Duties when facing insolvency – how to navigate the “twilight zone” and foreign jurisdictions
November 17, 2016
In PwC’s Business recovery services team we have seen growing nervousness amongst directors when their business is facing solvency and cash flow issues. The law in this area can appear severe for directors. This short article seeks to raise awareness of some of the issues. Please remember that:
(1) the rules apply to ALL directors (and not just execs, but also Private Equity (PE) nominees etc),
(2) each legal entity has to be considered on a stand-alone basis, and
(3) the rules vary considerably by jurisdiction.
Entering the “twilight zone”
Generally when a business enters into the "twilight zone" (when the economic interest moves from shareholders to creditors), the board of directors will often be in unknown territory and will be uncertain on how to balance their duties in regards various stakeholders. They will also be nervous as to what the implications might be for them personally by continuing to trade whilst the business is insolvent, or potentially so.
UK law is not prescriptive about when this occurs, precisely what directors should do, or when a business should file for insolvency protection. It’s accepted practice that directors may, and indeed should, allow trading to continue if there is a realistic prospect of avoiding formal insolvency. In this scenario they need to closely monitor day to day trading and take what steps they can to mitigate potential losses to creditors. Continuing to trade in these circumstances allows time for rescue plans to be considered with the best prospect of preserving value. But it is not always a "slam dunk" and they must take advice, be seen to be considering different courses of action and checking the position of all creditors.
Considerations for businesses operating across foreign jurisdictions
Further caution needs to be exercised if the business has branches or subsidiaries in foreign jurisdictions. Whilst the desire to preserve value will be common, the law, custom and practice when trading in the “twilight zone” in other jurisdictions is different to the UK. So the way in which directors operate within local jurisdictions will not necessarily accord with that of directors that are wholly UK based. This may cause tensions where the whole group is trying to steer in a particular direction which can easily be overlooked when advising the main board.
For example, in France the law prescribes filing for insolvency protection within 45 days of the directors becoming aware of the insolvency and the over-arching requirement of the law is to preserve jobs ahead of the interests of creditors. The risks to the directors from insolvent trading are also lighter than in most other jurisdictions. Accordingly, whilst there is time to assess options, considering the fate of the workforce has a higher priority.
As a further example, in Poland which is heavily influenced by Germany, the law prescribes filing within 14 days of when the directors become aware of insolvency. The sanctions on the directors regarding insolvent trading include personal liability for losses to creditors and also criminal liability. Further, a low burden of proof is required for actions to be brought against them, and creditors as well as an insolvency office-holder can initiate action. Acting in good faith to explore a sale or new funding is not a defence, as that is seen as something which should be undertaken by an insolvency office-holder. Accordingly, the directors take the obligation to file within 14 days very seriously.
Directors' positions and mind sets are a key element of a successful reconstruction. In most cases they are seeking to preserve value. However, they need to navigate the vagaries of different jurisdictional rules and often different degrees of conservatism in the advice they receive. Please get in touch with us using the details below if you want to discuss this further.