Generally speaking, wrongful trading is the special form of liability where a director of a company is liable for damages towards the creditors for the mismanagement of an insolvent company.
A special feature of the wrongful trading concept is that it may give rise not only to the liability of the director of the company but also to the liability of the director, management, employee of the parent company or even of the grandparent company (so called shadow director).
The pandemic and the related measures taken to restrict social contacts are challenging many businesses. In this summary we would like to draw your attention to the above special aspect of the situation: executives of foreign parent companies can potentially be held liable under the laws of Baltic/CEE/SEE countries for certain acts and decisions relating to their Baltic/CEE/SEE subsidiaries.
Please see below an overview of Latvian laws on this matter.
The principal rule of the liability of the directors
Directors under Latvian law are: Members of the management board (in Latvian: valdes locekļi) of a limited liability company („SIA”), members (in Latvian: biedri) in an unlimited partnership („PS”) or limited partnership („KS”) members of the management board (valdes locekļi) of a joint stock company („AS”)., in certain cases – the members of the supervisory board (in Latvian: padomes locekļi) of SIA or AS.
The principal rule according to the Latvian Commercial Law is that a director (or directors) must act as decent and careful manager in the interests of the company. A director (or directors) is liable for losses that he/she has produced to the company, unless he/she can prove that he/she acted as a diligent and careful manager. Several directors have joint liability. At the same time, the liability directors is assessed, taking into account the division of roles within the board and the tenure of each director. Even a slight carelessness may lead to the liability. A member (or members) of the management board is liable to third parties (creditors) if the company itself (in insolvency – an insolvency administrator on behalf of the company) fails to bring a claim.
Special liability regime for directors in threatening insolvency
Director (or directors) must take care about safeguarding the assets for the creditors as well as timely apply for insolvency of the company. Additionally, both director (or directors) and any other responsible representative must be able to transfer the books and assets of the company to the insolvency administrator, should insolvency proceedings of the company be started. The director (or directors) who are management board members are jointly liable for losses caused to the company in case they fail to transfer the books to the insolvency administrator, or, if the condition of the books does not allow to obtain a clear understanding of the company’s transactions and assets in the three years prior to the commencement of insolvency proceedings. The Insolvency Law contains a presumption that the losses are in the amount of the accepted principal claims of the creditors.
When will a threatening insolvency situation occur?
The Insolvency Law of Latvia does not contain specific provisions related to threatening insolvency. Pursuant to the Insolvency Law, the directors of the company must file for insolvency in case the company has not fulfilled its debt liabilities due for more than two months. In addition, liquidators of a company in liquidation must file for insolvency in case the company lacks assets to satisfy all substantiated creditors’ claims in the course of liquidation and, the directors of a company undergoing legal protection proceedings (restructuring proceedings) must file for insolvency in case the company cannot settle liabilities provided in plan of measures of the legal protection proceedings.
What are the legal consequences if the director breaches the special duty described in section 2?
The insolvency administrator on behalf of an insolvent company can claim compensation of losses. As mentioned above, in case of failure to transfer the books of the company to the insolvency administrator the Insolvency Law contains a presumption that the losses are in the amount of the accepted principal claims of the creditors.
Does this wrongful trading liability apply to persons other than the directors?
The liability for losses may apply to any person who wilfully influences director, supervisory board, procurator or authorised person to act against the interests of the company.
Who is a shadow director?
The law does not stipulate a definition of a shadow director. Any person who wilfully influences member of the management board, supervisory board, procurator or authorised person to act against the interests of the company may be considered as a “shadow director” for the purpose of claiming losses, except if such person votes at the shareholder’s meeting or legitimately exercises its influence according to the Law on Group of Companies.
How to determine if the company is in a threating insolvency?
Any of the circumstances that are described in response to question No 3 will indicate that the company is in a threatening insolvency.
A director is presumed to know if and when the company is in a threatening insolvency state therefore he or she must be able to substantiate any decision and action thus demonstrating that he or she is acting as a diligent and careful manager, or else he or she may be liable for losses either to the company or its creditors. The shareholders or any other persons must not influence a director, procurator or any authorised person to act against the interests of the company or else they may become liable for arisen losses. We suggest therefore a careful and considered action, regular cash flow monitoring and sensitive treatment of decision-making in each cases if the Latvian subsidiary faces or may face liquidity turbulence or payment difficulties.
This overview was prepared by our senior associate Edvīns Draba and counsel Raivo Raudzeps who are happy to help you in case of any additional questions. Our regional COVID-19 task force is also at your disposal.