Clarifying Supreme Court ruling on liability for the Board and CEO
On December 14, 2017, the Supreme Court ruled in a case of personal liability for the CEO of a shipyard established as a limited liability company. The company's Board of Directors filed a bankruptcy petition, and two subcontractors brought action for damages against the CEO submitting that insufficient information had been given about the failing financial situation of the yard while the work was ongoing. The Supreme Court imposed liability on the CEO. The ruling clarifies issues of great importance in regard to management's personal scope of action and related due care standards, including the correlation between incomplete information and insolvency.
The case concerned a shipyard that had engaged subcontractors to carry out work on several vessels being outfitted on the yard. The subcontracts were delivered on credit, and as the shipyard's Board filed a bankruptcy petition in October 2011, several of the contracting parties did not receive settlement for work performed during the last period up to the time of the bankruptcy petition. Two different subcontractors brought legal action against the Board and the CEO of the shipyard. The formulation of the basis of liability was that the CEO should have prevented the subcontractors from suffering a loss by continuing to perform work at a time when the shipyard's financial situation indicated that it was unable to meet its obligations as they fell due. The legal action against the Board was waived during the main hearing in the District Court. The District Court found that the CEO had not acted negligently and acquitted the CEO of the subcontractors' claims. The District Court also assumed that a compensation-sanctioned duty of disclosure in regard to the shipyard's failing financial situation would not occur until the shipyard was insolvent. The contracting parties appealed the District Court's ruling to the Court of Appeal, where the CEO was held liable for one of the two subcontractors' claims. Unlike the District Court, the Court of Appeal found that a duty of disclosure towards the subcontractors could arise even before the insolvency occurred. The CEO appealed the Court of Appeal's ruling to the Supreme Court.
The principal issue before the Supreme Court was whether a CEO has a compensation-sanctioned duty to notify the subcontractors of a company's failing financial situation before the company has objectively become insolvent and before the obligation to file a bankruptcy petition has occurred.
In order to be able to decide on the matter's principal issue, the Supreme Court first had to consider when the shipyard's insolvency had occurred. In this regard, the Supreme Court ruled on a question that has been discussed in legal literature, namely whether Section 61 of the Bankruptcy Act requires an actual default of payment
in order for illiquidity to be established. The Supreme Court found that such a claim cannot be stipulated, since the question of illiquidity must be "answered based on whether the liquid capital that he has available, in addition to the liquid capital that he is expected to be able to access in the future, is sufficient to cover his already overdue liabilities as well as his other obligations as they fall due ". With this legal understanding of Section 61 of the Bankruptcy Act, the Supreme Court found that the shipyard was insolvent by mid-August 2011 and not in September 2011 as assumed by the insolvency estate's auditor, the District Court and the Court of Appeal.
The Supreme Court then considered whether the subcontractor could require information about the shipyard's prospective payment issues. Reference was made to the contractual principle of loyalty, under which there may be a duty to notify a contracting party of an expected default of payment in current contractual relationships, and, as a starting point, such duty of disclosure will arise if an insolvent company receives services on credit, for which it cannot assume that it will be able to pay on maturity. The Supreme Court found in favour of the CEO, in that a breach of the duty of disclosure does not necessarily entail personal liability for the management of a company. A company experiencing a difficult financial situation must, according to the Supreme Court's opinion, have the possibility to try and save the company quietly, and any imposition of personal liability is not relevant as long as the management has a sound reason to believe that the company is solvent. The Supreme Court also found in favour of the CEO in his submission that personal liability for the CEO should not occur even if the company is insolvent, as long as there is still a realistic hope of rescuing the company from insolvency proceedings, the company's management actively and loyally works towards that end, and the Board files a petition for insolvency within a reasonable time if the rescue operations are unsuccessful. This is a fundamentally important clarification by the Supreme Court, which is of great importance to the management's scope of action where a company has financial difficulties.
The question of the management's right to save the company as long as there is realistic hope did not come to the forefront of this case, as the Supreme Court found that no rescue operation had taken place in the shipyard. The CEO and the Board were unaware that the shipyard had accumulated a deficit during 2011, and filed a bankruptcy petition as soon as it was revealed. This unawareness was in the Supreme Court's opinion caused by insufficient financial statements and financial management. This constituted a breach of the CEO's duties pursuant to Section 6-14 of the Norwegian Limited Liability Companies Act, and the Supreme Court imposed liability for damages on the CEO on the basis of Section 17-1 of the Norwegian Limited Liability Companies Act. This aspect of the ruling shows that a relatively strict and formalistic managerial responsibility applies in Norwegian law. The case also underlines the importance of the company taking out liability insurance that protects employees and the Board against claims from the company's contracting parties and creditors.
Schjødt, by partner Klaus Henrik Wiese-Hansen, litigated the case on behalf of the CEO.
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