Directors and officers

Directors’ liability – failure to commence proceedings and trading while insolvent

If proceedings are not commenced, what liability can result for directors and officers? What are the consequences for directors and officers if a company carries on business while insolvent?

The new Insolvency and Economic Rehabilitation Law-2018 stipulates that if a director or CEO knew or should have known that the corporation was insolvent, and did not take reasonable measures to reduce the scope of insolvency, the court may, per the request of the trustee and after issuing an insolvency order, order that such director or CEO be liable to the corporation for damages to its creditors resulting from such director's or CEO's failure to act. One of the measures that a director is expected to take, per section 288(b) of the Insolvency Law, is to actively initiate insolvency proceedings.

Directors’ liability – other sources of liability

Apart from failure to file for proceedings, are corporate officers and directors personally liable for their corporation’s obligations? Are they liable for corporate pre-insolvency or pre-reorganisation actions? Can they be subject to sanctions for other reasons?

An officer or person who previously held office may be liable for breaching an obligation towards the corporation and may be required to compensate, repay or return certain property to the corporation (section 289 of the Insolvency Law). In the case of fraudulent management by an officer, or if the court found that a previous officer knowingly co-managed the corporation in a fraudulent manner, the court may determine that such officer is liable for damages to the corporation resulting from such fraudulent management and may disqualify such officer from serving as an officer in another corporation for up to five years (section 290 of the Insolvency Law). The Insolvency Law does not provide for criminal sanction for directors or officers in connection with insolvency proceedings. However, there may be criminal consequences resulting from ancillary actions to insolvency under other legislation (such as, for example, violation of tax legislation provisions connected to insolvency or labor laws).

Directors’ liability – defences

What defences are available to directors and officers in the context of an insolvency or reorganisation?

A possible defence for a director or officer would be to show that he or she has taken measures prescribed by law to reduce the scope of insolvency, including consulting with insolvency experts or negotiating with the company's creditors to reach a debt settlement. Initiating insolvency proceedings may also serve as a defense for the director or officer in this regard. Directors may also be afforded protection by the Business Judgment Rule (BJR), which provides that in cases where the decision-making process was appropriate, the director will not be judged according to the undesirable outcome of such a decision.

Shift in directors’ duties

Do the duties that directors owe to the corporation shift to the creditors when an insolvency or reorganisation proceeding is likely? When?

Once a director or officer knows (or should know) that the corporation is insolvent, in addition to his existing fiduciary duties, he or she also has a duty to reduce the scope of insolvency. A director or officer may therefore be liable for damages caused to creditors as a result of failing to reduce the state of the corporation’s insolvency.

Directors’ powers after proceedings commence

What powers can directors and officers exercise after liquidation or reorganisation proceedings are commenced by, or against, their corporation?

Upon appointment of a trustee and initiation of insolvency proceedings, all powers vested in the corporation's organs and officers are transferred to the appointed trustee (section 43 of the Insolvency Law). It is possible to keep officers in office under the trustee or to appoint one of them as a trustee, under certain circumstances. Section 91 of the Insolvency Law provides that after a restructuring has been approved, the powers transferred to the trustee shall be returned to the company's organs, according to the provisions of the arrangement plan and on the date specified therein, unless otherwise ordered by the court.

Law stated date

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11 October 2020.