May 31st, 2010

Continental European Legislative and Judicial Trends: Dutch Insolvency Law and Directors & Officers Liability

Posted at 2:00 AM ET

2010_legislative_thumb-22David Lewin, Managing Director
Contact

 

The worldwide economic downturn has had a huge effect on the Dutch economy. Many companies in the Netherlands face the risk of bankruptcy. In 2009 almost 11,000 enterprises were declared bankrupt, an increase of more than 51 percent compared with 2008. A similar number of companies are expected to enter bankruptcy in 2010. An even greater number of companies will be affected as they become entwined with the insolvencies of their contractual counterparties.

This short report provides a summary of Dutch insolvency law in the context of
directors’ and officers’ liability. It specifically addresses the risks that directors and
officers face when a receiver (curator) is appointed to closely examine the actions
and inactions of the company and its management as they may relate to the causes
of a bankruptcy. The intent is to provide further insight into Dutch practices to
directors & officers (D&O) liability insurers and reinsurers. We also review the need
for (re)insurers to re-examine terms and conditions of applicable D&O policies in
light of the legal issues.

Dutch Insolvency Law - A Brief Summary

In the Netherlands, insolvencies are primarily regulated by the Dutch Bankruptcy Act
(Faillissementswet) - which is currently under review - and the European Insolvency
Regulation (1). The Bankruptcy Act focuses on two different situations:

i) Suspension of payment (surseance van betaling), with the appointment of an
administrator (bewindvoerder). Suspension is primarily designed to allow for an
opportunity of recovery and reorganization;

ii) Bankruptcy (faillissement), with the appointment of a receiver (curator) whose primary instruction is to take control over the estate and to prepare the liquidation
of assets.

A petition for bankruptcy may be filed by any interested party, such as (i) the
debtor/company itself, (ii) any creditor and (iii) the Public Prosecutor’s Office.

The Court that rules on the petition will apply the so called “cash flow test,” which is
normally considered passed if the petitioner demonstrates that more than one creditor
remains unpaid. Normally, the Court will deliver a decision following the hearing.
The order is immediately enforceable with a possibility for appeal within eight days. 

The Court will appoint a supervisory judge (Rechter-Commissaris) and - in most cases -
one receiver, with the possibility of appointing more receivers if the complexity of the
insolvency or the nature of the activities of the company requires it. The receiver will
generally be a lawyer, although it is not unusual for a finance expert to be appointed,
as well.

The primary goal of the bankruptcy and of the receiver’s task is the administration and liquidation of the estate. The Bankruptcy Act however, also provides for an optional offering to the creditors that avoids the liquidation of assets.

Consequences of bankruptcy include, but are not limited to:

■ Automatic termination of all individual attachments on assets (as the bankruptcy
itself is considered to be an attachment for the benefit of all creditors on all assets
and liabilities of the company);

■ Enforcement rights of unsecured creditors are immediately suspended;

■ The receiver assumes all external representational powers;

■ The receiver has the power to rescind certain contracts and to immediately lay-off
employees;

■ The receiver has the option to initiate claw-back actions against pre-bankruptcy
transactions which may be regarded as detrimental to the estate or to some of the
creditors (Actio Pauliana).

The Powers and Duties of the Receiver - D&O Liability

Immediately upon appointment, the receiver is charged with the administration and
liquidation of the bankruptcy estate. The receiver represents the bankrupt company
externally and is granted powers to take actions that will preserve the estate. The
receiver directly reports to the supervisory judge and is required to file three monthly
reports, which are open for review by the public.

Part of the receiver’s role involves the investigation into the cause(s) of the bankruptcy. There is a growing tendency in the last few decades to specifically focus on the role of the management board. As in many other European jurisdictions, Dutch law stipulates that a director of the company is, in principle, liable for the shortfall (deficit) if the bankruptcy is determined to have been the result of mismanagement.

Because there is likely to be an economic shortfall in most bankruptcies the receiver
needs to thoroughly investigate potential directors’ and officers’ liability. Article 2:248
of the Dutch Civil Code (”DCC”) gives the receiver useful tools to perform that activity.

If the findings demonstrate that the directors have failed to draw up and publish/deposit in a timely fashion (within 13 month after the close of the financial year) the annual accounts, or have breached their obligation to keep books, mismanagement is assumed to have occurred. This mismanagement is presumed to be an important cause of the bankruptcy. The director does however, have the ability to deliver proof to the contrary or proof of other (more) important causes of the bankruptcy.

The receiver will immediately investigate whether the annual accounts have been
published in time and whether the books have been properly kept.

In addition, the receiver will also closely examine all acts and admissions by the company and its directors during the period prior to the bankruptcy. In the Netherlands no formal “twilight period” (the period prior to the bankruptcy during which the acts of a company may be questioned or undone) exists. Although claims relating to mismanagement may only be based on circumstances in the period three years prior to the date of the company being de facto bankrupt (thus not per definition the date of the bankruptcy order), the possibility to question certain transactions is, in principle, unlimited in time.

The receiver has the power to annul certain transactions that may be regarded as
advantageous to some creditors and harmful to others. The receiver may additionally
hold a director liable for any damage that the bankrupt company itself has suffered
as a result of mismanagement.

Besides actions of the receiver, individual creditors will specifically look at transactions that occurred while directors knew or should have known that bankruptcy was unavoidable. Those creditors will either try to convince the receiver to take action against the directors or take actions themselves. The bankruptcy itself does not affect the right of third parties to directly file a claim against the directors.

The claims from the receiver or other stakeholders in the company (creditors, shareholders, employees) will be based on general concepts of law (tort, negligence, breach of duty of care, mismanagement or fraud). Distinction should be made between the director’s internal liability towards the company (for which situation article 2:9 DCC provides a broad basis) and the director’s external liability (towards third parties such as creditors, for which in general article 6:162 DCC is applicable).

We have provided a brief overview of examples of only some of the risks a director or
officer may face in light of his/her personal liability.

D&O Liability Insurers

D&O liability insurers and reinsurers need to be aware of the broad possibilities
where receivers, creditors and other stakeholders (both within as well as beyond
insolvency proceedings) may make claims against directors and officers and the
need to closely review applicable policy terms, especially the exclusions.

Most D&O liability policies stipulate that the insurance will terminate automatically
in the case of a bankruptcy, with the possibility of an extension (”loss occurrence”).
The insurer will probably want to assess whether the insurance premium
still is in balance with the (increased) risks involved, considering the growing tendency
of both the receiver and the creditors to actively pursue management for
either the entire deficit in the bankruptcy or the loss suffered by individual creditors
or the company itself.

The uncertainties and huge impact of an economic downturn creates specific
risks. At the conclusion of a transaction with a third party (future creditor) it may
prove to be difficult for directors and officers to determine if bankruptcy is
unavoidable. It is extremely difficult to weigh all relevant factors. In the aftermath
of the bankruptcy, a creditor faced with the bankruptcy of his/her counterparty
will go the extra mile to demonstrate that the so called “Beklamel” situation
applies. This can be interpreted to mean that the director knew or should have
known that bankruptcy was unavoidable. These kinds of claims may increase in
the future. An extra burden is likely to be created for D&O liability insurers and
(re)insurers in managing and financing the additional litigation that will emerge.

Considering the huge financial impact that a failure to publish and deposit the
annual accounts may have, the insurer will need to closely monitor the timely
deposit of those annual accounts. The insurer will also need to pre-warn the
directors and communicate the potential consequences that failure to do so
may have on insurance coverage. Although many insurance policies burden the
company with the obligation to annually provide the insurer with those annual
accounts, insurance companies may benefit from closely monitoring this obligation
as well as requesting evidence of timely publication.

Yet Another Trend: Reclaiming Criminal Fines on Directors

Separate from the concept of insolvency, another issue that may be of interest to
D&O insurers and reinsurers is the attempt by a company to claim repayment of
a criminal fine from its directors.

In a recent ruling from a civil court (2), a company successfully made a claim against its (former) director in relation to violation of the Iraqi Sanctioning Decree. The matter related to a transaction involving the sale of potatoes, which had been approved by the United Nations. Part of the transaction included a kickback payment by the company to the Iraqi Government, to which payment was not exempt from the Sanctioning Decree. The payment was however, imperative for the company’s being awarded this and consecutive contracts. Considering the violation of the Sanctioning Decree, the company was criminally investigated and in order to avoid further prosecution, it paid an amount of EUR170,000 to the public prosecutor in a settlement. The Civil Court was called to rule on the claim of the company against its (former) director for repayment of the out-of-court settlement amount. On the basis of article 2.9 DCC (duty to correctly fulfil the managerial tasks) and article 6:162 DCC (tort) the Civil Court rejected all defenses raised by the director.

In this specific matter, the court attached considerable weight to the fact that the
former director was aware that payment to the Iraqi Government was in fact punishable and awarded the claim in full.

Although many D&O liability insurance policies exclude coverage for fines and
penalties for fraudulent acts of the director, it is questionable whether the latter
exclusion also applies to fines/penalties being imposed on the company itself and
not the director. Insurers may also want to review if similar situations are sufficiently
dealt with properly in policy terms and conditions.

Notes:

1 In this contribution only the Dutch Bankruptcy Act is discussed. The summary given applies to regular enterprises in general, not to financial or insurance institutions. Such institutions are subject to a special regime.

9 Civil Court Zwolle d.d. 25-03-2009

Click here to download the report >>

Click here for all articles from this series >>

Click here to register for e-mail updates >>

* Securities or investments, as applicable, are offered in the United States through GC Securities, a division of MMC Securities Corp., a US registered broker-dealer and member FINRA/SIPC. Main Office: 1166 Avenue of the Americas, New York, NY
10036. Phone: (212) 345-5000. Securities or investments, as applicable, are offered in the European Union by GC Securities, a division of MMC Securities (Europe) Ltd., which is authorized and regulated by the Financial Services Authority. Reinsurance
products are placed through qualified affiliates of Guy Carpenter & Company, LLC. MMC Securities Corp., MMC Securities (Europe) Ltd. and Guy Carpenter & Company, LLC are affiliates owned by Marsh & McLennan Companies. This communication
is not intended as an offer to sell or a solicitation of any offer to buy any security, financial instrument, reinsurance or insurance product.

Guy Carpenter & Company, LLC provides this report for general information only. The information contained herein is based on sources we believe reliable, but we do not guarantee its accuracy, and it should be understood to be general insurance/reinsurance information only. Guy Carpenter & Company, LLC makes no representations or warranties, express or implied. The information is not intended to be taken as advice with respect to any individual situation and cannot be relied
upon as such.

Readers are cautioned not to place undue reliance on any historical, current or forward-looking statements. Guy Carpenter & Company, LLC undertakes no obligation to update or revise publicly any historical, current or forward-looking statements,
whether as a result of new information, research, future events or otherwise.
Statements concerning, tax, accounting, legal or regulatory matters should be understood to be general observations based solely on our experience as reinsurance brokers and risk consultants, and may not be relied upon as tax, accounting, legal or
regulatory advice which we are not authorized to provide. All such matters should be reviewed with your own qualified advisors in these areas. 

AddThis Feed Button
Bookmark and Share


Related Posts