Duties of managing directors in a crisis/insolvency risks

The economic effects caused by the coronavirus may lead to a crisis for individual entities.

Risk of insolvency

In the worst case, a managing director is required to examine whether the duty to file for insolvency has already arisen owing to a lack of liquidity.

When is a company insolvent?

The duty to file for insolvency exists in the event of insolvency or overindebtedness for entities that do not have a personally liable partner or shareholder, who is a natural person.

Insolvency exists when a debtor is not able to meet payment obligations that are due.

Even if (balance sheet) overindebtedness is determined, a duty to notify may be triggered: overindebtedness exists when a debtor’s assets can no longer cover the existing liabilities unless an entrepreneur can credibly demonstrate that circumstances are such that the continuation of the entity is highly likely.  A forecast is generally only positive if it is ongoing and encompasses the subsequent financial year.

What leeway is there when money is tight?

The law tolerates temporary liquidity shortfalls. In general, the Federal Court of Justice views a liquidity ratio of 0.9 to be tolerable: “Should it not be possible for a debtor to eliminate a liquidity shortfall that is less than 10% of the total outstanding liabilities within three weeks, solvency is generally assumed unless it is already foreseeable that the shortfall will soon exceed more than 10%.”

It is expected that financial planning be at least performed for a 12-month period on a regular basis.

A temporary suspension of the duty to file for insolvency may apply for “corona cases”

A filing for insolvency is, without undue delay, to be done not later than three weeks after the occurrence of insolvency or overindebtedness. (In principle, a three-week deadline)

To avoid that entities affected by the circumstances triggered by the coronavirus are solely required to file for insolvency for this reason because neither applications for public assistance can be processed nor financing or reorganisation negotiations can be completed within the three-week insolvency filing deadline, the duty to file for insolvency is to be suspended by a legal regulation for the time period up to the 30th of September 2020.  The requirements for such a suspension are that the reasons for insolvency are based on the effects of the coronavirus epidemic and that there are reasonable prospects for recovery owing to the fact that the person required to file for insolvency has applied for public assistance or is negotiating measures for either financing or reorganisation.  

What demands are placed on an entity’s reporting and budgeting systems in managing liquidity in a crisis?

In a crisis it is appropriate to monitor an entity‘s financial status on a daily basis in order to assess if a shortfall in liquidity exists. In the event of a shortfall, it is necessary to assess by means of a forecast if it may be presumed that the shortfall can be eliminated in the next three weeks.

At the very latest in a liquidity crisis experts recommend that liquidity planning be performed on a weekly basis and be set up as rolling budgeting with a range of 13 weeks.

Should an entity be on the verge of insolvency, management not only has the duty to file insolvency without delay, it must additionally provide evidence on which payments should or must still be made and which payments or measures may no longer be made or taken in order to avoid disadvantages for the creditors. At the insolvency stage the management can be made personally liable and can, if applicable, be prosecuted.

How do I manage a looming liquidity crisis?

In principle, it is recommended that liquidity bottlenecks be avoided as far as possible by taking appropriate measures.

In order to stabilise a liquidity situation, several measures may be considered and their suitability needs to be examined. Such measures range from arranging credit with suppliers, having customers pay early, up to organising bridging loans with an entity’s bank. 

The 13-week liquidity planning described above is a tool for planning centrally as well as for reporting and controlling.

In order to avoid a crisis or if an entity is in a crisis, it is strongly recommended that management be advised at an early stage.

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