Malta has, to date, chosen to address corporate distress as a result of the COVID-19 pandemic by extending credit capacity through the issuance of State guarantees, thus allowing them access to financing channels that would otherwise have been impossible to secure.
The country seems now ready to jump onto the insolvency-buffer bandwagon, several weeks after the rest of the world began to enact special COVID-19 inspired amendments to their insolvency laws. Bill 128 of 2020 proposes amendments to the Companies Act which include, inter alia:
– Extended rules for company director disqualification
– New powers for the relevant Minister to:
(a) suspend the right to make winding-up applications; and
(b) suspend the wrongful trading provisions.
However, making a winding-up application unforeseeable does not
mean the state of insolvency no longer exists. Simply allowing a
company to survive does not mean it is no longer able to pay its
debts as they fall due. This, coupled with the availability of a
State guarantee, might create perverse incentives for directors to
make 'high risk, high reward' decisions, risking asset
depletion to the detriment of:
(i) Pre-existing creditors, who now have access to a smaller slice of the pie due to the introduction of new credit; as well as
(ii) Taxpayers, who will eventually suffer the economic effects associated with the enforcement of that guarantee against the State.
The consequent necessity is ensuring that appropriate safeguards are put in place to curb any such behaviour, such as a mechanism assessing the entity's eligibility for this breathing space, with a focus on past and present director behaviour and an analysis of the company's financial history.
Moreover, relaxing the wrongful trading rule alone, while providing some temporary relief, will not do away with the fundamental challenge that the rule entails. Wrongful trading liability arises at the very edge of the 'zone of insolvency', a point in time that is notoriously difficult, if not impossible, to identify; as is evident from the notable sparsity of Maltese case law on wrongful trading. At this point, a radical change in business strategy must take place: shareholder-appointed directors must shift from shareholder-oriented objectives to creditor-oriented ones. Directors have a duty to minimize creditors' losses, which in turn requires changing the strategic management of the company from an entrepreneurial one to a custodial one that focuses on protecting the company's assets.
Significantly, director liability in this zone does not only emanate from the wrongful trading rule, but also from the remedy against delinquent directors in Article 312 of the Companies Act, which has a much broader scope of application than the wrongful trading rule. Under Art. 312, an action for compensation to the company's assets can be brought against a director for a breach of duty in relation to the company that has allegedly taken place at any point in the company's lifetime, and which covers any improper performance or breach of duty in relation to the company. Thus, Art. 312 can attack a wide spectrum of director misbehaviour during or even before the company is approaching insolvency, and must, therefore, be appropriately addressed along with the relaxation of the wrongful trading rule.
Apart from this general duty of care, directors also have fiduciary duties towards the company which are protected by both ordinary civil law, as well as by Article 136A of the Companies Act that requires directors to act honestly and in good faith in the best interests of the company, and imposes liability for proper management and an obligation to exercise the appropriate degree of care, diligence and skill, as well. Thus, liability for a breach in these fiduciary duties will subsist.
An Ex Ante Approach
Perhaps lawmakers should give equal consideration to what happens to financially distressed companies outside of the insolvency process, rather than simply within it. Even with increased access to finance, most businesses will eventually have to restructure their debt anyway. The painful reality is that this ever-expanding debtor protection serves only to side-line the rights of creditors, who now have access to fewer pressure points over their debtor companies.
The effect? Creditors will be less likely to agree to a debt rescheduling plan in an informal workout. Faced with a multi-party prisoners' dilemma, there will inevitably be strategic holdouts aimed at destabilizing contractual efforts.
Creditor cooperation rules should be developed to regulate unstable and fragmented creditor bodies with heterogenous interests, essentially constraining rogue creditor behaviour in an informal workout. From the point in time where a workout process has been initiated, and creditors are unable to reach an agreement, the effect of such rules might provide a useful disciplinary framework within which collaboration is encouraged.
As a minimum, creditors should be obliged to negotiate a restructuring plan in good faith. The obligation to provide reasons for one's bargaining position has been proven to have cooperation-enhancing effects. Going further, creditors who refuse to participate and effectively torpedo an efficient workout plan to maximise their own personal gain might run a liability risk if the company is forced to file for insolvency. Perhaps lessons might also be taken from the quasi-judicial reorganization process recently introduced for SMEs in Columbia, in which the Chamber of Commerce appoints a mediator proposing strategies to encourage agreement among creditors, thereby prolonging negotiations.
Emergency legislation in this regard could prevent debt gamblers from turning a global human tragedy into an economic nightmare. The measures proposed in this Bill should not be the end game.
This article was first published in the Times of Malta on 1 June 2020.
Originally Published 1 June 2020
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