The Court of Justice of the European Union has ruled that a provision of German law falls within the scope of Article 4 of the EC Regulation on Insolvency Proceedings, thereby paving the way for a German court to require a director of an English incorporated company to make payments under German law where the company has been placed into insolvency proceedings in Germany.
The decision highlights the need for directors to be mindful of the laws relating to insolvency in all jurisdictions in which a company operates and to seek specialist cross-border advice if the company is facing financial difficulties.
What was the case about?
In Simona Kornhaas v Thomas Dithmar (Case C-594/14) the company, Kornhaas Montage und Dienstleistung Ltd, was registered in England and Wales but had a branch in Germany. It was subject to insolvency proceedings opened in Germany, being the member state in which the company was mainly active.
Under Article 4 of Regulation 1346/2000 (The EC Insolvency Regulation) the law applicable to insolvency proceedings and their effects is the law of the member state within the territory of which such proceedings are opened. In particular, rules relating to the "voidness, nullity, voidability or enforcement of legal acts detrimental to all the creditors" are governed by the law of the state in which proceedings are opened.
German law imposes strict rules on the opening of insolvency proceedings so that a managing director is required to file for insolvency at the latest three weeks after the company has become unable to pay its debts. Managing directors are required to reimburse the company in respect of any payments made after the company becomes insolvent or after it was established that the company was over-indebted.
The German liquidator of Kornhaas Montage und Dienstleistung Ltd sought to recover payments from the director for sums paid out after the company had become insolvent. The question asked of the CJEU by the referring German court was whether such an action against a director could be brought under German law where the company was incorporated in another member state, namely the UK.
What did the CJEU decide?
The Court of Justice of the European Union ruled that the German provision was within the scope of Article 4 notwithstanding that the company was incorporated in another member state. This was so even though on its face it was arguable that the relevant German provision was one of German company law rather than insolvency law and that it specified no express extension to overseas companies. The CJEU was satisfied that the provision was "directly derived or closely connected" to the insolvency proceedings.
The court also concluded that the German action did not infringe Articles 49 and 54 on freedom of establishment in the Treaty on the Functioning of the European Union. The court was satisfied that the German law in no way concerned the formation of a company in a given member state or its subsequent establishment in another member state as the relevant law only applied after the company had been formed and after it had become insolvent.
What does the decision mean for directors of companies operating in multiple jurisdictions?
It is important to note that this judgment was not a decision against the director but a clarification of EU law. The case will now be referred back to the German court, which has already expressed the view that the action against the director is well founded under German law.
Companies increasingly operate in multiple jurisdictions and when a company faces financial difficulties, directors need to be aware that the laws governing their actions and liability are not only those in the jurisdiction of the company’s incorporation, but also include the laws in jurisdictions in which the company operates. This is particularly the case where the company’s COMI is likely to be located in another jurisdiction or where the COMI of the company is shifted to another jurisdiction.
While a director’s duties will generally be governed by the law of the company’s incorporation, the waters are muddied on insolvency. The fact that the company in this case was incorporated in England and Wales was not enough to protect the director against potential liability under German law. Directors of companies facing financial difficulties and which are operating in multiple jurisdictions should carefully check the terms of their D&O insurance to see whether they are covered for breaches of local laws.
At CMS we frequently work with directors of companies operating throughout Europe and the wider world and are able to offer tailored, comprehensive cross-border advice on directors’ duties, restructurings, and insolvency. For more information on these issues please contact: Rita Lowe or Helen Coverdale.