COVID-19 Insolvency: APAC Guide To Directors’ Duties And Insolvent Trading.
Legal News & Analysis - Asia Pacific - Insolvency & Restructuring
7 April, 2020
The COVID-19 pandemic has placed immense strain across the whole of the economy and raises the issue of how company directors should balance their obligations to shareholders and creditors while ensuring that they protect themselves from any personal liability.
Companies and their directors in the following sectors of the economy face difficult decisions:
- Tourism, Hospitality and Leisure,
- Projects and constructions
In this article we consider what directors should know about insolvent trading and how they can protect themselves from liability.
Directors Duty's to Creditors and Fraudulent Trading
As part of the director's fiduciary duty to act of the interests of the general creditors as a class, where a company is insolvent or nearly insolvent, the directors must take account of the interests of the general creditors as a class. This duty also arises in any situation where a proposed transaction is likely to lead to the insolvency of the company Section 275 of the Companies (Winding-Up and Miscellaneous Provisions) Ordinance, confirms that directors must not knowingly defraud creditors by allowing the company to incur debts with no reasonable prospect of avoiding insolvency. Section 276 also confirms that a director can be held personally liable and contribute to the assets of the company for any misfeasance or breach of their directors' duties. Being a knowing party to the carrying on a business in a fraudulent manner is also a criminal offence and can lead to a disqualification as a director for up to 15 years.
Hong Kong's companies laws do not contain any provisions for imposing personal liability on directors and senior managers for trading while insolvent, and the requirement to prove a fraudulent intend can be difficult due to the burden of proof requirements, and as a result actions for breach of duties and fraudulent trading in rare. However, the recent case of Moulin Global Eyecare Holdings Limited v Olivia Lee Sin Mei  HKCFI 1715, illustrates that directors can be found liable for breaching their duty of care and skill if they fail to properly investigate red flags concerning the solvency of the company. In Moulin, the Defendant was a non-executive director and a member of the audit committee; she was also an experienced commercial solicitor. The Court determined that the defendant had acquired knowledge that should have caused her serious concern and prompt further investigation; had she done do the fraudulent conduct of the company would have been revealed. The Court found in favour of the liquidators and held that Lee breached her duty of care and was personally liable for Moulin’s losses and the relevant interest (approximately HK$464 million in total).
Schemes of Arrangement
The main restructuring tool used in Hong Kong remains a scheme of arrangement. Hong Kong does not have a formal procedure such as voluntary administration in the UK or Australia, or Chapter 11 in the US. As such, schemes of arrangement do not provide statutory protections and companies and directors remain at risk of creditors proceeding with compulsory liquidation.
Recently the government has announced a new round of consultations for the introduction of Chapter 11 style corporate rescue laws to shield companies from liquidation while they attempt to restructure. A key proposal may include giving companies a six-month moratorium from wining up of liquidation proceedings while they attempt to restructure or find a "white knight". The proposal is likely to include insolvent trading provisions. The government intends to finalise the bill and introduce it to the Legislative Council in October 2020.
Director's Responsibility for Insolvent Trading under the Singapore Companies Act (Cap. 50)
Under the current legislative regime in Singapore, a director's liability for insolvent trading in the context of a corporate insolvency is dealt with in the Companies Act (Cap. 50).
Section 339(3) of the Companies Act provides that where a company is in the course of the winding up or being subject to any proceedings, if an officer of the company who was knowingly a party to the contracting of a debt had, at the time the debt was contracted, no reasonable or probable ground of expectation of the company at the time of the company being able to pay the debt, the officer will be guilty of an offence and liable on conviction to a fine not exceeding $2,000 or to imprisonment for a term not exceeding 3 months.
Section 340(2) of the Companies Act further provides where a person has been convicted of an offence under section 339(3) in relation to the contracting of a debt referred to in that subsection, the Singapore court, on the application of the liquidator or any creditor or contributory of the company, may declare that the person shall be personally responsible for the payment of the whole or any part of that debt.
In other words therefore, under the current legislative regime, a director must first be convicted of the offence of insolvent trading before he can be made personally liable for the debts incurred.
Director's Responsibility for Wrongful Trading under New Insolvency Act
However, the current legislative regime in Singapore will change soon. On 1 October 2018, Singapore's parliament passed Insolvency, Restructuring and Dissolution Act 2018 ("New Insolvency Act"), and the act is expected to come into force soon. The New Insolvency Act seeks to consolidate Singapore’s existing corporate and personal insolvency and restructuring laws into a single enactment. When it comes into force, the Bankruptcy Act will be repealed and provisions in the Companies Act concerning corporate insolvency and restructuring will be deleted, with the provisions being consolidated in the new act.
What is relevant to the present discussion is that the New Insolvency Act introduces a new "wrongful trading" provision (section 239) to replace the existing insolvent trading regime. Under the new provision, a company "trades wrongfully" if it incurs debts or other liabilities, when insolvent (or becomes insolvent as a result of incurring such debts or other liabilities), without reasonable prospect of meeting them in full (section 239(12)).
Section 239(1) provides that in the course of the judicial management or winding up of a company or in any proceedings against the company, the Singapore court may, on the application of a judicial manager, liquidator or creditor or contributory of the company, declare that any person who was a party to the company trading wrongfully is personally responsible for any or all of the debts or other liabilities of the company if that person:
(i) knew the company was trading wrongfully; or
(ii) as an officer of the company ought, in all the circumstances, to have known that the company was trading wrongfully.
Accordingly, under the new legislative regime to come into force shortly, it is no longer necessary to establish criminal liability for a director be held personally liable for wrongful trading.
Further, a new statutory defence has also been introduced under section 239(2) such that the Singapore court may relieve the person declared responsible from the personal liability if: (i) the person acted honestly; and (ii) having regard to all the circumstances of the case, the person ought fairly to be relieved from personal liability.
There is also criminal liability for wrongful trading under section 239(6), which imposes a fine not exceeding $10,000 or to imprisonment not exceeding 3 years or both.
Directors are therefore advised to pay close attention to this new section 239, as they may be held personally liable if there were a party to the company trading wrongfully, and they are unable to establish that they had acted honestly.
Temporary Relief Bill Proposed
The Ministry of Law announced on 1 April 2020 that it will introduce a Bill to Parliament next week, which is aimed at providing temporary relief for individuals and businesses in financial distress caused by COVID-19. Some highlights:
- For individuals: The monetary debt threshold for personal bankruptcy is raised from $15,000 to $60,000;
- For businesses: The monetary debt threshold for corporate insolvency is raised from $10,000 to $100,000; and
- The statutory period to respond to demands from creditors before a presumption of insolvency will arise is extended from 21 days to 6 months.
Directors will be also be temporarily relieved from their obligations to prevent their companies trading while insolvent if the debts are incurred in the company’s ordinary course of business. Directors will remain criminally liable if the debts are incurred fraudulently.
The Bill will also prohibit the contracting parties in certain types of contracts from enforcing their strict legal rights e.g. from taking court or insolvency proceedings or seeking enforcement of security over property used in business or trade. The contracts to which the Bill will apply are leases or licences for non-residential property; construction contracts or supply contracts; contracts for the provision of goods and services for events, such as weddings; certain tourism-related contracts; and certain loan facilities granted to small and medium-sized enterprises that have a turnover of $100 million or less.
Further, as a safeguard against unfair outcomes, assessors will be appointed by the Minister for Law to resolve disputes arising from the application of the Act. They will decide if the inability to perform contractual obligations was due to COVID-19 and will have the powers to grant relief that is just and equitable in the circumstances. The process is intended to be affordable, fast, and simple. Parties will not be allowed to be represented by lawyers, and there will be no costs orders. Assessors’ decisions will be final and not appealable.
Importantly, the proposed measures will have retroactive affect and cover relevant contractual obligations that are to be performed on or after 1 February 20201, for contracts that were entered into or renewed before 25 March 2020.
The Ministry has stated that these measures will be in place for at least six months from the commencement of the Act but may be extended, for up to a further six months if required.
Directors Duty to Prevent Insolvent Trading
Australia has some of the toughest insolvent trading laws in the world. Section 588G of the Corporations Act 2001 confirms that directors must prevent their company from incurring debts where the company is insolvent or would become insolvent by incurring that debt. The duty is personal and can result in directors facing civil penalty proceeding of up to $200,000, paying compensation to creditors and if dishonesty is a factor in insolvent trading, criminal proceedings and potential disqualification from continuing as a director or managing a company.
Unlike the Hong Kong and Singapore legislation, insolvent trading offences in Australia are strict or absolute liability offences. This means it is only necessary to prove that the company was trading while insolvent and it is not necessary to prove a fraudulent intention, making it more difficult for Australian directors to avoid prosecution.
On 23 March 2020, the Australian Government passed the Coronavirus Economic Response Package Omnibus Bill 2020. The new legislation includes a moratorium for the next six months from being held liable for debts incurred by an insolvent company. The moratorium is not retrospective and will only apply to debts incurred for the next six months from 23 March 2020. It is also unclear how the moratorium on insolvent trading laws will interact with other director's duties imposed by the Corporations Act, for example, trading while insolvent may also breach the duty of care and diligence (s180), which can attract civil penalties.
Temporary changes are also being made to increase in statutory demand threshold at which creditors can issue a statutory demand or bankruptcy notice from $2,000 to $20,000.
The date to respond to a statutory demand will also be lifted from 21 days to respond to 6 months.
Safe Harbour Protections
In September 2017, Australia's insolvency regime introduced a safe harbour defence to the director's personal liability in certain circumstances. The defence excludes liability for insolvent trading if:
the director/s begin to suspect that the company has become insolvent and;
the board of directors start to develop a course of action or a turnaround plan that is reasonably likely to lead to a better outcome and;
further debt is then incurred in connection with that course of action.
A "better outcome", means an outcome that is better for the company than the immediate appointment of an administrator or liquidator.
Several conditions apply to allow a director to access the safe harbour defence. This includes at the time the debt is incurred, directors must:
Continue paying employee entitlements, including superannuation, by the time they fall due;
Give tax returns and other required documents required by the Australian Taxation Office.
Comply with their obligations to help a subsequently appointed administrator or liquidator.
In determining whether a turnaround plan was reasonably likely to lead to a better outcome for the company (and its creditors), the Court will look at factors such as whether a director:
Informed themselves about the company’s financial position
Took steps to prevent misconduct by officers and employees that could adversely affect the company's ability to pay their debts
Took appropriate steps to ensure the company maintained accurate financial records
Obtained advice from appropriately qualified advisers
Ensured that the advisors were given sufficient information to give appropriate advice; and
Took appropriate steps to develop and implement a plan to restructure the company to improve its financial position
The current situation is likely to provide a significant test of the efficiency of these provisions, which to date have not been considered judicially and aspects of the law remains unclear.
If directors cannot implement a turnaround plan, they may wish to consider entering voluntary administration. A voluntary administrator is usually appointed by a company’s directors after they decide that the company is insolvent or likely to become insolvent. Less commonly, a voluntary administrator may be appointed by a liquidator, provisional liquidator, or a secured creditor.
The effect of the appointment of a voluntary administrator is to provide the company with breathing space while the company’s future is resolved. While the company is in voluntary administration:
unsecured creditors can’t begin, continue or enforce their claims against the company without the administrator’s consent or the court’s permission;
owners of property (other than perishable property) used or occupied by the company, or people who lease such property to the company, can’t recover their property;
except in limited circumstances, secured creditors can’t enforce their security interest in the company’s assets;
a court application to put the company in liquidation can’t be commenced; and
a creditor holding a personal guarantee from the company’s director or another person can’t act under the personal guarantee without the court’s consent.
What Should Directors Be Doing?
Faced with the current situation, directors need to be proactive in monitoring the situation, ensuring they act in accordance with their duties.
The more prepared and proactive directors are the better the chances of protecting themselves from adverse action and the company getting itself out of difficulty. Steps directors should consider include:
have a business plan;
meet regularly to review the ongoing financial position and progress of the business plan (including cash flow projections/detailed management accounts);
carefully review any relevant transactions for which particular consideration should be given (i.e. those over a certain amount or outside the ordinary scope of business);
keep and maintain regular minutes of all meetings and decisions taken (including the rationale for such decisions);
obtain professional advice from specialist insolvency professionals. In particular cash flow analysis, as the tests for solvency relies on cash flow as opposed to the balance sheet;
engage with their funders/financiers and making sure they understand the steps the business is taking to turn around the current position;
liaise with suppliers to consider credit terms; and
be able to justify their continuing belief in the merits of continuing trading.
For further information, please contact
Simon McConnell, Partner, Clyde & Co