From the point at which a company becomes over-indebted or insolvent, the managing director is no longer allowed to make payments for the company because this would reduce the insolvency assets. If he violates this, he is personally liable with his private assets. Every insolvency administrator is obliged to assert such claims for damages. Due to the Covid19 crisis, the legislature has reacted and reduced the liability risk. Nevertheless, risks still exist.
Covid19 crisis – When is a company insolvent?
A company is insolvent if it is over-indebted or insolvent (Read here more on over-indebtedness and insolvency) A company is over-indebted if the value of its assets is not sufficient to cover all liabilities and there is no positive continuation forecast. A company is insolvent if it is not only temporarily unable to service more than 10% of its due liabilities and payment obligations. Temporary means less than three weeks. The insolvency regulations oblige every managing director to file for insolvency immediately, but at the latest within three weeks of the occurrence of insolvency.
Sole traders are the owners of the company themselves, so that as private individuals they can become insolvent with their assets. However, modified rules apply to them.
What are payments in the event of insolvency?
The managing directors are obliged to reimburse the company for payments that are made after the company becomes insolvent or after it is determined to be over-indebted. This does not apply to payments that are consistent with the care of a prudent businessman even after this point in time. Payments in the event of insolvency are therefore all payments that are made at the stage of the company's insolvency. This applies regardless of whether the managing director was aware of the insolvency or not. The term payment is to be interpreted broadly. The collection of an advance payment into a debit account is also recorded. The Federal Court of Justice confirmed this again in a recent judgment of February 11, 2020 (BGH, judgment of February 11, 2020 - Ref: II ZR 427/18).
How liable is the manager?
If a managing director makes payments when he becomes insolvent, he is liable for this with his private assets (Read here more on the liability of a managing director in the event of breach of duty). This is particularly unfortunate if the manager was not aware of the maturity of insolvency, i.e. the insolvency or over-indebtedness that had already occurred. However, the manager cannot justify this. He can, of course, claim a legal error because he was mistaken about whether the case was ready for insolvency. However, such a legal error can only exonerate him if the legal error was avoidable. Such avoidability will always have to be assumed when bankruptcy is ripe, because a managing director must objectively know whether his company is insolvent or over-indebted.
The managing director must personally reimburse the company or the insolvency administrator all amounts that he has arranged from the company's assets and which the insolvency administrator cannot recover from the recipient, for example through insolvency challenge.
However, the managing director does not have to reimburse all amounts. Payments that correspond to the care of a proper managing director are excluded. These are payments that a manager makes in the interest of maintaining restructuring opportunities, i.e. to secure the company, or to prevent damage. However, the managing director must explain and prove that his payment meets these requirements. He must explain to what extent he took care of the financial situation of the company, why he could not recognize that the company was ready for insolvency or why the payments were compatible with the principles of a prudent businessman.
Exception: employee share of social security
However, this does not apply in the case of so-called conflicts of duties of the managing director, i.e. if he has to make payments by law or under threat of punishment. An example of this is payments by the insolvent company on the employee's social security share. This is related to a conflict with criminal law that would otherwise arise. In particular, anyone who does not pay the employee's share to the social security institutions is committing a criminal offense. The managing director is therefore in danger of getting into an irresolvable conflict. If he does not pay social security contributions in the event of bankruptcy, he is committing a criminal offense. If he pays them, he is liable with his private assets. However, the criminal liability only applies to the employee's social security contributions, not to the employer's contributions. Therefore, the conflict only arises for the employee shares. The managing director must and may therefore transfer and pay these without making himself liable to prosecution. As a rule, these are payments that fall within the duty of care of a proper managing director.
What applies in the Covid19 crisis?
Initially, the obligation to file for insolvency is suspended from March 1st to September 30th, 2020 if a company was economically sound before December 31st, 2019 and became insolvent or over-indebted due to the Covid19 crisis. The legislature wants to prevent companies from slipping into insolvency even though they are still waiting for promises of loans or state aid.
The liability of managing directors for payments in the event of insolvency is also limited during the Covid19 crisis. Companies that are generally healthy should be protected from having to file for insolvency because they run into payment difficulties during the Covid19 crisis and the associated restrictions. For this reason, at the beginning of March the legislature relaxed the provisions of insolvency law until September 30, 2020 with a corresponding law. These relaxations also affect the strict liability of a manager for payments during corona-related insolvency or over-indebtedness.
The most important relaxation is: During the Covid19 crisis, in the event of insolvency or over-indebtedness, every payment made by the managing director in the normal course of business, such as rent payments or settlement of supplier invoices, is considered to be compatible with the care of a conscientious business manager. They therefore do not trigger any liability. This applies in particular to payments made to maintain or restart business operations or to implement a restructuring concept.
The legislature is confident that this has adequately protected the managing directors of affected companies. However, there are two, at first glance, inconspicuous restrictions that should not allow managing directors to go through the Covid19 crisis without supportive advice: Firstly, the managing director only has no liability if the obligation to file for insolvency is suspended. If the requirements for this are not met, for example because the company was already in “distress” on December 31, 2019 or because insolvency would have occurred even without the Covid19 crisis, the managing director cannot rely on his loss of liability. Secondly, it is only a “presumption” that the payments in the ordinary course of business in the period from March 1st to September 30th, 2020 are compatible with the care of a prudent and conscientious managing director. However, every assumption can be refuted. It is therefore to be expected that insolvency administrators will try to find arguments for refutability.
Covid19 crisis – what is important now?
The regulations to relax the strict insolvency law reduce the risk of managing directors becoming personally liable or even committing a criminal offense. However, the easing does not mean a “carte blanche”. The risks for managing directors are merely reduced, not eliminated. Despite the relaxation of the insolvency regulations, the obligation to file for insolvency is not suspended if the company was already insolvent or over-indebted as of December 31, 2019 or if there is no prospect of resolving the insolvency that has occurred.
Managing directors should therefore always keep an eye on the risks of insolvency or excessive indebtedness, even in a crisis. In particular, changes in business activities between December 31, 2019 and March 1, 2020 should be documented so that companies can prove that the Covid19 crisis triggered the corporate crisis and that a corresponding restructuring is possible and will be carried out.
Payments should always be checked to see whether they are part of the ordinary course of business. This will usually be the case for payments to landlords, staff, suppliers and service providers. However, the repayment of shareholder loans, for example, should be viewed much more critically.