each Director is mandated to call for all necessary investigations.

If the Board considers the company’s equity or liquidity insufficient in proportion to the risk and size of its operation, the Board shall immediately consider which measures that should be implemented to improve the situation. Further, the Board shall call for a general meeting and inform the shareholders of the challenges and possible solutions within reasonable time. Thus, the Directors could be held liable for economic damage that is caused by financial distress that they had not uncovered or handled properly. On the other hand, the Directors will not be liable if they make reasonable investigations and still consider the company as solvent.

If the company is insolvent, the company is expected to notify its trade creditors that they may not receive payment on time. If the company fails to give such notice, the company could be held liable for the creditors’ loss. Further, if it becomes evident that the creditors will not receive payment within reasonable time after the due date, the Board and thus the Directors are obliged to file for bankruptcy.

Regardless of the company’s obligation to notify creditors, the Board is permitted to fight for the company’s survival until it is unrealistic that the company can be saved, cf. Rt. 1991-119 (Normount) and HR-2016-1440-A (Håheller). Thus, up until the point of unrealism, the Directors have a “margin of discretion” and may try to save the company without notifying creditors of the financial difficulties. Accordingly, the liability of the Board does not necessarily correspond to the liability of the company. It is however expected that the Board’s decisions during a crisis are based on a balancing of the conflicting interests of the stakeholders as a whole, and that the Directors decide to file for bankruptcy within reasonable time, cf. HR-2017-2375-A (Blålid).

Still, in order to avoid any subsequent allegations of liability, the Board should consider informing and collaborating with existing and potential creditors as soon as it is evident that the company’s difficulties are not temporary. However, as such information to the creditors could complicate a rescue operation, the Board should also consider the strategic consequences of informing the creditors.

Case law regarding the Board’s obligations during a financial crisis:

As the financial crisis of 2008 had limited effects on the Norwegian economy compared to most of the world, there are just a few examples where the courts have considered the Board’s obligations during a global economic downturn.

In LG-2012-86908, Gulating Court of Appeal considered whether the Directors in a company which went bankrupt due to the financial crisis in 2008 were liable towards a creditor that had suffered a loss. The creditor argued that the Board was obliged to provide information on the financial difficulties in the company, and that its loss then would have been avoided. After carefully considering the actions of the Directors between the occurrence of the financial difficulties and the bankruptcy, the court decided that the Directors had acted appropriately. A reason why the court gave its judgement in favour of the Directors was that the minutes from the board meetings evidenced that they had:

  • Made themselves familiar with and discussed the company’s financial difficulties;
  • Implemented measures they saw fit;
  • Discussed their financial position with their bank; and
  • Included the company’s legal advisor and auditor in the board meetings.

Thus, the judgement underlines the importance of implementing measures at an early stage and ensuring that the minutes from the board meetings are accurate and complete.

This is also exemplified in Borgarting Court of Appeal’s judgement in LB-2011-161685, where three Directors were criticised for being too optimistic regarding the financial outlook in a shipping company during the financial crisis in 2008. In the Directors’ witness statements, they explained that the company’s financial downturn occurred suddenly and thus that the finances were sufficient when the debt towards the creditor’s incurred. Yet, the court concluded that the company’s problems evolved gradually over time, and that the Directors therefore should have acted differently. In our opinion, it is however likely that the court would have concluded otherwise if the Directors’ witness statements had been substantiated by contemporaneous minutes from meetings and advice from third parties.

Despite the criticism from the court, the Directors were not held liable as the court concluded that also the plaintiff had acted negligent.

Do not hesitate to contact any of BAHR’s lawyers for further information or advice.

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