21st May 2021
Insolvency & The Obligations of Officers & Directors Stringam

Insolvency & The Obligations of Officers & Directors

Written by Luke Day & Joe Eisenlohr

Once a corporation is unable to pay liabilities as they become due, it enters “insolvency.” This is naturally a time of heightened scrutiny, and officers and directors will face a number of decisions. As much as possible, they should act in the best interests of the corporation and its stakeholders. 

Of course, as officers and directors have a number of responsibilities, let’s discuss their duties before and during insolvency, as well as some other key details that should be kept in mind. 

The Verge of Insolvency

Prior to insolvency, companies may negotiate a Forbearance Agreement. This is where a creditor agrees to delay collection proceedings in exchange for certain benefits. Generally speaking, a Forbearance Agreement is a good way to buy some time. In some cases, this may even create an opportunity to work out an informal settlement with an anxious creditor.

During Insolvency

Directors in Canada owe a duty to act honestly and in good faith with a view to the best interests of the corporation.  This duty does not change when the subject company is in distress or on the verge of Insolvency.  A breach of this duty may result in personal liability against a director.

Best interests are broader than shareholder interests.  Directors can (and should) consider the interests of other stakeholders including, when relevant, the interests of creditors. This is vital to be able to show that stakeholder expectations were considered within a decision-making framework.

In times of distress like insolvency, the board and director’s decisions will be subject to heightened scrutiny. The best protection from this scrutiny is to follow a proper process. This includes seeking out and relying on professional advice. 

Following a proper process gives an opportunity for the Business Judgment Rule and a Due Diligence Defense to protect decisions from being challenged. As much as possible, officers and directors should keep records of reliance on financial advisors and other professionals, including documentation of proper deliberations undertaken in the decision-making process.

Other Details and Liabilities to Keep In Mind

What is a Fraudulent Preference? 

A Fraudulent Preference is a payment, transfer of property, provision of service or a benefit/charge given by a debtor who is insolvent, or on verge of Insolvency, to a creditor with the intent of preferring that creditor over other creditors.  

Fraudulent Preferences are deemed as void as against other creditors.  For the purposes of the Bankruptcy and Insolvency Act, RSC 1985, c B-3, the review period for Fraudulent Preferences is typically 3 months to 1 year before the initial bankruptcy event.  The review period and burden of proof for intent differs depending on if you are dealing with a Non-Arm’s’ Length Creditor.

What is a Fraudulent Conveyance?  

A Fraudulent Conveyance is a disposition of property by a debtor who is insolvent, or who is rendered insolvent by the disposition, with the intent to hinder, delay, defeat or defraud creditors.  Fraudulent Conveyances are deemed as void. 

For the purposes of the Bankruptcy and Insolvency Act, the review period for Fraudulent Conveyances is typically 1 year before the initial bankruptcy event.  The review period and burden of proof for intent differs depending on if you are dealing with a Non-Arm’s’ Length Creditor.

Potential Reversal Of Dividends, Share Redemptions and Termination/Severance Benefits, Etc. Under the Bankruptcy and Insolvency Act

Within a review period of 1 year before the initial bankruptcy event and where the company was insolvent during (or rendered insolvent because of) such actions, Section 101 of the Bankruptcy and Insolvency Act allows for the reversal of dividends, share redemptions and termination/severance benefits and other benefits paid to directors or any person who manages or supervises the management of the company.  

Personal liability may be suffered by directors and shareholders in this scenario.

Additional Director Liabilities

Directors can be liable for a number of obligations under various federal and provincial statutes. Some examples of potential liabilities include (but are not limited to):

  • Up to six months of unpaid wages owed to employees; 
  • HST/GST/PST collections/remittances;
  • Employee/payroll source deductions including income tax deductions; and
  • EI/CPP withholdings/contributions/remittances.

Advice for Directors and Business Owners

Because of the uncertainty with respect to a director’s duty to a company’s creditors when a company is on the verge of Insolvency, as well as the significant liabilities for which a director may be exposed, the directors of a company experiencing financial difficulties should, at the earliest possible time, seriously consider obtaining independent legal advice in order to protect their interests and minimize their exposure to any liabilities of the company on a go-forward basis.

Obtaining Directors’ & Officers’ Insurance before the verge of Insolvency is a good way for the directors of a company to mitigate their potential liabilities.

Questions? We Can Help. 

If you have questions about insolvency – or you need independent legal counsel before or during insolvency – contact our team of capable lawyers today to discuss your options and answer your questions. 

mm

Written by Luke Day