According to the current wording of the Republic of Lithuania Enterprise Bankruptcy Law, a head of an enterprise or a shareholder must file a petition with a court for the initiation of the enterprise bankruptcy proceedings in the event where the company is not able and/or shall not be able to settle with its creditors or where the company has made a public announcement or has informed the creditors that it has no intention to discharge its obligations. In such manner the entities who have the best knowledge of financial status of the enterprise are encouraged to take immediate actions to reduce a number of creditors facing the damage and a scope of overdue liabilities.
Unfortunately, in practise this provision has often been and continues to be ignored. On the contrary, often executives and shareholders of the enterprise know that the company is insolvent and will not be able to discharge its obligations, but they still hide the actual situation, fail to inform the creditors, and continue a loss-making business. They enter into new agreements, undertake new obligations, purchase property, gain other benefit, and delay with decision making while having no intention to perform the agreements.
At the moment when creditors finally file a petition for the initiation of bankruptcy of insolvent enterprise, total debts of the company are so big that majority of claims by the creditors in the bankruptcy proceedings remain unsatisfied, since the company undergoing bankruptcy has little property, it is already pledged, mortgaged or otherwise encumbered.
In such cases the only possibility left to the creditors is to direct their claims against executives and shareholders of the bankrupt enterprise and try to prove that they intentionally delayed and did not apply for the initiation of the bankruptcy case, therefore they must compensate damage incurred by the creditors due to such delay. Such provision is entrenched in the Enterprise Bankruptcy Law, as well. Moreover, such approach is actively applied by Lithuanian courts.
In one of the recent cases[i], the Supreme Court of Lithuania has been discussing whether the CEO of the bankrupt enterprise must compensate for the damage claimed by the bankruptcy administrator as a representative of the enterprise’s creditors and the enterprise itself. It was established in the case that it was back in late 2006 that the company’s records already indicated that the company was insolvent, therefore its CEO and shareholders had a duty to request initiation of the bankruptcy proceedings. However, this step had not been taken until late 2011, when the bankruptcy proceedings were initiated by the creditors. For this reason the Supreme Court of Lithuania held that the company’s CEO infringed his duty to apply for initiation of the bankruptcy proceedings and this resulted in damage both to the company and its creditors.
Nevertheless, it is important to note that liability of CEO who delays addressing a court is not unlimited. Subsequent to both the law and consistently formulated jurisprudence of the Supreme Court of Lithuania, liability of the CEO who infringed the imperative provisions of law is limited to the increase of company’s liabilities which originated due to the failure to initiate the bankruptcy proceedings in due time.
When deliberating on the scope of damage to be awarded, the Supreme Court of Lithuania explained that the company’s CEO is liable for the increase of damage caused to all creditors from the moment when the duty to initiate the bankruptcy proceedings originated until the moment when his authority expired. Moreover, the panel of judges noted that the CEO is liable solely for the increase of damage which originated due to unlawful delay within the period when he acted as the CEO.
In the course of determining the scope of damage account is taken of the company’s liabilities against its creditors (both overdue and unexpired) at the moment when the duty to initiate the bankruptcy proceedings originated, and the liabilities that have not been covered during the bankruptcy proceedings. Moreover, a court of cassation noted that in the event that the company was under management of several CEOs during the period when it avoided applying for the initiation of the bankruptcy proceedings, an individual assessment of the scope of damage caused by each of them has to be made, meanwhile joint and several liability does not apply in their respect.
This is not the first ruling of the Supreme Court of Lithuania in which the court holds that having ignored the financial status of the company and having failed to timely apply for the initiation of the bankruptcy proceedings the personal liability of the CEO must be limited to his property against the creditors. It is possible that the existing Lithuanian case law will encourage the company’s CEOs to monitor more rigorously the financial status of the company managed by them, to timely take necessary measures and in this way to protect their own interests. Moreover, this could also inspire the company’s CEOs to more often apply for civil liability insurance of corporate managers which may protect (depending on the conditions of the insurance) the CEOs and cover litigation expenses plus compensate the awarded damages.
[i] Civil case No 3K-3-327-706/2016
By Audrius Žvybas, Senior Associate, Attorney-at-Law, law firm GLIMSTEDT
Teisininkai: Audrius Žvybas