The Conference on European Restructuring and Insolvency Law’s (‘CERIL’) executive statement has called upon national legislators to temporarily relax certain insolvency provisions due to COVID-19. How can Malta follow such advice without an express duty on directors to file for insolvency?

In the UK, where there is also no duty on directors to file for insolvency, the government announced that it will be giving businesses some “breathing space” by relaxing the wrongful trading rules. In ordinary circumstances, directors may be found personally liable for wrongful trading and consequently made to contribute to the assets of the company if they continue to trade when the director/s knew or ought to have known that there was no reasonable prospect that the company can avoid insolvency.

Here, the directors’ sole defence is whether they took every step to minimise the potential loss to the company’s creditors. The measures introduced by the British government have suspended wrongful trading provisions for three months (which may be extended if necessary) with retrospective effect from March 1, 2020.

The raison d’être behind this measure is to give directors greater confidence to use their best endeavours to continue trading during this pandemic crisis without the constant worry that personal liability will kick in should the company ultimately have to be wound up due to insolvency imputable to the pandemic itself.

Such temporary relaxation of the wrongful trading provisions could also serve to avoid the situation highlighted by CERIL whereby directors throw in the towel and close shop prematurely due to the (real) threat of personal liability looming over their heads.

Naturally, avoiding a situation where directors prematurely decide to liquidate the company would prevent the domino effects of such a premature decision on the livelihoods of employees and the economy at large.

Notably, the appropriate safeguards which should be imposed if the suggestion to relax the wrongful trading rules is heeded to, need to be clear and the appropriate balance struck as we do not want to promote a situation where companies which have reached the point of no return continue to incur debts with no intention to repay them, to the detriment of their creditors.

Some British commentators have also argued that such relaxation may damage creditor confidence in the market. We must also be mindful to never incentivise cases of blatant dishonesty or fraud by directors who may use this situation for sole gain.

In fact, it is submitted that there should be no relaxation of the fraudulent (as opposed to wrongful) trading provisions, which require that the fraudulent intent of the directors be proven. However, with the correct safeguards, the temporary relaxation of the wrongful trading provisions may prove beneficial and necessary in the circumstances.

Desperate times call for desperate measures

Another provision that may potentially be temporarily relaxed is Article 303 of the Companies Act which regulates fraudulent preferences and transactions at an undervalue, although, admittedly, this suggestion is fraught with some difficulty.

The law holds that every privilege, hypothec or other charge or transfer of property or rights and any payment or other act relating to property or rights made by or against the company and any obligation incurred by the company within six months before its dissolution, shall be deemed to be a fraudulent preference against its creditors, whether it is of a gratuitous nature or onerous nature if it constitutes a transaction at an undervalue or a preference is given.

The law, therefore, creates a rebuttable presumption of irregularity, albeit a very important one. Arguably, the current climate within which companies may require to enter into transactions at a value lower than would have otherwise been considered, could imply that such transactions will be deemed to constitute fraudulent preferences if the company were to become insolvent within six months from the relevant transaction.

This provision may perhaps be relaxed by temporarily limiting the time period within which certain transactions at an undervalue will be caught by the provision. It is not being suggested to relax the rule in so far as transactions at an unjustifiable undervalue are concerned nor with regard to fraudulent acts, the sole or primary intent of which is to prefer one creditor over another.

In fact, it is suggested that the temporary relaxation of such rule would have to come with its own safeguards as no matter how dire the circumstances, the relaxation of these rules should never promote fraud or dishonesty by directors to the detriment of the company’s creditors. The line here is admittedly a fine one. 

It may also be potentially useful for the courts to refuse any winding up applications on the basis that the company is “unable to pay its debts” by any creditor/s in terms of Article 218(1) of the Companies Act, by implementing a moratorium (for an amount of time determined by the legislator) against creditor action where the company is facing challenges instigated by COVID-19.

Desperate times call for desperate measures. Some sort of flexibility seems necessary so directors of companies which would have stood a fighting chance in a market not totally usurped by COVID-19 can focus on trying to keep the companies afloat without having the very real threat of personal liability looming over their heads. To reiterate, such temporary relaxation needs to be met with sufficient safeguards to ensure that fraud or egregious dishonesty is never justified.

The Maltese government has not yet temporarily relaxed any of the above-mentioned rules and we will have to wait and see if it shall act upon CERIL’s advice and take a page out of other countries’ books.  

Maria DeBono, Associate, Fenech & Fenech Advocates