Shareholder’s liability for creditor’s loss resulting from subsidiary’s failure to file a bankruptcy petition

The degree to which a company’s creditors are satisfied may depend in large measure on timely filing of a bankruptcy petition. But sometimes the dominant shareholder will pressure the members of the management board to refrain from filing for bankruptcy.

Poland’s Bankruptcy & Recovery Law requires a debtor to file a bankruptcy petition with the court no later than two weeks after the grounds for declaration of bankruptcy arise (Art. 21(1)). With respect to a limited-liability company or joint-stock company, such grounds arise in the case of two types of events, either of which means that the company is insolvent: (i) lack of liquidity, meaning that the company has permanently ceased to perform its due and payable monetary obligations, and (ii) when the company’s obligations exceed the value of its assets (even if it is performing its obligations currently). In the latter case, the lawmakers optimistically assumed that a declaration of bankruptcy immediately after the obligations of the company exceed the value of its assets would allow the creditors to satisfy their claims from the proceeds of auctioning off the company’s assets.

The debtor’s delay in filing a bankruptcy petition typically results in injury to the creditors in the form of failure to satisfy their claims, equal to the difference between what the creditor would have received from the bankruptcy estate if the debtor had filed a timely bankruptcy petition and what the debtor actually received as a result of conducting the company’s bankruptcy.

The loss is caused by increasing the indebtedness of a company that is already insolvent (which is prohibited by law), satisfying competing creditors out of the debtor’s assets, and devoting the proceeds from sale of assets to the company’s operating costs (without the ability to cover the costs out of profits). Moreover, continuing to operate an insolvent company increases the likelihood that valuable assets will be removed from the company by the shareholder as well as the risk of selective payment of creditors.

Therefore, failure to file a bankruptcy petition by the time provided by law means that the company may squander its chances for successful debt restructuring (at least as a result of a reduction in its obligations agreed with the creditors) and for payment of a significant portion of its obligations.

Provisions of the Bankruptcy & Recovery Law, the Commercial Companies Code, the Penal Code, the Tax Ordinance and the Social Insurance System Act contain severe sanctions for failure to file a bankruptcy petition within two weeks after the company becomes insolvent. These sanctions are aimed at the members of the company’s management board. Shareholders, supervisory board members and commercial proxies are not threatened with these sanctions.

Usually the threat of sanctions works as a powerful motivation on the management board to pay attention to the interests of creditors and file a bankruptcy petition, even though it could be detrimental to the owners of the company.

But sometimes the controlling shareholder, counting on an improvement in the company’s condition and seeking to avoid a decrease in the value of its shares in the subsidiary or a sudden departure of the subsidiary’s customers, pressures the management board to refrain from filing a bankruptcy petition for many months. Meanwhile, it may actively participate in leading the creditors on with the prospect of prompt payment of their claims as soon as certain transactions are carried out, or promises to buy out their claims. When a bankruptcy petition finally is filed (by the debtor’s management board or frustrated creditors) and it turns out that the company’s assets are insufficient to pay the creditors, but the members of the management board do not have personal assets sufficient to cover the loss, the question arises whether there is any chance to enforce the claims out of the assets of the shareholder which stage-managed the actions of the management board of its subsidiary as a shadow director.

This issue is particularly urgent for creditors in a situation where the bankruptcy is declared more than two years after conclusion of a loan agreement between the shareholder as lender and the company as borrower, and hence under Commercial Companies Code Art. 14 §3 the shareholder’s claim for repayment of the loan is no longer treated as a contribution to the company but as an ordinary claim competing with other claims for satisfaction out of the bankruptcy estate.

The injury to the creditors will be even more severe if the loan was secured against the debtor’s property (e.g. by a mortgage on the debtor’s real estate). Such security will guarantee the shareholder satisfaction of its claim against the subsidiary under a separate, privileged track. Consequently, it can be shown that the shareholder had a clear interest in pressuring the management board to refrain from filing a timely bankruptcy petition.

Under provisions of the Commercial Companies Code concerning limited-liability companies (Art. 151 §4) and joint-stock companies (Art. 301 §5), shareholders are not liable for the company’s obligations. This rule clearly reduces the protection of creditors. In weighing the interests of the creditors against the interests of the shareholders, the law provides better protection to the shareholders, who are encouraged to invest in the company and hopefully create new jobs and generate tax revenues.

At first glance the position of the creditors in this situation may appear hopeless, but it may nonetheless be possible for them to pursue claims against the shareholders for damages under Civil Code Art. 422, which provides for civil liability for inducing another to cause a loss, aiding another in causing a loss, or knowingly benefiting from another’s loss.

For the reasons outlined above, litigation against the shareholder in such a case will be difficult, but it may succeed in improving the creditor’s negotiating position and achieving satisfaction of its claim by the shareholder who was responsible for causing it.

Konrad Grotowski, Bankruptcy, Restructuring, and Difficult Receivables Recovery practices, Wardyński & Partners