Duties of directors in bankruptcy proceedings
In case there is no chance of refinancing the debt of a corporation during times of crisis, the board of directors must initiate a bankruptcy proceeding.
We are going to focus on the duties of the directors of a corporation in a situation of bankruptcy. Directors of a corporation have a duty to act with honesty diligence and prudence, the so-called duty of care. Directors will be held liable if they fail to comply with their obligations, not only to the corporation itself, but to the creditors as well. This liability could be civil and criminal.
Bankruptcy situation: duties of the board of directors
There are two types of bankruptcy proceedings:
- Voluntary: when the board of directors voluntary requests the initiation of the bankruptcy proceeding.
- Necessary: when a third party requests the initiation of the bankruptcy proceeding.
In the voluntary proceeding the board of directors maintains its management powers and control over the assets of the corporation. However, trustees may intervene if they get authorization from the directors.
In the necessary proceeding, the management powers of the board of directors get suspended. Trustees will hold the corresponding powers.
Therefore, if the board of directors wants to keep its power, it should be aware of the situation of the corporation in order to know whether a bankruptcy proceeding is necessary or not, so they can voluntary request the initiation of the bankruptcy proceeding and keep its powers.
The board of directors must request the initiation of the bankruptcy proceeding when the corporation cannot regularly comply with its financial obligations. Upon learning about the situation of insolvency, the board of directors must request the initiation of the bankruptcy proceeding within two months.
The law provides that the board of directors is presumably aware of the situation of insolvency, iuris tantum, when one of the following situations takes place:
- Unpaid regular obligations of the corporation.
- Existence of seizures that generally affect the corporation assets.
- Hasty liquidation of the assets of the corporation.
- General failure to comply with the following obligations: tax payments, social security payments, salaries, severance payments and similar during three months.
Directors have the duty of being aware of those situations and if appropriate request as soon as possible the initiation of the bankruptcy proceeding. Upon the request, directors must personally appear before the corresponding civil court and before the trustees as many times as required in order to collaborate and inform about all necessary information.
Directors cannot wind up the corporation until authorization of the court. Directors cannot burden the assets and rights of the corporation until having the corresponding authorization. However, they can perform what it is necessary for the continuation of the regular activities of the corporation. If the board of directors gets suspended, the trustees will exercise the management power to continue with the normal activity of the corporation if possible.
Directors must also provide the trustees with all the accounting material regarding the assets and equity of the corporation. The obligation of preparing and auditing the annual accounts remains. However, there is an exception for the audit of the annual accounts when the trustees have been already appointed. This exemption does not apply when the corporation has securities in secondary markets or when it is under public surveillance by the Bank of Spain, the General Direction of Insurances and Pensions or by the National Commission of the Spanish Stock Markets.
Thus, the preparation of the annual accounts during the bankruptcy proceeding corresponds to the directors, oversaw by the trustees when the corporation is inspected, and to the trustees when the powers of the board of directors are suspended.
Effects of the bankruptcy proceeding to directors
During the liquidation of the corporation, management power of the directors is suspended. The judicial resolution initiating the liquidation includes the declaration of the dissolution of the corporation and the cessations of the directors, who will be substituted by the trustees. As a result of the liquidation, the deferred credits will expire and those non-monetary credits will turn now into monetary credits.
Upon the liquidation begins, trustees must file a plan to sell assets and rights of the corporation. This plan will be of public record and directors and creditors will be allowed to review it in the corresponding civil court. Both are entitled to file petitions for the modification of its content if appropriate.
Classification of bankruptcy proceedings and directors liability
In order to know whether a director can be held liable we have to check the classification of the bankruptcy proceeding made by the judge. The bankruptcy proceeding could be classified either as accidental or guilty. This classification takes place only when:
- There is a plan that establishes a reduction of the debt for all creditors or for those of one particular group; or when the waiting time to get paid is over three years.
- In all cases when the liquidation takes place.
Therefore and in order to avoid the bankruptcy proceeding of being negatively classified, a plan with the following content must be achieved: reduction of the debt only up to 33% and a waiting time no longer than three years.
If the report of the trustees and the order of the equivalent to the Attorney General, if appropriate, classify the bankruptcy as accidental, the judge will immediately order the termination of the proceeding where no appeal could be filed.
In case the bankruptcy is classified as guilty, the corporation would be entitled to a hearing within ten days and the court will summon all persons affected by the classification of the bankruptcy, so they can appear before the court within five days if they have not previously appeared. The corporation and its accessories would be entitled to request the court to dismiss such classification.
On one hand, the bankruptcy of a corporation would be deemed guilty, when there is a failure of the corresponding duty of care of the directors or liquidators when winding up the corporation, i.e., that the behavior of those individuals has produced or aggravated the insolvency situation of the corporation.
On the other hand, when one of the following causes takes place the bankruptcy would be automatically deemed guilty:
- Failure to comply with the accounting obligations.
- Filing of inaccurate or fake documentation within the framework of the bankruptcy proceeding.
- When the initiation of the liquidation is ordered by the State.
- When the corporation sells all or part of its assets in a way that is prejudicial for the creditors or prevents the effectiveness of a seizure.
- Fraudulent use of equity during the last two years.
- Equity simulation before initiating the bankruptcy proceeding
The judgment of the civil court holding that the bankruptcy is guilty will explain the cause of such classification and the following statements:
- Persons affected by the classification and their accessories. If any of them has acted as if they were directors or liquidators, the court must explain the reasons why they have been held out as the actual directors/liquidators.
- The court will bar those persons from the management of assets of third parties from two to fifteen years. They will neither be allowed to represent any person during that period of time. The penalty will vary taking into consideration the seriousness of the particular facts.
- These persons will no longer be entitled to any right with regard to the bankruptcy proceeding and they will have to reimburse all assets and rights that have been inappropriate acquired. They will have to pay the corresponding damages as well.
If those current directors have to cease, the trustee will call a meeting with the shareholders so they can appoint new directors.
Besides, the Bankruptcy Proceeding Law provides that seizures of the personal assets of current and former directors up to two years before the bankruptcy can be carried out. This preliminary injunction can only be ordered when there is enough evidence for the bankruptcy to be classified as guilty and the equity of the corporation is not enough to pay all its debts. The judge will determine the amount of the seizure that it could be substituted by a bank guarantee if preferred by the directors.
Conclusion
The current Bankruptcy Proceeding Law increases the level of liability of directors of a corporation. Therefore, directors must pay attention not only to the accounting and management aspects of the corporation, but also to the legal issues of their business and agreements in order to avoid liability at least within the framework of a bankruptcy proceeding.
Tags: accidental guilty bankruptcy spain, bankruptcy proceedings Spain, directors trustees liability spain, insolvency situation spain, necessary bankruptcy proceeding spain, voluntary bankruptcy proceeding spain
