The Spanish Supreme Court has established the legal concept of insolvency as an objective requirement for the Declaration of Insolvency pursuant to Section 2.1 of the bankruptcy Act by virtue of the decision taken by the Court on April 1, 2014.

The Court overruled the decision given at the first instance and absolved the directors of the company under bankruptcy proceedings that were declared liable by considering them guilty for the insolvency situation, stating it was fortuitous and therefore directors should not respond for it.

The original decision was based on the opinion of the Court on a wrong comparison between the situation of insolvency and the legal cause of corporate dissolution by reason of losses, which according to the  first instance courts obliges directors to declare insolvency. Therefore, not having proceeded in such way, pursuant to Section 165.1 of the bankruptcy Act, the directors had acted either with malice aforethought or created a serious fault by worsening the insolvency situation.

The ruling of the Supreme Court states that the Court of first instance had wrongly applied the bankruptcy Act by considering that the company was insolvent in the year 2003, when it had incurred in the situation of worsened losses, and therefore the company directors had been unduly declared responsible.

The Supreme Court declares that the insolvency legal definition, where a company cannot regularly comply with its social duties, should not be misled as compared with the situation of compounded losses, or even with the negative equity capital that, according to corporate legislation, will only determine the directors duty to carry out the necessary actions for the dissolution of the company, and its non-compliance, will only give rise to the liabilities that are set out in Spanish corporate law.

Thus, according to the clarifications stated by the Supreme Court, the situation of net worth imbalance tends to concur with the situation of insolvency, these are not comparable situations, being able to attend one without the other, and vice versa, so must be distinguished.

On the other hand, the Supreme Court added that the equation between the insolvency situation and the general cessation of payments shall not be correct since, even being a revealing fact of insolvency, it could be subject to challenge by the debtor, who could allege its non-concurrence, or even denying the lack of insolvency despite that is not the situation.

Accordingly, the Court stated that whatever the  financial situation of the company is, since this could have obtained as a result of external funding, what is determinant for appreciating the insolvency situation  is that the company is unable to comply with its payment obligations  on a regular basis, and only in such case the directors would be obliged under the Bankruptcy Act to declare the company insolvent.

Administrators may only be declared liable for incurring malice or gross negligence by having worsened the insolvency situation, if after they knew, or they should have known such state, it took them more than two months to request such declaration of insolvency. Circumstances that did not concur in the case under discussion in this article, because the Courts of First Instance made an infringement of Sections 2.2, 5.1 and 165.1 of the Bankruptcy Act, since they did not determine when such insolvency situation was produced, and did not proceed to calculate the required statutory period.

In summary, for the purposes of applying Sections 165.1 and 164.1 of the Bankruptcy Act, the Courts of First Instance had wrongly considered that it was a unique behaviour, not having adopted the enforceable measures required pursuant to the Spanish corporate law, given the legal cause of dissolution as a result of worsened losses, thus confusing such situation with the insolvency status of the company.