This article is produced by CMS Holborn Asia, a Formal Law Alliance between CMS Singapore and Holborn Law LLC.
Impact of COVID-19 on corporate failures and directors’ conduct
Given the uncertainties surrounding the COVID-19 pandemic, it is anticipated that the number of formal insolvencies in Singapore will trend upwards across numerous sectors as companies see a decline in their financial position.
While the introduction of the COVID-19 (Temporary Measures) Act 2020 on 7 April 2020 is a welcome development which provides both temporary breathing space to entities that are unable to meet their debts due to the impact of COIVD-19, as well as temporary relief to directors from the risk of personal liability in certain circumstances, it is inevitable that some of these corporate failures will still result in scrutiny of the actions of the companies’ directors. Directors should therefore remain cognisant of their obligations to shareholders and creditors and fully aware of potential liability they may face.
Ordinarily, directors have a statutory duty to promote the success of the company for the benefit of its shareholders. However, when a company is in the zone of insolvency, directors are required to consider and act in the interests of the company’s creditors. Directors are required to balance creditors’ rights and genuine attempts by directors to revitalise a company’s financial difficulties to keep the company afloat. In balancing these interests, directors should avoid any actions which give shareholders or specific creditors a preference over other creditors.
The courts will generally not be too quick to act where directors are acting in good faith to facilitate the preservation or rehabilitation of a company, and where they have reasonable commercial grounds for believing that the transaction would benefit the company. However, it is important to note that a breach of duty by a director can result in a claim against a director personally.
Key duties every director should know
The same legal duties are owed by all directors, whether one is an executive director, non-executive director, de facto director or shadow director. The basis on which a director owes fiduciary duties towards its creditors is not dependent on whether an entire group of companies is insolvent, as it is assessed on an entity by entity basis and each company in a group (and its respective creditors) must be considered separately.
Specific steps may need to be taken to address conflicts of interest that may arise, e.g. from a director being on more than one board of different group companies, or also employed by a shareholder or a lender.
Transactions with Connected Parties
Directors should also ensure that all transactions are demonstrably on an arm’s length basis and undertaken for sound commercial reasons. The transfer cannot be at an undervalue or amount to an unfair preference (that is, the transaction cannot put the person in a better position than he would otherwise have been in when the company was placed in winding up).
It is generally not advisable for a director to resign without having first discharged his/her duties and resignation will not absolve a director from liability for any breaches of duties.
Temporary Increase in Monetary Thresholds and Time Limits for Insolvency
Under the COVID-19 (Temporary Measures) Act 2020, the Singapore government has temporarily increased the monetary threshold of a company insolvency from SGD 10,000 to SGD 100,000. The statutory period to respond to creditor demands has also been temporarily lengthened from 3 weeks to 6 months. The measures will, at first instance, be in place for 6 months from the commencement of the Act.
Singapore has recently introduced a new “wrongful trading” provision under the Insolvency, Restructuring and Dissolution Act (“IRDA”) which has been passed by Parliament in 2018 (but has not yet to come into force as at the date of writing).
A company trades wrongfully if it incurs debt or liabilities when it is insolvent (or becomes insolvent as a result of incurring such debt or liability), without reasonable prospect of meeting such debts or liabilities in full. A claim can be brought by a judicial manager, liquidator, the official receiver or a creditor or contributory of the company declaring that any person who was a party to the company trading wrongfully is personally liable for all or any of the debts or other liabilities of the company if that person: (a) knew the company was trading wrongfully; or (b) as an officer of the company, ought, in all the circumstances to have known that the company was trading wrongfully.
A new statutory defence has also been introduced under the IRDA such that the Singapore court may relieve the person declared responsible from the personal liability if the person acted honestly; and having regard to all the circumstances of the case, the person ought fairly to be relieved from personal liability.
Accordingly, directors may be held personally liable if they are unable to establish that they had acted honestly whilst acting as a director in a company that trades wrongfully.
Under the new wrongful trading provision, it is not necessary to establish criminal liability for a director be held personally liable for wrongful trading. This differs from the existing insolvent and fraudulent trading regime, which requires that criminal liability be found as a prerequisite before an application can be made to impose civil liability against directors of the company.
COVID-19 (Temporary Measures) Act 2020
Under the COVID-19 (Temporary Measures) Act 2020, directors will be temporarily relieved from their obligations to prevent their companies from trading wrongfully (or from trading while insolvent under the current regime) if the debts are incurred in the company’s ordinary course of business. However, directors will remain criminally liable if the debts are incurred fraudulently.
Summary: Practical risk management for directors
Given the potential risks and liability faced by directors in the unprecedented economic climate, it is important that directors:
- seek specialist advice (legal and financial) early on;
- check D&O insurance policy cover;
- devise a contingency plan to be deployed if a consensual solution cannot be found;
- keep detailed board minutes;
- proactively manage cash and credit;
- engage with key stakeholders;
- hold regular board meetings to assess which duties are in play and whether there is still a ‘reasonable prospect’ of avoiding formal insolvency; and
- ensure all directors have up-to-date information.
More information can be found here.