The Directors’ Duty to File for Insolvency Proceedings in the European Commission’s Proposal for Harmonising Insolvency Law: the Dutch Perspective

In respect of the term ‘director’, it is clear from the Explanatory Memorandum23 as well as recital 32 that this term encompasses all persons who are in charge of making or do in fact make or ought to make key decisions with respect to the management of a legal entity. We observe that this description is considerably broader than the concept ‘feitelijk bestuurder’ (de facto director), in Dutch law, which refers to all (legal) persons who have defined the policy of the company as if they were a director.24 In Dutch literature there is a debate between those advocating a stricter and those defending a broader interpretation of this definition. This debate is reflected in the case law of lower courts. The stricter interpretation requires that the formally appointed directors were actually set aside by the person(s) acting as de facto director. According to the broader interpretation it is sufficient that the formal directors accept that a de facto director also defines the day-to-day management, leading to the situation that both the formal directors and the facto director function alongside one another.25 In a recent decision, the Supreme Court rejected the strict interpretation.26 It is not necessary that the formal directors were – completely – sidelined by the de facto director. What is required is that the de facto director has usurped at least part of the formal directors’ authority, thus (co-)determining the policy as if (s)he were a director. Where it may be doubtful whether this includes persons who ‘are in charge of making’ key decisions with respect to the management of a company, it is clear that this does not include persons who ‘ought to make’ such decisions. We believe that the ‘definition’ of ‘director’ suggested in the Explanatory Memorandum is too ambiguous. It increases the legal uncertainty that is inherent in the existing concept of ‘feitelijk bestuurder’ in Dutch law, because – as confirmed by the Supreme Court in its recent judgment – the qualification depends on all circumstances of the case. The concept referred to in recital 32 of the Proposal will be even more difficult for courts to apply in a uniform way than the current concept.

A more serious problem is that the Proposal leaves it to the Member States to define the concept of ‘insolvency’.27 This is especially problematic in respect of Articles 36 and 37, because ‘insolvency’ is what triggers the directors’ duty to file.

Where some Member States’ laws define insolvency on the basis of a cash flow test (‘inability to pay debts as they fall due’) other Member States – additionally – apply a balance sheet test of insolvency (‘debts exceed the assets’ or ‘Überschuldung’). Examples of Member States in which the duty to file for insolvency proceedings is also triggered in case of balance sheet insolvency are Germany and Austria. § 15a of the German Insolvenzordnung provides for a duty for directors of a legal person to file without culpable delay and at the latest 1) within three weeks after the legal person has become cash flow insolvent28 or 2) eight weeks29 after the legal person has become balance sheet insolvent.30 Similarly, § 69 of the Austrian Insolvenzordnung provides for a duty to file for a legal person’s directors without delay after the legal person has become cash flow or balance sheet insolvent, however ultimately within sixty days after the legal person has become cash flow insolvent

Article 36 does not only leave the choice of the insolvency test(s) to be applied to the Member States. It also leaves considerable scope for differentiation by merely providing that filing should ultimately take place three months after the directors became aware or can reasonably be expected to have been aware that the legal entity is insolvent, without specifying what directors should do within this maximum period. This hands-off approach is all the more striking, having regard to the fact that many Member States’ laws already provide for directors’ duty to file for insolvency proceedings and the fact that Article 37 (2) expressly allows Member States to have stricter rules in place. We have shown that both Germany and Austria currently provide for – considerably – shorter maximum filing periods, but note that they have chosen different periods. We add that, under both German and Austrian law, directors may only rely on the maximum period to the extent that they engage in serious restructuring efforts. This is the area where the duty regulated in Article 36 and 37 of the Proposal connects to Article 19 of the Preventive Restructuring Directive. This connection deserves more attention in the next steps of the legislative process.

It is evident that the hands-off approach reflected in the superficial nature of Articles 36 and 37 may lead to considerable differences in the application of the duty to file among Member States, thus calling into question the justification of the harmonisation objective of Articles 36 and 37.

We suspect that the Commission has – again31 – shied away from defining ‘insolvency’ because insolvency is – to put it mildly – a slippery concept. As aptly phrased by Mokal in a recent article: “Insolvency is a scalar attribute, that is, it is a matter of degree”. He rightly points out that what the law requires of a debtor’s decision makers – in particular: to attempt to trade the debtor out of its difficulties and/or to propose a restructuring or to seek to wind up the debtor – may depend on the degree of insolvency.32 We agree with this observation and we also agree with the second point that Mokal raises in respect of the concept ‘insolvency’: it is also “epistemically vague”. Although the criteria applied to determine insolvency may – in principle – be made precise, it will in practice often be difficult to establish on the basis of the chosen criteria whether or not the debtor is actually insolvent at a given time.33 As Mokal observes, “debtors may move along the solvency/insolvency spectrum in a continuous rather than quantized matter”.34

The scalar and vague nature of insolvency is reflected in the ongoing debate among legal scholars across Member States about the way the various insolvency tests should be applied in practice. This is perhaps best illustrated by the ongoing debate in Germany, in spite of attempts of both the legislature and the Bundesgerichtshof to achieve a certain degree of precision in the two tests that are used to determine insolvency. The application of the balance sheet test has been the subject of heated debate ever since it was introduced.35 Without going into detail, we mention that the German balance sheet test of insolvency is more than a balance sheet test: apart from a balance sheet test bases on liquidation values it also involves carrying out a going concern forecast over a period of twelve months starting from the date when a balance sheet based on liquidation values shows an excess of liabilities over assets.36 The debtor is only balance sheet insolvent in case of a negative balance sheet test and a negative going concern forecast. Drafting the going concern forecast, which in practice involves a cash flow-based prognosis of the probability of the company becoming illiquid within 12 months, is not an easy exercise, especially in a world that is affected by one major crisis after another, negatively impacting many (otherwise viable) businesses. In this respect, we mention that the German legislature recently shortened the going concern forecast to four months for the period starting on 9 November 2022 and ending on 31 December 2023, months. The maximum period for filing after Überschuldung was extended from six to eight weeks. These changes were adopted in view of the repercussions of the Russian war against Ukraine on the German economy.37 The amendments reflect the fluid nature of the concept ‘insolvency’ determined on the basis of a balance sheet test, tempting legislatures to intervene when they realise that economic circumstances create difficulties for those in charge of businesses to assess their solvency in the longer term.38

The fluid nature of insolvency determined on the basis of a cash flow test can be illustrated by the ongoing debate about the guidance given by the German Bundesgerichtshof on the application of this test in practice. The BGH clarified in older case law that cash flow insolvency exists when the debtor does not have sufficient funds to pay at least 90% of its mature debts over the next three weeks. This does leave the question of how exactly this is to be established. In 2022, the Bundesgerichtshof rendered a judgment in which it held that the determination of inability to pay does not require the drafting of a so-called Liquiditätsbilanz, but can also be determined by other means, notably by liquidity statements showing that on four different moments within the three week period the debtor was illiquid without the prospect of closing the liquidity gap.39 Even after this latest judgment of the Bundesgerichtshof, the debate on the cash flow test is still going on.40 This shows how hard it is to develop a cash flow test that offers legal certainty in practice and does not suffer from too much complexity.

It is disappointing that the Commission has refrained from touching on the issue of how to determine insolvency in practice. We recommend the commissioning of a study of the application in practice of the various insolvency tests (and corresponding directors’ filing duties) applied in the Member States before a final version of the Insolvency Directive is adopted. Such a study also seems necessary having regard to Article 38 of the Proposal, which obliges Member States to set out the conditions under which a microenterprise is deemed to be generally unable to pay its debts as they mature and ensure that these conditions are clear, simple and easily ascertainable by the microenterprises concerned.41

On the concept of insolvency, finally, we wish to draw attention to the fact that whatever the definition will be and how much precision the Commission or the national legislators seek in the process of defining, it is likely that the application in practice will lead to litigation. It does not take much imagination to envision that directors against whom a liability claim has been brought based on non-compliance with their duty to file, will take the position that the company’s ‘insolvency’ had not yet occurred.

Given the fact that the Commission has shied away from defining insolvency, it is hardly surprising that the Commission also leaves it to the Member States to define which national proceedings qualify as ‘insolvency proceedings’ for the purpose of Articles 36 and 37. However, the fact that the Commission’s choice is hardly surprising does not make it any less problematic, given the range of proceedings existing in EU Member States that may be opened in respect of debtors that are sliding down the (in)solvency scale. The Explanatory Memorandum offers only limited guidance in respect of what is an ‘insolvency proceeding’ for the purpose of Article 36 and 37. The statement that the minimum harmonisation standards of the Preventive Restructuring Directive “only apply to businesses that are not yet insolvent and pursue the very aim of avoiding insolvency for businesses that can still be returned to viability” and “do not address the situation where a business becomes insolvent and has to undergo insolvency proceedings” could be understood as implying that ‘insolvency’ proceedings are to be distinguished from ‘pre-insolvency’ proceedings.42 This would mean that the Proposal is not about pre-insolvency, but about insolvency proceedings. However, this still leaves us with the question of what defines an insolvency proceeding in the sense of the Proposal. The Proposal targets the three key dimensions of insolvency law: “(i) the recovery of assets from the liquidated insolvency estate; (ii) the efficiency of proceedings; and (iii) the predictable and fair distribution of recovered value among creditors”.43 This could be understood as implying that only proceedings aimed at liquidation of the insolvent debtor’s assets are covered by the Proposal. However, the first sentence of recital 3 acknowledges that insolvency proceedings can also be proceedings aimed at restructuring rather than liquidation: “Insolvency proceedings ensure the orderly winding down or restructuring of companies or entrepreneurs in financial and economic distress”. Assuming that pre-insolvency proceedings aimed at restructuring are – exclusively – covered by the Preventive Restructuring Directive, it would be logical to assume that only those reorganisation proceedings that are opened after the court has established that the debtor is actually insolvent are covered by Article 36. But this assumption ignores that certain insolvency proceedings aimed at reorganisation, such as the Dutch suspension of payments proceedings, may be opened when the debtor foresees that it will become insolvent.44 Such proceedings may therefore also be characterised as pre-insolvency proceedings because they are opened (at least in theory) before the debtor becomes insolvent. Perhaps the most pragmatic way – from a Dutch perspective – to interpret the concept of ‘insolvency proceedings’ used in Article 36, would be to assume that, as long as the debtor company is not yet unable to pay its debts as they fall due, its directors can use all ‘pre-insolvency’ options available, ranging from trying to reach an out-of-court settlement with (certain) creditors (which may – if necessary – be made binding on non-consenting creditors and shareholders by court confirmation of a restructuring plan in so-called WHOA-proceedings45) to filing for suspension of payments. However, once it is clear that the company has stopped paying its debts as they fall due, the directors will be under a duty to file for ‘faillissement’, which is aimed at liquidation of the assets (which may take the form of a going concern asset sale with or without a preparatory phase (pre-pack)). The problem inherent in this pragmatic approach is that the options available to directors that wish to comply with their filing duty under Article 36 will be defined – and limited – by ‘insolvency’, which – as we have argued is a scalar and vague concept.

The Proposal also contains provisions obliging Member States to ensure the availability of so-called pre-pack proceedings (Articles 19-35 Proposal)46 as well as simplified winding-up proceedings for microenterprises (Articles 41-45).47 The Proposal does not clarify whether these proceedings qualify as insolvency proceedings for the purpose of Article 36 and 37. In respect of pre-pack proceedings, the fact that these are split up into two phases – a preparatory and a liquidation phase – could cast doubt, especially in view of Article 20, which provides that the liquidation phase qualifies as an insolvency proceeding as defined in Article 2 point 4 EIR. We believe, however, that this does not imply that directors cannot comply with the duty to file prescribed by Article 36 by requesting the opening of the preparatory phase. This request is ultimately aimed at the opening of insolvency proceedings involving a liquidation phase. Therefore, directors can comply with their duty to file by filing for a pre-pack. In respect of the simplified winding-up proceedings, there can be little doubt that these qualify as ‘insolvency proceedings’ for the purpose of Article 36 and 37, given that Article 38 expressly provides that these proceedings must be available to microenterprises that are insolvent, which must – pursuant to Article 38 – be assessed exclusively on the basis of a cash flow test.

A final issue that we wish to address in this section is: who has standing to bring the claim for violation of the duty to file: the insolvency practitioner (IP) and/or individual creditors? This question is related to the nature of the duty to file, which is not clear from the Proposal. Should the duty to file be qualified as a duty owed to the body of creditors as a whole or is it – also – a duty owed to individual creditors, in particular those who entered into a contract with the company after it became insolvent? Recital 33 offers a clue, where it is stated: “In that case directors should compensate creditors for the damages resulting from the deterioration in the recovery value of the legal entity compared to the situation where the request would have been submitted on time”. This sentence exclusively refers to the damage suffered by creditors who were already on board. It does not refer to the damage suffered by creditors in respect of whom the company incurred contractual obligations after it became insolvent. These so-called ‘new’ creditors will wish to be placed in the situation that would have existed if the company had refrained from entering into the contract. This means that they will claim to be compensated for reliance loss, not just the difference in recovery compared to the situation of timely filing (so-called ‘Quotenschaden’). We believe that the exclusive focus of the Proposal on a claim for Quotenschaden is not justified. New creditors should be compensated for the reliance loss they suffered. Moreover, the prospect of recovery of reliance loss (to the extent that the defendant offers recourse) can be a real incentive for new creditors to bring a claim. In comparison, there will be little incentive for individual creditors to bring a claim for Quotenschaden, because they will only be able to recover part of what is owed to them. There is also little incentive for the IP to bring this claim because a considerable amount of time and effort may be involved in showing what the recovery rates would have been in case of timely filing. That this can be a daunting task48 seems to have been overlooked by the drafters of the Proposal.

First, as we discussed above in paragraph 3, the proposed duty to file is not so clear-cut at all. It is left to the Member States to define the core components of the duty to file, which are the moment that a duty to file is triggered (‘insolvency’) and the type of proceeding that qualifies as ‘insolvency proceeding’. We have argued that with regard to the moment that the duty is activated, the ongoing discussion in Germany,49 where a duty to file has been part of the law for a long time, illustrates that it is a difficult task to formulate a definition of insolvency that on the one hand encourages early intervention for the sake of creditor’s interests and on the other hand must guard against directors giving up to too early, which can be harming to creditors’ interests as well. In fact, we believe that, given that a company’s state of financial affairs is rather a continuum with fluctuations than a quantified matter of static calculations,50 a likely consequence of a hard and fast rule to file will be that directors will file too early in order to avoid a perceived risk of personal liability, thus leaving unexploited promising opportunities for restructuring. Especially, if we juxtapose the rather vaguely defined director duties laid down in Article 19 of the Preventive Restructuring Directive against a hard and fast rule like the proposed duty to file, there is a likelihood that directors will opt for the safe route by complying with the duty to file. In this way, the desired early intervention can turn out to be detrimental to creditors’ interests. This will particularly be the case if no escape options, in the form of justification or exculpation grounds in case of non-compliance, are provided in respect of the duty to file. In the absence of such grounds, a duty to file has the potential to harm creditors’ interests, and will run counter to the policy objectives of the Preventive Restructuring Directive.

Second, Dutch law already provides for different rules that aim to restrain directors’ behaviour in case of (deepening) insolvency. As we observed above, most of these rules entail open norms which leave room for a differentiated assessment of directors’ course of conduct. However, these norms have been substantiated in a significant volume of case law. Moreover, if the proposed duty to file is to take effect exclusively when the debtor is insolvent (which, as we argued above, is particularly difficult to determine), Dutch law regarding directors’ liability provides for rules that activate duties to consider creditors’ interests already before the moment of insolvency (regardless of how this is defined). In light of the stipulated purpose of the proposed duty to file – which is, as we discussed in paragraph 2, to stimulate early action – the Dutch rules for directors’ liability seem more fit to serve that purpose. We just mention the main grounds of liability that may be invoked against directors of insolvent companies.51 These concerns in the first place claims for the full deficit brought by the liquidator, typically based on a number of provisions simultaneously (Article 9 Book 2, Article 138/248 Book 2 and Article 162 Book 6 of the Dutch Civil Code). The essence of these claims is that the company has been mismanaged. Secondly, there is the so-called Beklamel-claim for reliance loss brought by ‘new creditors’ on the basis of tort law.52 These are creditors who entered into agreements with the debtor after the director knew or should have known that the debtor would not be able to perform and would not offer recourse for damages arising from non-performance. Next to these grounds of liability, we mention a third category, tort claims brought by the liquidator or by individual creditors against directors for making ‘selective payments’ on behalf of the company. The latter pertains to preferential payments of debts by the director which may qualify as unlawful and give rise to the directors’ personal liability to pay damages if certain requirements are met. It is particularly this ground of liability that can activate a duty for the director to consider creditors’ interests before insolvency – understood either as cash flow insolvency or balance-sheet insolvency – has occurred. For instance, in cases where selective payments were made to creditors related to the debtor, Dutch courts have held directors liable when at the time of the payment the directors had to seriously consider the possibility of insolvency or liquidation proceedings (‘faillissement’).53

In addition to these general rules that may lead to director liability in insolvency, we do not want to leave unmentioned a (fourth) specific liability rule that contains a notification duty for the director as well. Article 36 of the Tax Collection Act (TCA) enables the tax collector to bring a specific liability claim against de jure and de facto directors in respect of unpaid tax debts owed by the company. Directors are jointly and severally liable if non-payment of taxes owed by the company is due to ‘manifestly improper management’, with the possibility of individual exculpation. The ‘manifestly improper management’ must have occurred in the period of 3 years preceding the notice of inability to pay taxes (‘melding betalingsonmacht’) or, if they have not given such notice, 3 years before the company’s first default in payment. In case directors have failed to timely and correctly notify the tax collector of the company’s inability to pay, directors are presumed to be liable, unless they prove that they cannot be blamed for the failure to give notice and for the failure to pay the taxes that were due.54 Although the notification duty is directed towards a specific creditor – the tax authorities – and thus does not entail the filing of formal proceedings, Article 36 of the Tax Collection Act shows that Dutch law already contains an obligation for the directors to notify a third party about the debtor’s distress, and by doing that de facto disclose the debtor’s inability to pay to the outside world.

The mentioned liability rules aim to ensure that directors do not carelessly continue trading when insolvency has occurred or is imminent. The rules contain to a greater or lesser degree specified duties for directors to take into account creditors’ interests in case of deepening insolvency. They do not force directors to file for the opening of (specific) insolvency proceedings but leave room for out-of-court workouts, thus offering more flexibility. Although most duties are more or less specified, the open character of the norms enables directors to bring forward facts and circumstances that can justify their course of conduct or exculpate them. This allows courts to achieve a judgement that takes into account all circumstances of the case. This seems particularly reasonable regarding the issue we are dealing with, where ‘the moment of truth’ is difficult to determine and if it is determined, it is akin to a rather arbitrary fixation on the state of affairs of the debtor.

Based on the foregoing analysis, we argue that a duty to file as proposed in the Proposal is not beneficial for Dutch law, and we believe that Dutch law does not require such a rule to reach the policy objectives set forth in the Explanatory Memorandum of the Proposal and the attached impact assessment. However, if a duty to file as proposed is to be implemented in Dutch law, aside from what we already have noted, we foresee the following issues that the Dutch legislature should take into account.