Riding through the storm: duties of board members in times of crisis

This is, of course, a very difficult time for both individuals and businesses as they navigate deep waters of the on-going COVID-19 pandemic. Governments around the world have imposed measures to combat the spread of COVID-19, a number of which have had an immediate impact on the revenue of many companies. Even companies that are not directly affected by the measures are also starting to feel the strain from the economic slowdown caused by this crisis. The question for many companies in the Czech Republic, and beyond, is what are the obligations of the board to ensure the company remains on solid financial footing, and what are they obliged to do if serious commercial or financial problems are foreseen?

Ordinarily, directors have a statutory duty to promote the company’s success for the benefit of its shareholders. This includes a duty to avoid insolvency. If insolvency is luring behind the corner, such duty may lead to the board feeling compelled to take on riskier projects with the intention to maximize the shareholder value and keep the company afloat. However, such risky projects may potentially come at significant costs for their creditors, when they do not deliver the expected value. To protect stakeholders in this situation, Czech law prescribes that boards are obliged to convene a general meeting and propose a solution (e.g. additional (equity) funding or stand-still agreement) in case of impending insolvency.

If there is no apparent solution to the impending insolvency, then the company will most likely become insolvent. This is when the duties of the board typically shift towards the creditors of the company and under Czech law, the board will be obliged to file an insolvency petition (however, see below the caveat in relation to Lex COVID-19). Failing to do so would typically result in unlimited liability for the board members. This liability is significantly wider under Czech law than the English concept of wrongful trading. It may also lead to the directors being disqualified from taking up directorships in the future.

On the other hand, filing an insolvency petition if your company is not insolvent could make board members liable for damaging the reputation of the company and decreasing its value. Fortunately, the directors are not expected to have a crystal ball. However they are expected to show that their decision-making and future expectations were based on sound reasoning. This reasoning will typically be preceded by the board and its specialist advisers:

• identifiying the company’s options, including restructuring options;
• creating a stable environment for business to continue, and;
• identifying which stakeholders (shareholders and/or creditors) are key to delivering the modified business plan and working out how to obtain their buy-in.

To bring relief to companies and their boards in the current situation, the Czech Government has approved Lex COVID-19. The draft has been sent to the Parliament for approval and is expected to enter into effect within the next days. One of the implications of the law is that the statutory duty of the management to file for insolvency will be suspended if the insolvency has been predominantly caused as a result of the pandemic. The suspension is proposed to remain in place for six months following the termination of the current state of emergency, however not later than until 31 December 2020. Boards should be aware that their remaining duties, e.g. the duty to promote company’s success for the benefit of its stakeholders, shall remain in place in spite of the suspension.

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