What are directors’ duties and personal liabilities when a company is insolvent?

Who is responsible?

Directors, de facto directors and shadow directors

What are their core duties?

Australian law does not impose a standalone statutory duty on directors to place a company into liquidation. However, directors can effectively be compelled to do so in practice because, once insolvency is unavoidable, failing to appoint an external administrator will usually expose them to personal liability for insolvent trading and breach of duties. Directors have a statutory duty to prevent insolvent trading.

Whilst there is no express obligation to liquidate, directors have general duties set out in the Corporations Act 2001, which include the duty of care and diligence owed by company directors and officers, the duty of good faith and to conduct their duties for a legitimate corporate purpose.

A company may also appoint a voluntary administrator where its directors form the opinion that it is insolvent or likely to become insolvent, which reflects their duty to act in the best interests of the company and, when approaching insolvency, to prioritise the interests of creditors.

What is the risk of personal liability?

A positive duty is imposed on directors to prevent a company from incurring debts while insolvent, making it a major source of personal liability. A breach occurs where the company is insolvent, or becomes insolvent by incurring the debt, where there are reasonable grounds to suspect insolvency, and the director knew or ought reasonably to have known of those grounds.

A breach can result in civil liability penalties, disqualification as director, and criminal liability where dishonesty is involved, subject to statutory defences.

The safe harbour regime provides a defence to directors where, after suspecting insolvency, directors incur debts in connection with a course of action that is reasonably likely to lead to a better outcome for the company than immediate administration or liquidation and where advice is being obtained from an appropriately qualified entity.

A breach of director duties or fiduciary duties can result in civil penalties, compensation orders, disqualification, and, if dishonesty is proven, criminal charges.

For queries related to Australia, please contact Hannah Griffiths of Pinsent Masons.

Who is responsible?

Directors and de facto directors; shareholders if there are no directors in office.

What are their core duties?

German law imposes a statutory duty on directors to file an application for the opening of insolvency proceedings if a company becomes illiquid or over-indebted. The filing has to be made without delay, but no later than within three weeks of the company becoming illiquid or six weeks once the company has become over-indebted.

While the directors are under duty to file for insolvency, no payments may be made from the company’s funds unless the payments are made with the care of a prudent businessman. If the filing for insolvency is delayed, there is a statutory presumption that all payments were not made with the care of a prudent businessman.

If there are no directors in office, the responsibility for the filing for opening of insolvency proceedings may shift to the company’s shareholders. However, the responsibility does not shift to the shareholder if the shareholder can prove that it was unaware of the company’s financial distress, or that the shareholder was unaware that the company had no directors in office.

What is the risk of personal liability?

Failure to comply with the duty to file for insolvency constitutes a criminal offence.

Directors can be held personally liable by the insolvency administrator for all payments that were made from the company’s funds at a time when the director was under a duty to file for opening if insolvency proceeds, if the payments were not made with the care of a prudent businessman. The burden of proof falls to the director to demonstrate that the payments in question were made with the care of a prudent businessman.

In addition, the director has a personal liability towards contractual creditors if the insolvent company is unable to fulfil its contractual obligations but entered into the underlying contract with the creditor regardless at a time when the director was aware that he was already under duty to apply for insolvency.

Lastly, there are personal responsibilities and potential liabilities for the director regarding payment of social security contributions on behalf of the company’s employees.

For queries related to Germany, please contact Attila Bangha-Szabo of Pinsent Masons.

Who is responsible?

Directors and managing directors. In some circumstances de facto directors and former directors.

What are the core duties?

Those liable are required to file for insolvency within two months from the date on which the debtor became aware, or should have become aware, of the state of actual insolvency.

They are also obliged to prevent aggravation of the insolvency. If the insolvency petition is not filed within the legal deadline, directors may be held personally liable for any worsening of the company’s financial situation.

They must make all books, documents and records available to the insolvency administrators so they can properly carry out their work. The company’s administrators and directors must also appear whenever required and provide full cooperation and information to ensure the proper progress of the insolvency proceedings.

Managing directors may incur criminal liability if they engage in criminal conduct including disloyal management, asset stripping, fraud, falsified accounting and any other actions that deliberately harm creditors.

Under Spanish law, this duty includes avoiding actions that fraudulently reduce the company’s assets, concealing or destroying accounting records, fabricating claims, artificially creating insolvency, or managing company assets in a way that harms the insolvency estate or creditors.

What is the risk of personal liability?

There are criminal consequences for late filing. Failure to file for insolvency within two months from the moment the state of insolvency was or should have been known may negatively affect the final classification of the insolvency proceedings, including potential criminal implications.

Directors may be held liable for worsening the insolvency. If the insolvency petition is not filed within the legal deadline, directors may be held personally liable for any deterioration in the company’s financial situation, which may result in sanctions and compensation obligations.

Liability extends beyond the term of office and does not disappear upon leaving the position. Claims may be brought against anyone who served as a director during the two years prior to the declaration of insolvency.

Managing directors may incur criminal liability if they engage in conduct such as disloyal management, asset stripping, fraud, falsified accounting, or any action that deliberately harms creditors.

These actions may incur prison sentences, fines, and disqualification from managing or representing legal entities.

For queries related to Spain, please contact Fernando Tallón Martínez of Pinsent Masons.

Who is responsible?

Current directors and, in some circumstances, former directors, de facto directors and shadow directors.

Some offences are also extended to those “knowingly involved” and to other officers of the company.

What are the core duties?

Directors’ general duties are set out in statute and are owed to the company and its shareholders.

When a company is insolvent or nearing insolvency, directors must shift focus to creditors’ interests, giving them priority where they conflict with shareholders’ interests. As financial distress worsens, creditors’ interests carry increasing weight and, once insolvency is unavoidable, become paramount.

What is the risk of personal liability?

Directors may be ordered to contribute personally if they continue what is known as ‘wrongful trading’ when they knew, or ought to have known, there was no reasonable prospect of avoiding insolvent liquidation/administration.

Personal liability also arises where the business is carried on with intent to defraud creditors or for any fraudulent purpose.

Directors can be held liable for misfeasance, where a director has breached fiduciary or other duties or misapplied company assets; and misfeasant trading, where a director breaches their duty to protect creditor interests by allowing trading while insolvent or bordering on insolvency.

Any antecedent transactions - transactions at an undervalue – or preferences before insolvency may be set aside, and will be evidence of breach of duty. In Scotland these are known as ‘gratuitous alienations’ and ‘unfair preferences’.

For five years after liquidation, a former director cannot manage a company with the same name or a similar name unless an exception applies. Breach is a criminal offence and may trigger personal liability for the new company’s debts.

Unfit directors may be disqualified for up to 15 years, with possible compensation orders, often arising from conduct before insolvency.

Directors of listed companies should also be aware of the specific rules that may apply both under statute and the rules of the relevant market, particularly those relating to misleading the market and the requirement to make announcements.

For queries related to the UK, please contact Edward Smith of Pinsent Masons. 

Who is responsible?

Directors

What are the core duties?

A company must not carry on its business recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose. In addition, and if the company is financially distressed – in other words the company is unlikely to be able to pay its debts in the next six months or is likely to become insolvent in the next six months – directors have a duty to consider and, if appropriate, commence with business rescue proceedings.

What is the risk of personal liability?

A director will be held personally liable for any loss, damage or costs sustained by the company as a consequence of the directors having carried on its business recklessly, with gross negligence, or with intent to defraud any person or for any fraudulent means.

They will also be personally liable if they have been party to any act or omission by the company despite knowing that the act or commission was calculated to defraud a creditor, employee, or shareholder.

Directors that make false statements, engage in reckless conduct, and are non-compliant with their statutory duties, or fail to take action when trading in insolvent circumstances, may also incur a fine or imprisonment not exceeding 10 years upon being found guilty.

For queries related to South Africa, please contact Mark Thomas of Pinsent Masons.