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Board Duties in Times of Crisis

On 11 March 2020, the WHO declared the worldwide outbreak of COVID-19 a pandemic. As COVID-19 spreads, the Danish Government is adopting more and more measures to contain the spread of COVID-19. However, all these measures have major consequences for the Danish economy. This leaves many Danish companies in a difficult financial situation, and in that scenario, it is important that management acts.
23. March 2020

Introduction

For a number of Danish companies, the COVID-19 crisis will mean that in the near future they will be in a situation where they risk breaking financial covenants and lack liquidity. In addition, several Danish companies will most likely end up in a situation where they will have to suspend their payments temporarily until they can resume normal operation through the use of the Government’s bailout packages and through other forms of adjustment and restructuring, respectively.

This newsletter addresses the most important considerations for the board of directors of Danish companies facing financial difficulties and provides recommendations as to the considerations the company’s board of directors must take into account in light of the acute financial problems caused by the COVID-19 crisis. In companies that do not have a board of directors, the responsibility rests with the executive board. The considerations and responsibilities described in the following are in all material respects common to all management functions in companies.

Duties of the board of directors

Section 115 of the Danish Companies Act contains an obligation for the board of directors not only to take care of the overall and strategic management, but also to ensure a sound organization of the capital company’s activities. This entails, among other things, a duty for the board of directors to ensure that it receives the necessary reporting on the company’s financial position on an ongoing basis, and that the company’s capital resources are sound and adequate at all times, including that there is sufficient liquidity to meet the current and future obligations of the company as they fall due.

The board of directors is thus obliged at all times to assess the financial situation. The board of directors has an obligation to actively respond to a crisis that the Company may face because of COVID-19, in order to protect the Company, including its creditors, and avoid the risk of liability.

In the current situation, where the financial difficulties of several companies is directly attributable to the COVID-19 crisis, this assessment is particularly difficult, as the difficulties cannot be attributed to conditions within the company’s sphere of control, but conditions that must be expected to end over time. However, it remains uncertain when this time will come. The fact that the conditions are expected to end over time can be included in the assessment, so that the board of directors in its assessment and forecast for future operations tries to involve and adjust the company – not only to the current economic reality of the company, but also in terms of the expected future situation of the company. Considerations on an unannounced suspension of payments concurrently with a scale-down of the company’s activities can be included in the assessment. In respect of considering an announced suspension of payments, the board of directors should consider seeking external advice, as the board of directors or the company may potentially face liability if not carried out in accordance with applicable law.

The board of directors’ obligation to ensure adequate capital resources

The duty to ensure adequate capital resources implies that the board of directors must continuously be aware of and monitor the company’s financial position, including the liquidity situation, and decide whether the situation is financially sound.

The company must have sufficient liquidity and equity to withstand temporary falls in earnings. It is the right as well as the duty of management to continue running a company in financial crisis and try to overcome it, but management must not incur additional liabilities on the company that cannot realistically be covered. The management’s responsibility for the company’s sound capital resources also entails a responsibility for the operation and thus a duty to stop the company’s operations if a sound continuation is no longer possible (in Denmark referred to as the moment of hopelessness).

In assessing whether the capital resources can be deemed adequate, particular attention must be paid to the future. The evaluation must be done taking, among other things, the company’s updated  budgets and forecasts based on the current situation into consideration; however, the fact that the conditions are expected to end over time can also be included, cf. the considerations above.

In assessing whether the company’s capital resources are sound and adequate, the board of directors should also consider the possibility of obtaining financial support through the Government’s various bailout packages, and the expected positive effect of such packages may also be included in the company’s budgeting and assessment of the adequacy of the company’s capital resources.

Duties of the board of directors in the event of insolvency

When a company is in a situation where it does not have sufficient liquidity, the board’s main task is to protect and/or increase the creditors’ expected payments from the company – either through a solvent restructuring or through an insolvent restructuring and ultimately a bankruptcy. In this case, it is the creditors, and not the shareholders, that are the first priority of the board of directors.

The general assessment of insolvency is a test of the ability to pay. The crucial factor is not whether the company is insolvent on its balance sheet, but, on the other hand, whether the company is able to pay its creditors as claims fall due for payment and that the lack of ability to pay is not just temporary. Particularly, as regards the latter – the fact that the lack of ability to pay must be more than just temporary – is a crucial factor if it is due to a sudden drop in sales directly related to COVID-19. In the assessment of such current insolvency, the board of directors may include the possibility of applying for financial support through the Government’s bailout packages, the effects of short-term scaling-back and the forecasts of the company overcoming the crisis within a (short) period of time.

If the company lacks liquidity, the board has an obligation to protect the interests of creditors and thus take all reasonable steps to avoid that the insolvency becomes worse and that the creditors’ losses increase, respectively. In many cases, a bank will step in and make additional credit facilities available to avoid insolvency, but in the current situation, substantial amounts of funds may be received through the Government’s bailout packages. In addition, the company may consider suspending its payments and initiating negotiations for a composition/respite with its most important creditors, respectively, including in particular if the access to financial support through bailout packages will be able to improve the results of operations. This will also be the case if, in the long term, further steps may prevent the insolvency and additional losses, respectively. In conclusion, it is important that the board of directors prepares concrete action plans for how the company is going to overcome the crisis which the company is facing, and the board of directors should as soon as possible take the measures necessary to maintain and supply liquidity.

If, based on an overall assessment, the company is deemed insolvent, and the insolvency is not realistically expected to be prevented through the voluntary measures and bailout packages, etc., the board of directors may be required to initiate formal proceedings before the bankruptcy court. Either in the form of a petition for restructuring, which, among other things, gives the company creditor protection under an announced suspension of payment, whereas the possibility of a comprehensive scheme with its creditors is investigated in consultation with an appointed restructuring administrator and a restructuring accountant. In the last resort, and if there is no basis for a restructuring, the board of directors may have to file the company’s own bankruptcy petition.

However, the formal insolvency measures will not be necessary as long as there is reasonable prospect of preventing the insolvency by way of refinancing, support through bailout packages, voluntary arrangements or the like. In other words, the board of directors may, before initiating proper insolvency proceedings, examine the possibility of a solvent refinancing/solution and include this possibility in the basis for decision. In principle, the company will be entitled to continue its business while in pursuit of such refinancing in consultation with its key creditors, as long as this is done on a realistic and well-founded basis. It is crucial that the board of directors continuously evaluates the possibility of refinancing, whether by way of e.g. owner’s equity contribution, bank financing or the Government’s bailout packages, so that any measures can be taken in time. Depending on the specific situation, it will generally be a good idea to operate with several different action plans that take into account that the company operates in a changing market with many unknown factors.

Responsibility of the board of directors

Section 361(1) of the Danish Companies Act states that members of management who intentionally or negligently have caused damage to the company, shareholders or creditors are liable to pay damages. However, under Danish law, the board of directors is granted relatively broad frameworks in its attempt to save the company from a current insolvency as long as it is made on a well-founded, realistic and carefully prepared basis. In this respect, a crucial factor is that the board of directors constantly ensures that it does not act contrary to, e.g., the principles of equal distribution laid down in the Danish Insolvency Act (konkursloven) and that, after insolvency has been determined, no new substantial liabilities are established which the company will not be able to meet later. Generally, we recommend that the company’s board of directors seeks advice if a current insolvency is determined, as regulation in this area is comprehensive, and there are many pitfalls and legal risk weightings.

Recommendations

If a company risks breaking financial covenants and is lacking liquidity, the board of directors should be aware of the following:

  • The board should consider drawing up a detailed action plan and align it with key creditors;
  • The possibility of obtaining financial support through the Government’s bailout packages and the effects of these and the effects of organizational restructuring, etc. may be and should be included in the assessment of the company’s capital resources and solvency, respectively.
  • In its assessment of a possible insolvency, the board of directors may thus include the expected future improvement of the situation – and must not necessarily act solely on the current situation.
  • The board of directors may consider initiating an unannounced suspension of payments and a dialogue with its most important creditors, respectively, as regards a short respite until, e.g., the effects of the bailout packages, organizational restructuring, etc. are in place.
  • The company should not make material investments. Asset disposals should only take place after careful consideration and consultation with legal advisers and key creditors.
  • The company should refrain from incurring new, substantial debt.
  • The company should, in a current insolvency situation, refrain from taking actions that are not in the interest of all creditors, including payments to creditors that are not critical to the business. This is especially the case if the company is only able to pay some, but not all, creditors, see above regarding considerations in respect of an unannounced suspension of payment.
  • The board should document all considerations and actions in the board minutes.

The measures required will of course depend on a specific assessment of the company’s financial situation. It can be difficult for board members to assess which decision is the right one. However, it is important that the board of directors reacts quickly to the crisis. In case of insolvency, and before suspension of payments is effected, we recommend that the company seeks advice.

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