6/5/20 Directors' Duties in Financially Distressed Companies - Post Covid 19 • Chandaka Jayasundere 1 What is a Distressed Company? 2 1
6/5/20 Section 57 specifies that a company shall be deemed to have satisfied the solvency test, if: Legally Insolvent a) it is able to pay its debts as they become due in the normal course Section 57 of of business; and the Companies b) the value of the company’s assets is Act greater than: (i) the value of its liabilities; and (ii) the company’s stated capital 3 • ‘cash flow’ insolvency • a company may be insolvent if it cannot meet the debts as they fall due although having substantial assets over liabilities • ‘balance sheet’ insolvency Financially • a company may be insolvent although it has no Insolvent outstanding current debt, but the assets are not sufficient to cover its present, future and contingent liabilities. • The law is not concerned whether the insolvency is balance sheet insolvency or cash flow insolvency. The law presumes and acts in a certain manner if the statutory requirements as contained in the Companies Act are met. 4 2
6/5/20 • The provisions discussed are only the legal remedies available under the Companies Act and not other methods of riding out the distress. Non-Legal • Before any decision is taken regarding insolvency or otherwise there are other methods to overcome Remedies for difficulties such as: Companies in • asset liquidation, • fresh infusion of equity capital by shareholders Distress or investors; or • drawing down retained profits or other reserves etc.; or • Other financial recourses available which might entail the restructuring of the capital, assets and ownership. 5 Director’s Duties Fiduciary Duties • A fiduciary is a person who acts for and on behalf of another in a relationship of trust and confidence. A person thus acting in a fiduciary capacity owes a duty not to utilize his or her position in a way that is adverse to the interests of the person to whom the fiduciary is acting. • The classic situation where this fiduciary duty arises is the relationship between a trustee and his beneficiary. • The relationship between a Company and its Directors are also inherently fiduciary. But Directors are not trustees, although they occupy a fiduciary position towards the company whose board they form. • Thus, directors of a Company must act bona fide in what they consider is in the interest of the Company and not for collateral purposes . 6 3
6/5/20 Sections 187, 188 and 189 of the Act • Three fundamental duties that a director must adhere to and act upon. o Section 187 provides that a person exercising powers or performing duties as a di director of a company shall act in good d faith, in what that person believes to be in in the he in interests of the he company . o Section 188 provides that a di director of a company shall n ll not a act ct o or a agree t ee to t the e co company a act cting , in a manner that co contraven venes es a any p provi visions o of t the A e Act ct , or the provisions contained in the ar articles of f the compan any . o Section 189 provides that a person exercising powers or performing duties as a director of a company: (a) shall not act in a manner which is reck di eckles less o or g grossly ly negli ne ligent nt ; and (b) shall exercise the degree of skill and d care that may reasonably be expected of a person of his knowledge and experience. 7 Duty towards Creditors and other stakeholders o A Director’s duty is not exclusively towards the company but is also towards the shareholders, creditors and other stakeholders. o The duty towards the creditors become more important in a situation where the company is in financial distress and is either insolvent or about to be insolvent. o In exercising their powers, the directors must take into consideration the interest of the Company’s creditors. o Thus, if a director acts in a situation of doubtful solvency the directors are not acting in good faith when the Directors only act in the interest of the Company or its shareholders and not of its creditors. 8 4
6/5/20 Duty of Directors on insolvency Section 219 • The fundamental duty of Directors in the case of insolvency is stipulated in section 219 of the Companies Act. • These provisions cast a duty to upon the directors or a director to take certain steps regarding the possible insolvency of the Company. • Section 219 states that a director of a company who believes that the company is unable to pay its debts as they fall due, shall: • forthwith call a meeting of the board; • to consider whether the board should apply to court for the winding up of the company; and • the appointment of a liquidator or an administrator or carry on further the business of the company. 9 Repercussions – Section 219 (2) • Where the directors fail to comply with the above, they would be liable for any loss suffered by creditors if the company is subsequently put into liquidation. • Section 219(2), stipulates that: • where a director fails to comply with the requirement of 219(1) and at the time of that failure, the company was unable to pay its debts as they fell due, and the company is subsequently placed in liquidation, the court may on the application of the liquidator or of a creditor of the company, make and order that the director shall be liable for the whole or any part of any loss suffered by creditors of the company as a result of the company continuing to carry on its business. • Thus, if the Company is unable to pay its debts as they become due, and the Directors do not comply with the provisions of section 219, and due to that act and the company goes into liquidation, the Directors will be personally liable for the entire or part of the loss suffered by creditors. 10 5
6/5/20 A company shall be deemed to be unable to pay its debts where- (a) a creditor by assignment or otherwise, to whom the company is indebted in a sum exceeding fifty thousand rupees then due, has served on the company, a demand under his hand requiring the company to pay the sum so due and the “unable to pay company has for three weeks from the date of so leaving, neglected to pay the sum or to secure or compound for it to the reasonable satisfaction of its debts” - the creditor; or section 271 (b) execution or other process issued on a judgment, decree or order of any court in favour of a creditor of the company, is returned unsatisfied in whole or in part; or (c) it is proved to the satisfaction of the court that the company is unable to pay its debts, and in determining whether a company is unable to pay its debts, the court shall take into account the contingent and prospective liabilities of the company. 11 • Section 219 does not mandatorily require that the company should proceed to liquidation. Liquidation is • The Section clearly states that at the meeting of the board of directors that is to be called in terms not mandatory of section 219 the directors must decide either: under section (a) to apply to court for the winding up of the 219 company; (b) to appointment of a liquidator or an administrator; or (c) carry on further the business of the company. 12 6
6/5/20 Duty of Directors on serious loss of capital – Section 220 • Section 220 provides that: • if at any time it appears to a director of a company that the net assets of the company are less than half of its stated capital, • the board shall within twenty working days of that fact becoming known to the director, • call an extraordinary general meeting of shareholders of the company for the purposes of the section • The notice calling a meeting under this section shall be accompanied by a report prepared by the board, which advises shareholders of: (a) the nature and extent of the losses incurred by the company; (b) the cause or causes of the losses incurred by the company; (c) the steps, if any, which are being taken by the board to prevent further such losses or to recoup the losses incurred. • Where the board of a company fails to comply with these provisions, every director who knowingly and wilfully authorises or permits the failure or permits the failure to continue, shall be guilty of an offence and be liable on conviction to a fine not exceeding two hundred thousand rupees. 13 Repercussions of not complying Repercussions of not complying with the provisions of section with the provisions of section 219 are monetary in that the 220 are penal and would entail Directors would have to committing an offence and recompense the damage thereby exposing oneself to a suffered by Creditors in the fine. event of liquidation 14 7
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