Duties of Directors during Insolvency or in the likeliness of Insolvency
- What law determines the Directors’ liability for insolvency related duties?
When a company faces financial difficulties and is veering towards insolvency, the Directors cannot sit pretty and hope for the best, as this may result in personal liability, administrative penalties and possibly in case of fraud fines and imprisonment.
The Companies Act, is the legal instrument which determines the Directors’ liability for insolvency related duties. Certain fiduciary duties however may be read into the articles of the Civil Code.
Duty to File for Insolvency
Article 329A of the Companies Act provides that where the Directors become aware that the company is unable to pay its debts or is imminently likely to become unable to pay its debts, they shall convene a General Meeting of the company to review the company’s position and to determine the next steps that should be taken. The next steps would usually involve either the Dissolution of the company or some form of restructuring, such as the procedure commonly referred to under Maltese Law as the Company Recovery Procedure (CRP) (Art 329B of the Companies Act).
Where a company is unable to pay its debts or is imminently likely to become unable to pay its debts, a Company Recovery application may be filed in the Registry of Courts, requesting the Civil Court (Commercial Section) to place the company under a Company Recovery Procedure.
The Court is bound to decide whether the company should be placed under such procedure (Art 329B(3)(e) of the Companies Act) within a period of 40 days, and if the Court rejects such application because the company is not viable, then the company would be dissolved by the Court. The court may also reject the application in view of other circumstances, such as lack of proof, in which case the Court would not be bound to dissolve the Company.
If, on the other hand the Court accedes to such application then it will appoint a Special Controller (SC) who will take over, manage and administer the business of the company for a period to be specified by the Court. The SC will decide on the extent of the Debtor in Possession principle, which would be given to the company, that is the extent of control given to the Company to manage its own matters. However, it should be pointed out that the SC would in most cases keep ultimate control.
The fees of the SC would be initially paid from the Company Recovery Fund, which has been established by L.N. 192 of 2020. The funds which are paid out in relation to a company are recoverable interest free from the company itself, if the company returns to profitable business, or if the procedure fails, from the liquidation proceeds.
In terms of the Companies Act, any act which dispossesses the property or rights of the company made in the period of 6 months prior to the dissolution of the Company, shall be deemed as fraudulent preference against its creditors if it is made gratuitously or at an undervalue or if preference to any creditor is given. A person who benefits from such disposition shall be liable personally in terms of the Companies Act (Art 303 of the Companies Act).
Duty to Keep Proper Accounting Records
Directors may incur liability when proper accounting records are not kept by the insolvent company (Art 314 of the Companies Act). Whenever a company is dissolved, if it is shown that:
- Proper accounting records were not kept by the company throughout the period of 2 years immediately preceding the Dissolution, or the period between the registration of the company and the Dissolution, whichever is the shorter; and
- The company was, at the moment of its Dissolution, unable to pay its debts,
every officer of the company (Director or Company Secretary) who is in default shall, unless he shows that he acted diligently and that in the circumstances in which the business of the company was carried on the default was excusable, be guilty of an offence and liable on conviction to a fine of not more than €46,587.47 or imprisonment for a term not exceeding 3 years, or to both such fine and imprisonment.
Fraudulent trading may be defined as the carrying of any business of the company with intent to defraud:
- creditors of the company; or
- creditors of any other person; or
- for any fraudulent purpose
Directors of a company may be held responsible for Fraudulent Trading (Art 315 of the Companies Act). Responsibility for Fraudulent Trading arises if any business of the company has been carried on with intent to defraud Creditors. One of the preconditions for responsibility to arise is the knowledge of the Directors that they were parties in the carrying on of the business with intent to defraud Creditors. If the Court is satisfied of the fraudulent behaviour in the manner aforementioned, it may order that the Directors shall be personally liable for all or any of the debts or other liabilities of the company, as the Court may direct.
The fraudulent act must be performed prior to the dissolution of the Company. An application for Fraudulent Trading may be brought before the Court during the winding up procedure, whether such procedure is a Members’ or Creditors’ Voluntary Winding Up, or a Winding Up by the Court.
An application for Fraudulent Trading may be filed by:
- the Official Receiver;
- the liquidator; or
- any Creditor or contributory of the company.
An action for Wrongful Trading may be instituted on the basis of Article 316 of the Companies Act. It applies to both Directors as well as to Shadow Directors, that is persons who would have taken the role and performed the functions attributable to a Director, without being appointed as Director. This Article would bring about personal liability of the Directors to make a payment towards the company’s assets of a contribution in the amount as the court may order.
Liability under this Article arises when a company has been dissolved and is insolvent, and it appears that the Director/s (i) knew, or (ii) ought to have known, prior to the Dissolution of the company that there was no reasonable prospect that the company would avoid being dissolved due to its insolvency.
An action for Wrongful Trading may only be brought about by the liquidator of the Company, and therefore by implication may only be brought during the Winding Up process.
One last consideration which becomes relevant in view of the wording of this Article is the term ‘ought to have known’. The law specifies that the facts which a director of a company ought to know or ascertain, the conclusions which he ought to reach and the steps which he ought to take, are those which would be known or ascertained, or reached or taken, by a reasonably diligent person having both:
- the knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by or entrusted to that director in relation to the company; and
- the knowledge, skill and experience that the director has.
Article 309 of the Companies Act provides for certain offences by officers of the company (therefore Directors are included) during the Winding Up procedure. For instance, such officers may be held liable for not revealing to the liquidator all the property of the company, and not delivering the accounts and records to the liquidator. Directors of a company may also be guilty of committing fraud either in anticipation of dissolution or during the Winding Up. Any person found guilty of any one of these offences may be liable on conviction to a fine (multa) of not more than €232,937.34 or imprisonment for a term not exceeding 5 years or to both such fine and imprisonment.
This document does not purport to give legal, financial or any other advice. Please be directed to seek appropriate advice from warranted professionals. Do not hesitate to contact the Office of the Official Receiver for further information if necessary or for any clarification.