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 Lithuanian laws on this matter.

The principal rule of the liability of the directors

Director (in Lithuania: “direktorius”) under Lithuanian laws is only a sole management body (general manager): director of a limited liability company („UAB”), public company („AB”), general partnership („TUB”), personal enterprise (individuali įmonė), limited liability partnership (Mažoji bendrija) or limited partnership („KUB”). Also general manager may be a member of management board, but the management board and its members (except when member thereof is general manager) cannot act as general manager and fulfil duties of this sole management body.

The general rule of liability for a director (sole managing body) is that the director must act in good faith and reasonable manner in respect of the legal person according to Civil Code of Republic of Lithuania § 2.87(1).

A member of  a managing body of a legal person (including director) who fails to perform or performs improperly his duties specified in legal acts or incorporation documents must compensate all damage incurred by the legal person except as otherwise provided by law or incorporation documents.

Diligence that is normally expected from a director is determined on case-by-case basis. According to court practice, directors are treated as persons who are subject to higher standards of care and diligence than ordinary persons subject to the duty of care (bonus pater familias).

Special liability regime for directors in threatening insolvency

In case of threatening insolvency obligation to act in good faith and reasonable manner in respect of the legal person does not change, i.e. it still applies. Moreover circumstances of threatening insolvency also create obligation to act in favour of creditors of the legal person.

Therefore in such situation director is obliged to

1) immediately initiate insolvency proceedings of the legal person (bankruptcy or restructuring (if it is possible to restructure the legal person);

2) safeguarding the assets of the legal person so that it could be used to fulfil obligations to the creditors to the greatest extent possible;

3) carry activities of the legal person in a way that benefits creditors, i.e. increases the chances of fulfilling obligations to the creditors  to the fullest extent possible.

When will a threatening insolvency situation occur?

Law on Insolvency of Legal Persons of the Republic of Lithuania does not contain specific provisions related to threatening insolvency.

According to Law on Insolvency of Legal Persons of the Republic of Lithuania a director is obliged to initiate insolvency proceedings when legal person becomes insolvent, i.e.

1) the legal person is unable to fulfil its property obligations, including financial obligations, in time or

2) the obligations of the legal person exceed the value of its assets.

The same obligation is applied to the liquidator of the legal person.

In case of breach of indicated duties, the insolvency administrator on behalf of an insolvent legal person or creditors thereof can claim compensation of losses caused by non-performance or improper performance of such obligations, for an example, compensate the increase in claims which arose from the moment when the legal person became insolvent and director was obliged to initiate insolvency proceedings until the moment when such a procedure was initiated.

Obligation to submit a timely bankruptcy declaration is set out to hold creditors harmless from kinds of damage:

1) a timely bankruptcy declaration protects the assets of the company and therefore secures the claims of the creditors,

2) a timely bankruptcy declaration secures that an insolvent company does not engage in economic activities and does not acquire obligations from creditors.

Moreover the court has the right to restrict the right of the director (from 1 to 5 years) to be appointed and hold the position of the director of a public and / or private legal person, or to be a member of a collegial management body.

Does this wrongful trading liability apply to persons other than the directors?

This liability applies first and foremost to the director. The court may also apply it to the members of the management board and/or the shadow directors as well.

This liability does not apply to the employees of the company, except if they are shadow directors.

Who is a shadow director?

The law does not stipulate a definition of a shadow director. Nevertheless, according to the court practice, the criteria for recognizing a person as a shadow director, i.e. person who has not been officially appointed as the director of the company, are:

1) performance of the management function (including giving mandatory instructions to formally appointed management bodies);

2) indicated management is of a permanent nature – shadow director systematically performs actions that are characteristic to the director of the legal person according to the laws and the founding documents.

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.

To objectively determine, whether a company is in threatening insolvency, multiple factors must be considered. Also, certain aspects must be taken into accounts, such as the volatility of the market, flaws in the management of the company, the insolvency of the company’s debtors, or other factors causing the company to fail to perform its obligations.

Summary

Law on Insolvency of Legal Persons of the Republic of Lithuania does not contain specific provisions related to threatening insolvency.

In case of threatening insolvency obligation to act in good faith and reasonable manner in respect of the legal person does not change, i.e. it still applies. Moreover circumstances of threatening insolvency also create obligation to act in favour of creditors of the legal person.

In case of breach of this obligation, the insolvency administrator on behalf of an insolvent legal person or creditors thereof can claim compensation of losses caused by non-performance or improper performance of such obligations, for an example, compensate the increase in claims which arose from the moment when the legal person became insolvent and the director was obliged to initiate insolvency proceedings until the moment when such a procedure was initiated.

A shadow director may also be liable for a breach of this duty.

This overview was prepared by our senior associate Kazimieras Karpickis and associate Greta Kubiliūnaitė who are happy to help you in case of any additional questions. Our regional COVID-19 task force is also at your disposal.