Elements of directors' obligations in the period approaching insolvency

• Author: United Nations Commission on International Trade Law
• Pages: 11-30

11

II. Elements of directors’ obligations

in the period approaching insolvency

A. The nature of the obligations

1. While the underlying rationale for considering directors’ obligations in the

vicinity of insolvency may be similar in dierent jurisdictions, dierent approaches

are taken to formulating those obligations and determining the standard to be met.

In general, however, laws tend to focus upon two aspects – rst, imposing civil

liability on directors for causing insolvency or failing to take appropriate action in

the vicinity of insolvency (which under some laws might include commencing

insolvency proceedings pursuant to an obligation under national law to do so – see

para. 2 below) and second, once insolvency proceedings have commenced, avoid-

ing actions taken by directors, including transactions that may have been entered

into, in the vicinity of insolvency.

1. Obligation to commence insolvency proceedings

2. As noted above, some national laws impose on directors an obligation to apply

for commencement of insolvency proceedings, which would include reorganization

or liquidation, within a specied period of time (usually fairly short, such as three

weeks) aer the date on which the company became factually insolvent. Failure to

do so may lead to personal liability, in full or in part, for any resulting losses

incurred by the company and its creditors, and in some cases criminal liability, if

the company continues to trade. is obligation is discussed in more detail in part

two, chapter I, paragraphs 35-36.

2. Civil liability

3. Civil liability imposed on a director in the vicinity of insolvency is typically

based on responsibility for causing insolvency or failing to take appropriate action

to monitor the nancial situation of the company, avoid or ameliorate nancial

diculty, minimize potential losses to creditors and avoid insolvency. Liability may

12 Legislative Guide on Insolvency Law—Part four

arise when directors enter into transactions with a purpose other than ameliorating

nancial diculty and preserving the value of the company (such as high-risk trans-

actions or transactions that dispose of assets from the company’s estate that may

result in a material increase in the creditors’ exposure without justication). It may

also arise when the directors knew that insolvency could not be avoided or that

the company could not meet its obligations as they fell due, but nonetheless con-

tinued to carry on business that involved, for example, obtaining goods and services

on credit, without any prospect of payment and without disclosing the company’s

nancial situation to those creditors. Under some laws, liability may arise when

directors fail to meet various obligations, for example reporting inability to make

certain payments, such as tax and social security premiums, or making a formal

declaration of insolvency.

4. Directors generally might be expected in the circumstances outlined above to

act reasonably and take adequate and appropriate steps to monitor the situation

so as to remain informed and thus be able to act to minimize losses to creditors

and to the company (including to its shareholders), to avoid actions that would

aggravate the situation, and to take appropriate action to avoid the company sliding

into insolvency.

5. Adequate and appropriate steps might include, depending on the factual

situation, some or all of the following:

(a) Directors could ensure proper accounts are being maintained and that

they are up to date. If not, they should ensure the situation is remedied;

(b) Directors could ensure that they obtain accurate, relevant and timely

information, in particular by informing themselves independently (and not

relying solely on management advice) of the financial situation of the company,

the extent of creditor pressure and any court or recovery actions taken by

creditors or disputes with creditors. Directors may need to devote more time

and attention to the company’s affairs at such a time than is required when the

company is healthy;

(c) Regular board meetings could be convened to monitor the situation, with

comprehensive minutes being kept of commercial decisions (including dissent)

and the reasons for them, including, when relevant, the reasons for permiing the

company to continue trading and why it is considered there is a reasonable prospect

of avoiding insolvent liquidation. e steps to be taken might involve continuing

to trade, as there may be circumstances in which it will be appropriate to do so

even aer the conclusion has been formed that liquidation cannot be avoided

because, for example, the company owns assets that will achieve a much higher

value if sold on a going concern basis. When the continuation of trading requires

further or new borrowing (when permied under the law), the justication for