The third article in a series on company directors’ duties and liabilities
Duty of listed companies to issue company announcement
The Listing Rules issued by the Listing Authority of the MFSA require any company whose shares or bonds are listed on the Malta Stock Exchange to issue a company announcement in relation to any price-sensitive facts which arise the company’s sphere of activity and which are not public knowledge as soon as possible.
Broadly speaking, unpublished price-sensitive information is information of a precise nature relating, directly or indirectly, to the company or its listed securities, which is not publicly available and would, if publicly available, be likely to have a significant effect on the price of the company’s listed securities.
Information is likely to have a significant effect on price if, and only if, it is of a kind that a reasonable investor would be likely to use as part of the basis for his investment decisions. Likely inside information would include information that materially affects the assets and liabilities of the company, the financial condition of the company and the performance, or expectation of the performance, of the company’s business.
Listed companies also have a separate, though related, duty to issue a company announcement where it is necessary to avoid the creation or continuation of a false market in the company’s listed securities.
More specifically, the Listing Rules also require any listed company to promptly issue a company announcement inter alia where the board of directors of the company determines that the results in respect of any published financial information materially differ by 10 per cent or more from any published forecast or estimate or financial projections by the company. The company announcement must contain an explanation of such difference.
An issue of particular concern can arise where no announcement of financial difficulties is made and a false market is created in the trading of the company’s listed securities.
The securities may be trading on the basis of the latest financial statements or company announcement indicating or implying that its business is profitable, when the directors know that the company is breaching its contractual undertakings or that negotiations with its bankers are underway or is otherwise experiencing financial difficulties.
Without an additional announcement, trading on the listed securities may be made on the basis of the earlier financial statements or announcement leading potential investors to attribute a higher (and effectively false) value to the securities.
Any breach of the requirements of the Listing Rules could potentially subject the directors to personal liability.
Disqualification of directors
Apart from the risk of incurring personal liability, a director of an insolvent company may face disqualification, by means of a court order, from acting as a director, company secretary, liquidator, provisional administrator, or special manager of other companies and even from being concerned in any way, whether directly or indirectly, or taking part in the promotion, formation or management of a company.
The court will examine a number of factors in deciding whether a person is unfit to be a director or to be otherwise involved in the management of companies.
Relevant misconduct includes engaging in fraudulent or wrongful trading, breach of duty and responsibility for the insolvency. If a director is found to be unfit to act as a director, the disqualification order may be for a minimum period of one year and a maximum period of fifteen years.
Regrettably, the remedy of disqualification remains uncharted territory in Malta as to date, no disqualification order has been issued against a director.
Vulnerable transactions – claw-backs
In addition to the above considerations, directors should also be aware that if a company enters into certain types of transactions within specified periods before its dissolution, an interested party (typically, a creditor or the liquidator) may be able to apply to the court for an order that the parties be put back into the position in which they would have been had they not entered into the transaction or that other appropriate remedy be applied.
The Companies Act broadly provides that any obligation incurred by a company within six months before the dissolution of the company by reason of its insolvency is void if it constitutes a “transaction at an undervalue” or if a “preference” is given. Entering into such transactions may be regarded as a breach of duty by the directors, in particular if the transaction is at an undervalue or qualifies as a preference.
“Transaction at an undervalue”
A company is deemed to have entered into a “transaction at an undervalue” if the company makes a gift or otherwise enters into a transaction on terms that provide for the company to receive no consideration or if the company enters into a transaction for a consideration the value of which, in money or money’s worth, is significantly less than the value in money or money’s worth of the consideration provided by the company.
The provision in our law is closely modelled on the corresponding provision found in the English Insolvency Act. English authors tend to grant the word ‘transaction’ a very wide meaning – it is not merely confined to contracts but extends to other arrangements which are not based on contract. ‘Consideration’ is deemed to amount to anything which constitutes a valid consideration at law.
A company will, for example, be deemed to have entered into a transaction at an undervalue when it undertakes an obligation for no consideration, takes a property (whether movable or immovable) on lease for a rent that is significantly more than the rental value of the leased property, leases out its property at a rent significantly lower than its rental value, allows an asset to be retained by the other party in satisfaction of a claim against the company which is significantly less than the value of the asset or takes an asset in satisfaction of a claim which is significantly more than the value of the asset or gives a guarantee and receives by way of benefit significantly less than the value of the benefit conferred by the guarantee.
In practice, acts which may be seen as being perfectly legitimate in the normal course of circumstances may be considered differently when the company is insolvent since the company is not entitled to be so free with its money or other assets at the expense of the creditors.
The transaction at an undervalue will not be void if the party in whose favour it is made proves that it did not know and did not have reason to believe that the company was likely to be dissolved by reason of insolvency.
Granting of a “preference”
A “preference” is given to a creditor or a guarantor of the company’s debts or other liabilities if the company does anything or suffers anything to be done which, in either case, has the effect of putting that person into a position which, in the event of the company going into insolvent winding-up, will be better than the position he would had been had that act or omission not occurred.
The provision relating to preferences is, unlike the provision relating to the transactions at an undervalue, concerned with transactions that unfairly favour one creditor at the expense of the general pool of creditors, whether or not they diminish the company’s assets. A few examples of circumstances that would be deemed to constitute a “preference” include a repayment of an unsecured debt by a company to its supplier or bank or the provision of security for past advances.
The test for the application of this provision would be whether an act or thing that has been done has disturbed the statutory order of priorities in an insolvent liquidation by placing the particular creditor or guarantor in a more advantageous position that he would have had at the expense of the other creditors.
Apart from the personal liability of directors, shareholders can also, in certain limited circumstances, become liable to make good for the liabilities of a company
This section is in fact aimed at avoiding those transactions that would disturb the statutory order of distribution. Accordingly, it is not a preference for the company to pay a secured creditor a sum not exceeding the value of his security since this would constitute the extinguishment of the security interest and leaves the position of the other creditors unaffected.
English authors argue that for the purposes of the preference provisions, the term “creditor” should be restricted to existing creditors of the company, since it is only they who by definition will have received a payment or transfer without giving new value. It is also argued that although a creditor could be paid in advance of performance, this would not constitute a preference since he remains liable to perform and thereby give value.
Although to constitute a preference, the payment must come from the company’s assets, it is not necessary for the company itself to make the preferential payment or transfer. Merely allowing or permitting the payment to be carried out suffices.
The following scenarios do not amount to the giving of a “preference”: payment to a validly secured creditor of a sum not significantly exceeding the value of his security, having regard to any preferential debts then in existence ranking in priority to the security; payment to avoid the loss of an asset or of a right having a value not less than the amount of the pay-out; the exchange of an asset of the company for one of at least equal value; and the grant of a security for a contemporaneous or subsequent advance or other new value.
The granting of a preference will not be void if the party in whose favour it is made proves that it did not know and did not have reason to believe that the company was likely to be dissolved by reason of insolvency.
Claw-back under the Civil Code
Transactions may also be vulnerable under the Civil Code. For example, a registration of a lawful cause of preference, such as a hypothec or privilege, is ineffectual if it is made at a time when the company is in a state of bankruptcy or if it is proved that the creditor, at the time of the registration, knew of the existence of circumstances on which the company could found a declaration of bankruptcy.
By rendering the security without effect, the law is thus protecting the company’s assets and attempting to place all creditors on an equal footing when the exercise for the ranking thereof is commenced.
Claw-back may also be ordered by a court pursuant to the exercise of the actio pauliana remedy. This is the action available to any creditor to impeach any act made by his debtor in fraud of his claim. The requisites of the actio pauliana are the eventus damni (the prejudice causes to the debtor) and the concilium fraudis (the intention of the part of the debtor to defraud his creditor).
Groups of companies
Where a company in financial difficulties is part of a group of companies, the relevant issues need to be addressed in respect of each individual company. It is essential, for example, for the directors of each company within the group to separately analyse the financial position of that company.
Accounts should therefore be prepared on an entity-by-entity basis. Where a subsidiary relies on holding company support for finance and the holding company is in financial difficulties, the directors of the subsidiary should meet to consider whether it is appropriate for it to continue to carry on business or whether alternative finance is available.
In situations where the subsidiary has guaranteed the holding company’s bank borrowing, the directors will need to consider the implications of an increase in the subsidiary’s liabilities if a call is made under the guarantee.
Issues of conflict will also arise where a holding company and its subsidiary share common directors. Different duties will be owed by the directors of the companies to the different companies and they will be required to consider how to handle information received as a director of one company when considering issues in respect of another company.
Some group companies may be located overseas, and consideration will need to be given as to what advice is required by the directors in relation to their duties in respect of such companies.
EU regulation on insolvency proceedings
If a Maltese company that experiences financial difficulties has its main business interest in, or has been administered from, another EU member state, it is possible that a court in that EU member state opens main insolvency proceedings on the basis that the company’s “centre of main interests” is located in that jurisdiction.
Where the insolvency laws of that jurisdiction provide for remedies or penalties against directors for breach of duties, the Maltese company’s directors may well be subject to the law of that EU member state. Accordingly, advice should be sought on whether that law may regulate the duties of directors and if so, what action is required of the directors under such law.
Apart from the personal liability of directors, shareholders can also, in certain limited circumstances, become liable to make good for the liabilities of a company. There are three possible scenarios where liability on the part of a shareholder may arise:
- A shareholder may regarded as a “shadow director” and potentially liable for wrongful trading.
- A holding company may potentially be liable for the debts of an insolvent subsidiary where the subsidiary is under-capitalised and the holding company is intrusive in the affairs of the subsidiary (as happened in one of the Price Club cases).
- The shareholder/s may be liable for the debts of an insolvent company If the published audited accounts of the company refer to a commitment on the part of the shareholder/s to support the company by some kind of “letter of comfort” or other similar undertaking. Depending on its wording, a letter of comfort may be taken by a court as a form of guarantee. For a letter of comfort to give rise to a contractual obligation, it must have been written with the intention of creating a legally binding obligation. The intention should be determinable from the language used in the particular letter, which must be interpreted as a whole.
The next article in this series will tackle ways of mitigating the risk of liability for company directors.
Professor Andrew Muscat is a partner at Mamo TCV Advocates.