Introduction
Contribution of Directive (EU) 2019/1023
Duty to avoid insolvency
Duty to prevent insolvency
Duty of care and loyalty
Risk assessment
Public interest
Comment
Since March 2020, the world has undergone a profound change, and due to the recent Russia-Ukraine conflict, the deterioration of the global economy is intensifying. In particular, companies have been unable to meet their obligations due to cash flow difficulties. These arise from both the sharp drop in demand caused by the preventive isolation of citizens and the general suspension of their activities, which were in forced hibernation in 2020-2021.(1) Difficulties also arise from the repercussions of the sanctions that the international community has imposed on Russia, with special emphasis on the sharp rise in the prices of raw materials and fuels, as well as the financial instability resulting from the exclusion of Russian banks from the SWIFT system.
In the banking sector, levels of activity and profitability will depend on how long the disruptive impacts of the pandemic and the war last. Bank directors are convinced that the principle of continuity of operations will prevail. In fact, the main effects may stem from the increased credit risk and volatility of financial and non-financial assets, and from the restrictions on activity resulting from inflation and the economically and financially prudent behaviour of citizens. In such an unstable economic, political and social environment, it is important to reflect on the impact of the pandemic (and the recent war) on the duties of bank directors.
Contribution of Directive (EU) 2019/1023
Given the economic and social environment described above, Directive (EU) 2019/1023 of the European Parliament and of the Council of 20 July 2019 (the Directive) has made an excellent contribution to the Portuguese economy. This Directive has supported the assertion of management conduct committed to the long-term sustainability of companies, which should inform the management of Portuguese banks (although the Directive does not apply to credit institutions). Under it, banks should be guided by the growing importance of stakeholders' interests in achieving the social interest of credit institutions.(2)
The duty to avoid insolvency enshrined in article 19 of the Directive is innovative. Admittedly, article 64(1) of the Companies Code and article 186(1), (2) and (3) of the Portuguese Insolvency and Company Recovery Code (CIRE) (in conjunction with article 189 of the CIRE) already impose duties on bank directors that have a preventive effect on insolvency. However, the general duties of care and loyalty in the Commercial Companies Code target the normal course of the business and, fundamentally, the interests of the shareholders. Moreover, the duties of loyalty and care in the CIRE are essentially negative in content (they tell bank directors what not to do).(3)
On the other hand, the duty to prevent insolvency is positive (in content) duty. It requires bank directors to take appropriate measures to reorganise the bank's finances when there is a probability of it falling into insolvency.(4) They must do so to safeguard the interests of the creditors, shareholders and other stakeholders (the latter being in first line or, at least, in parity with the others).
Under article 19 of the Directive, member states must ensure that, where insolvency is likely, directors have due regard to "the need to take measures to avoid insolvency" (article 19(b) of the Directive).
In addition to carrying out specific legal and statutory duties, bank directors have to manage the bank by observing duties of care and loyalty towards it. The interest of the bank, served by these duties, is in normal practice primarily the (common) interest of the shareholders – whether a monistic or a more or less pluralistic conception of the bank's interest prevails.(5)
When it is possible that the bank will become insolvent, the greatest risk falls on the bank's creditors. Now (as before), the shareholders are neither entitled to the reimbursement of the contributions or the investment made to acquire their shareholdings, nor to have the bank pay their credits. If the company, in its current critical state, may no longer have sufficient assets to fully comply with its obligations, it will foreseeably have less assets afterwards, if the bank directors are not obliged to attempt a (viable) recovery and continue to act exclusively or preferentially in the interest of the shareholders.
In fact, this action could lead, for example, to an over-investment – namely, engaging in abnormally risky acts (in a sort of "flight forward"), which, if unsuccessful, would worsen in particular the situation of the creditors. Alternatively, it could lead to an underinvestment, namely not believing in the possibility that the continuity or recovery of the bank would benefit the shareholders (the benefits would mainly belong to the bank's creditors), which would lead to the directors losing interest in the bank and reducing or ceasing its activity.(6)
Due to the public interest arising from the stability of the financial system (provided for in article 101 of the Constitution of the Portuguese Republic), it is particularly important that bank directors serve the interests of stakeholders. Thus, directors have the duty to lawfully pursue the maximisation of value in the long term. Their mission is the lasting creation of wealth for the shareholders and the fulfilment of multiple interests that gravitate around banking companies (safeguarding the trust of depositors, employees and other creditors).
If the social interest is identified as the bank's long-term interest (with reference to the stability of the financial system and the balance of the national economies), the interests of all stakeholders (and not only the private interests of shareholders) are protected. This is because the director will decide in accordance with what is best for the sustainability of the credit institution. In this way, the bank's director will be able to satisfy and be loyal to the interest of all shareholders and stakeholders jointly considered, even if some consider themselves to be individually disadvantaged.
In order to enhance the social interest of stakeholders, and therefore to regain the trust lost by depositors, credit institutions (especially those in crisis) should invest in a culture of integrity and compliance based on the suitability, qualification and independence of their directors, so that they are able to impose on other bank employees compliance with efficient practices that reconcile the interests of the client with those of shareholders. In essence, the governance of banks should place ethics at the heart of the business by valuing a banking service culture, in which the sustainability of the banking company is the leading principle that will preside over the director's governance strategy.
For further information on this topic please contact Nuno Libano Monteiro or Francisco da Cunha Matos at PLMJ by telephone (+351 213 197 300) or email ([email protected] or [email protected]). The PLMJ website can be accessed at www.plmj.com.
Endnotes
(1) For more details on the negative impact of insolvency on companies, see:
- Ana Perestrelo de Oliveira, Manual de Corporate Governance, reprint of the 2nd Edition, Coimbra, Almedina, 2017, pp. 319-320;
- Alexandre Soveral Martins, Um curso de direito da insolvência, 2nd Edition, Coimbra, Almedina, 2016, pp. 464 et seq; and
- Francisco da Cunha Matos, "Portugal: The urgency of a company's recovery after the COVID-19 crisis" in Eurofenix, Summer Review, 2020, p. 36.
(2) For more details on corporate restructuring in general, see J. Pulgar Ezquerra, "Holdout accionarial, reestruturación forzosa y deber de fidelidad del socio" in Revista de derecho concursal y paraconcursal, no. 27, 2017, pp. 43-67.
(3) J. M. Coutinho de Abreu, "Administradores e (novo?) dever geral de prevenção da insolvência" in V Congresso de Direito da Insolvência, Coimbra, Almedina, 2019, p. 234.
(4) G. Spindler, "Trading in the Vicinity of Insolvency" in European Business Organization Law Review, Vol. 7, Issue 1, 2006, pp. 339, consulted here.
(5) J. M. Coutinho de Abreu, Curso de direito comercial, vol. II, 6.ª Edição, Coimbra, Almedina, 2019, p. 275.
(6) When the under-investment configures the "decapitalisation caused by shareholders", the creditors can hold those shareholders liable by means of the disregard of the legal personality (J. M. Coutinho de Abreu, Curso de direito comercial, p. 176).