Author: Maria DeBono, Associate
22nd April 2020
The stark reality of the COVID-19 pandemic on companies, like natural persons, is not a merry one. Akin to natural persons, while some companies will recover, others will not be so fortunate. While companies can indeed use this time to foster innovative business strategies, they need to have the funds to do so. If they don’t? Insolvency (as bleak as it may sound) might be the inevitable route for some, despite their best intentions. Company directors cannot simply abandon ship when things go south. Even in these abnormal circumstances, directors are forced to make already tricky decisions which they will be judged for (with the benefit of hindsight) if they make the wrong call. Apart from this, especially when the company is veering towards insolvency and creditors’ interests consequently take centre stage, directors have the threat of personal liability hanging over their heads. Temporary legislative intervention in the ambit of insolvency laws can seek to lighten this burden on directors during this unusual time.
CERIL’s Executive Statement
On the 20th of March 2020, the Conference on European Restructuring and Insolvency Law (“CERIL”) released an Executive Statement urging legislators to adapt insolvency legislation due to COVID-19. CERIL claimed to be “deeply concerned with the ability of existing insolvency legislation to provide adequate responses to the extremely difficult situation in which many companies find themselves as a result of the spread of the COVID-19. It calls upon EU and European national legislators to take immediate action and adapt insolvency legislations where necessary in light of the current extraordinary economic situation and to prevent unnecessary bankruptcies of entrepreneurs”. CERIL recommends that two steps be taken by European national legislators:
- To suspend the duty to file for insolvency proceedings based on over indebtedness. CERIL argues that the current uncertainty and distressed market conditions hamper the test to determine whether a business is still viable or not and whether it ought to initiate insolvency proceedings; therefore, in these circumstances, companies which would be viable in normal market conditions, might be forced to file for insolvency unnecessarily; and
- To respond to the illiquidity of businesses. CERIL holds that those businesses with limited cash reserves, due to lockdown measures for example, may be approaching a situation of illiquidity that qualifies as the “inability to pay”, thereby risking being considered as legally insolvent, while they would have probably remained viable in a normalised market situation.
Germany is one of the countries in the EU that seems to have heeded this call for governments to implement “good weather” insolvency legislation by CERIL, and the Government there recently introduced a measure to suspend the obligation to file for insolvency (which is usually 3 weeks from the date when it becomes evident that the company is insolvent) until 30 September 2020 in order to protect companies that encounter financial difficulties due to the COVID-19 crisis. This comes with the corresponding suspension of the power of third parties to instigate insolvency proceedings which is also suspended for three months, unless the reason for the insolvency already existed on the 1st March 2020. This should serve to allow directors of German companies the “legroom” to direct all their energy into ensuring that the company weathers the storm, without having to worry about receiving a barrage of insolvency claims from disgruntled creditors and other third parties during this extremely sensitive period and of course from facing personal liability for failure to put the company into liquidation in a timely manner. Indeed, in Germany, under normal circumstances, in a situation of illiquidity, directors may only make payments that are reconcilable with the diligence of a prudent businessperson. This provision has been relaxed in the circumstances so that all management decisions taken in the ordinary course of business will be deemed to be reconcilable for the purpose of law.
Which rules could be temporarily relaxed in terms of Maltese law?
In Malta, directors have many obligations, but a “per se” duty to file for insolvency (like in Germany) is not one of them. That being said, where the directors of a company become aware that the company is unable to pay its debts or is imminently likely to become unable to pay its debts, they must under Article 329A of the Companies Act (Chapter 386 of the Laws of Malta) not later than thirty days from when the fact became known to them, convene a general meeting of the company for the purpose of reviewing the company’s position and to determine what steps should be taken to deal with the situation, including giving due consideration as to whether the company should be dissolved and consequently wound up. This obligation on directors should not be temporarily suspended or relaxed as it is important now more than ever that the directors and shareholders of companies meet (albeit, virtually) to discuss and review their financial position in duly convened and minuted meetings.
However, there are other legal provisions which can potentially be relaxed. Despite the absence of an express duty to file for insolvency under Maltese law, a delay to put the company into insolvent liquidation may in fact give rise to liability of directors. Therefore, naturally, Malta’s response to the Executive Statement by CERIL, should be to relax those provisions which may impose liability on directors who are clutching at straws to keep their companies afloat provided the difficulties are a result of the COVID-19 pandemic and not to pre-existing conditions.
In the UK, where there is also no duty on directors to file for insolvency, the Government announced that it will be giving businesses and directors some “breathing space” by relaxing the wrongful trading rules. In ordinary circumstances, directors may be found personally liable for wrongful trading and consequently made to contribute to the assets of the company if they continue to trade when the director/s knew or ought to have known that there was no reasonable prospect that the company can avoid insolvency. Here the directors’ sole defence rests on whether the directors took every step to minimise the potential loss to the company’s creditors. The measures introduced by the British Government have suspended wrongful trading provisions for three months with retrospective effect from 1 March 2020. The legislation will allow for a further extension, if this proves necessary. The raison d’être behind this measure is to give directors greater confidence to use their best endeavours to continue trading during this pandemic crisis without the constant worry that personal liability will kick in should the company ultimately have to be dissolved and wound up due to insolvency imputable to the pandemic itself. Such temporary relaxation of the wrongful trading provisions could also serve to avoid the potential situation highlighted by CERIL whereby directors throw in the towel and close shop prematurely due to the (real) threat of personal liability looming over their heads. Naturally, avoiding a situation where directors prematurely decide to liquidate the company would essentially prevent the domino effects of that premature decision on the livelihoods of employees and the economy as a whole.
Notably, the limits and appropriate safeguards which should be imposed if the suggestion to relax the wrongful trading rules is heeded to, need to be clear and the appropriate balance must be struck as we do not want to promote a situation where companies which have reached the point of no return continue to incur debts with no intention to repay them, to the detriment of their creditors. Some British commentators for example have argued that such relaxation may damage creditor confidence in the market. We also need to be mindful to never promote or incentivise cases of blatant dishonesty or fraud by directors who may use this situation for their sole gain. In fact, it is submitted that there should be no relaxation of the fraudulent (as opposed to wrongful) trading provisions, which require that the fraudulent intent of the directors be proven. However, with the correct limits and safeguards, the temporary relaxation of the wrongful trading provisions may prove beneficial and necessary in the circumstances.
Another provision that may potentially be temporarily relaxed is Article 303 of the Companies Act which regulates fraudulent preferences and transactions at an undervalue although, admittedly, this suggestion is fraught with some difficulty. The law holds that every privilege, hypothec or other charge or transfer of property or rights and any payment or other act relating to property or rights made by or against the company and any obligation incurred by the company within six months before the dissolution of the company shall be deemed to be a fraudulent preference against its creditors, whether it is of a gratuitous nature or onerous nature if it constitutes a transaction at an undervalue or a preference is given. The law, therefore, creates a rebuttable presumption of irregularity, albeit a very important one. Arguably, the current climate within which companies may require to enter into transactions at a value lower than would have otherwise been considered, could imply that such transactions will be deemed to constitute fraudulent preferences if the company were to become insolvent within six months from the relevant transaction. This provision may perhaps be relaxed by temporarily limiting the time period within which certain transactions at an undervalue will be caught by the provision. It is not being suggested to relax the rule in so far as transactions at an unjustifiable undervalue are concerned not with regard to fraudulent acts the sole or primary intent of which is to prefer one creditor over another. In fact, it is suggested that the temporary relaxation of such rule would have to come with its own safeguards as no matter how dire the circumstances, the relaxation of these rules should never promote fraud or dishonesty by directors to the detriment of their creditors. The line here is admittedly a fine one.
It may also be potentially useful for the courts to refuse any winding up applications on the basis that the company is “unable to pay its debts” by any creditor or creditors in terms of Article 218(1) of the Companies Act, by implementing a moratorium (for a specific amount of time to be determined by the legislator) against creditor action where the company is facing challenges brought about by COVID-19.
Desperate times call for desperate measures. Some sort of flexibility seems necessary so that directors of companies which would have stood a fighting chance in a market not totally usurped by COVID-19, can focus on trying to keep their companies afloat without having the very real threat of personal liability looming over their heads. To reiterate, such temporary relaxation of specific rules needs to be met with the appropriate and sufficient safeguards to ensure that fraud or egregious dishonesty is never justified. The Maltese Government has not yet imposed any relaxation on any of the above-mentioned rules and we will have to wait and see if it shall act upon CERIL’s advice and maybe take a page out of other countries’ books.
©Fenech & Fenech Advocates 2020
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