Trustees stress board directors must understand legal obligations amid insolvency surge

With Canada soon to endure a surge in insolvencies, board directors need to know their obligations and potential liabilities when managing an insolvent corporation, say two insolvency trustees.

The current global economic decline; cessation of COVID-19 financial supports; interest-rate hikes; inflation; soaring energy costs; supply chain, production, and labour problems; and a dip in M&A activity are the ingredients for a rise in insolvencies in 2023, say Bryan Tannenbaum and Daniel Weisz. They say that board directors must be aware of the impact this “perfect storm” has on their corporation because insolvency will add to their responsibilities as directors.

Tannenbaum and Weisz are licensed insolvency trustees and partners in the restructuring and recovery practice at RSM Canada, an audit, tax, and consultancy firm focused on middle-market companies.

Many assumed insolvency trustees would be kept busy during the height of the pandemic, says Tannenbaum. But low-interest rates and COVID assistance such as the Canada Emergency Response Benefit (CERB) meant the opposite. With that buttress removed, the Office of the Superintendent of Bankruptcy Canada found that Canadian insolvencies were up 22.5 percent, year-over-year, last September.

“I’ve been through a number of these ups and downs, and I’ve not seen anything like this,” says Tannenbaum. “It’s certainly different.”

“I believe that it’s going to be a busy time for restructuring.”

As management steers the ship through choppy economic waters, directors have a duty to the companies “to be seen to be acting prudently,” says Weisz.

“As an overseer of management, their responsibility is to ensure that the company – if it is potentially facing insolvency headwinds – is addressing the various issues and making sure that management is positioning the company in a way that will assist them to ride out the storm,” he says.

Boards face the difficult task of protecting the interests of a company’s stakeholders when stakeholders include the company, its creditors, shareholders, and, sometimes, customers, say Tannenbaum and Weisz. The interests of these various parties will not always converge.

Generally, board directors’ obligations include a duty of care and loyalty to the corporation. Boards must act within their given authority and may be personally liable for resulting losses if they step outside of it.

The line between solvency and insolvency may be challenging to discern. Still, once directors become concerned it is approaching, they must ensure they are not breaching their fiduciary duties, they say. Once insolvent, a company’s “primary stakeholders” are its creditors, not its shareholders.

Companies should not trade if they know they are insolvent, and it is “incumbent on the board” to ensure they do not, says Tannenbaum. He says that when companies become financially strained, short-term cash-flow projections are essential to ensure adequate liquidity to meet the corporation’s daily liabilities.

The board should also assess their D&O insurance, looking at potential sales, mergers, and independent professional advice.

In the event of insolvency, some unpaid bills could also come from the board directors’ pockets, say Tannenbaum and Weisz. These include “payroll source deductions, wage arrears, vacation pay, harmonized sales tax, provincial sales tax, environmental obligations, pension benefits and income tax,” but may vary depending on the jurisdiction.

Also relevant are the applicable securities laws and their prescribed directors’ responsibilities regarding “misleading information, material misstatements, and the disclosure of material facts” and insolvency laws determining dividend and creditor payments and timeframes. Tannenbaum and Weisz add that directors are entitled to “retain resources” to help them meet these responsibilities, including from professional restructuring advisors.

“Boards have to be more proactive and have to be on top of things,” says Tannenbaum. “Given the environment today, in many respects, you can’t lag. You have to be ahead of the game.”

“For the most part,” adds Weisz, “when directors volunteer to accept those types of positions, they never really sign up to deal with an impending insolvency. Oftentimes, when they do sign up to be a board member, they’re not aware that that may be the road that the company ends up going on.

“As a result, board members need to take whatever steps – including seeking professional legal and restructuring advice – in order to not only assist the company but to relieve some of the stress that the directors may be feeling as a result of where the company is at.”