The board’s responsibility in financial crisis – duty to act, measures and risk of personal liability under Norwegian law
When a company runs into financial difficulties, the demands on the board and management increase significantly. A board position may appear attractive, but entails considerable responsibility – especially when the finances are under pressure. This article provides an overview of the measures the board should consider in order to secure continued operations while at the same time avoiding personal liability.
This article is based on Norwegian law and primarily addresses the rules applicable to Norwegian private limited liability companies (aksjeselskaper – AS).
When a company enters into financial distress, the legal and practical responsibilities imposed on both the board and management become significantly more stringent. Even though a board position may often appear to be an attractive and influential role, it is important to be aware of the extensive responsibility that comes with the role. This responsibility becomes particularly apparent when the company risks losing control of its finances. In such situations, questions often arise as to which specific measures the board should implement to ensure continued operations while at the same time avoiding personal liability. Below, key aspects that the board should be aware of in a financial crisis are reviewed, as well as how best to navigate in order to protect both the company and themselves.
Increased responsibility in crisis situations
Even before a crisis arises, the board should establish good routines for financial reporting and oversight. This is not only important in order to avoid liability, but also to be able to intervene in time. When revenues fall and expenses increase, it becomes crucial to have control over liquidity. The board must regularly assess whether both liquidity and equity are sound, and it is not sufficient to wait until the annual financial statements are available. It is recommended to prepare realistic liquidity budgets and monitor these closely. The board should also be aware of how quickly it may become necessary to implement measures to secure the company’s finances.
In practice, it can be a difficult balancing act to determine how open one should be externally about the company’s problems.
- On the one hand, by being very open about financial difficulties, one risks that suppliers and creditors become uneasy and impose stricter conditions – for example by only delivering goods against advance payment.
- On the other hand, withholding material information may give rise to liability for damages. It is particularly dangerous if the company continues to enter into agreements that the board or management knows are unlikely to be fulfilled. The board should therefore communicate clearly about uncertainty factors when new contracts are entered into, without painting an unduly bleak picture. It is a matter of being honest and fair, while at the same time avoiding creating unnecessary panic among business partners. The board’s responsibility generally becomes stricter the more pressured the situation is – both because the risk of loss for creditors and employees increases, and because Norwegian law expects the board to act proactively to avert insolvency and, ultimately, bankruptcy.
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The board has a statutory duty to ensure that the company at all times has equity and liquidity that are sound in light of the risk and scope of the business (cf. the Limited Liability Companies Act Section 3-4). This means that the board must continuously monitor the company’s financial position. If doubt arises as to whether the company’s capital is sufficient, one cannot wait – the board must immediately assess the situation more closely.
If the board concludes that the equity is no longer adequately high, or perhaps completely lost, the so-called duty to act act (handleplikt) under section 3‑5 of the Norwegian Private Limited Liability Companies Act is triggered. The board must then, without undue delay, deal with the matter and within a reasonable time convene the general meeting. At the general meeting, the board must present an account of the company’s financial position and propose the necessary measures to restore sound equity. Typical measures may be to inject new capital (for example through a share issue or subordinated loan from the owners) or to reduce the company’s costs and obligations (sell assets, close down loss-making activities, etc.). If the board does not find any realistic measures that can remedy the situation, the legal requirement is that the board must propose that the company be dissolved.
It is important to note that the general meeting is formally free to decide what it wants to do with the board’s proposal. In theory, the owners may decide to continue operations without following the board’s recommended measures. But such a choice will be highly risky. The board has then fulfilled its duty by giving notice and proposing solutions; the ball is with the owners. If the owners choose not to implement the necessary measures, they may, in the worst case, incur liability – and the board members must then consider their position. To avoid personal liability, the correct course of action may be for the board to file for bankruptcy for the company if insolvency is a fact. Alternatively, board members may choose to resign from their positions if the general meeting overrules reasonable rescue proposals. It will not be responsible to remain on a board that is prevented from acting in a sound manner; passivity in such a situation may render the board members personally liable for damages at a later stage.
When the company is in a pressured situation, the board’s work must be intensified. Board meetings should be held more frequently than normal – perhaps monthly or more often, depending on how quickly the situation is developing. In these meetings, the board must assess updated financial information, liquidity forecasts, new risks that have arisen, and the progress of any measures that have been initiated.
It is absolutely crucial that all of the board’s assessments and decisions are documented carefully. The minutes of the board meetings must be written in a detailed and precise manner. In retrospect, such minutes may become important evidence that the board in fact acted responsibly and did what it could, at the right time. Imagine a scenario where creditors or others later question the board’s decisions: in that case, good minutes, written reports and documentation of the assessments that were made will be the board’s best defence. It is better to document too much than too little. Ensure that all communication about important decisions – both internally within the board and between the board and the owners – takes place in writing or is confirmed in writing afterwards.
Another aspect of sound board work is to involve the necessary expertise when needed. In a crisis, it may be appropriate to consult the auditor, the accountant or external advisers (for example insolvency lawyers) to obtain a clear picture of the situation and possible solutions. Seeking external advice shows that the board is taking the situation seriously and is willing to do what is required to act correctly.
When a company encounters serious financial problems, the board must diligently explore all possibilities to avoid bankruptcy. Typically, a combination of several measures will be considered. Here are some instruments the board and management should consider:
- Strengthen liquidity: Contact the company’s banking relationships to explore the possibility of increased credit or loan facilities. An overdraft facility or short-term loan can provide breathing space. Be open with the bank about the challenges – they will often cooperate to find a solution rather than risk a loss in a bankruptcy.
- Owner contributions: Ask the current owners/shareholders whether they are able to provide funds. This may take place by the owners granting a short-term loan to the company, or injecting new share capital through a share issue. Existing owners often have a self-interest in saving the company if their values are at stake.
- Cut costs quickly: Review the cost structure critically. Where can savings be made immediately? Relevant steps may include temporary lay-offs of employees, reduction of payroll costs (for example temporary pay cuts or voluntary agreements on reduced working hours), as well as general downsizing or restructuring of operations. It may be necessary to put certain projects on hold, or close down departments, in order to reduce expenses to a level adapted to the declining income.
- Negotiate with creditors: Contact suppliers, landlords and other creditors to try to renegotiate payment terms. In a crisis, it may, for example, be possible to obtain deferrals of due dates, enter into instalment plans, or obtain discounts in return for prompt payment of part of the outstanding amount. Many creditors would rather ease the terms than see a good customer go bankrupt – provided a credible plan is presented. Be honest about the situation and show how the creditors will benefit from a solution (e.g. that they will receive settlement, albeit later, instead of standing in a queue of claims in a bankruptcy).
- Debt negotiations/restructuring: If the above measures are not sufficient, the board should consider formal debt negotiations. This may be done in two ways – either voluntarily or through the courts. Voluntary debt negotiations mean that the company itself agrees with its creditors on an arrangement (for example that the debt is repaid over time or partially forgiven) without the involvement of the courts. Court-supervised debt negotiations involve making use of the possibilities in the bankruptcy legislation for reconstruction (previously called debt negotiations via the district court). Reconstruction can give the company temporary protection against bankruptcy while an agreement with creditors is negotiated. The board must seek assistance from a lawyer/reconstruction practitioner to carry this out, and it usually requires that a realistic survival plan can be presented that a majority of the creditors will support.
In reality, several of these measures will have to be implemented in parallel in order to succeed. A single isolated solution is rarely sufficient in a serious crisis. The board should prepare a comprehensive action plan. For example, the plan may start with immediate measures (cost cuts and credit agreements), then temporary measures (lay-offs, deferred payments), and at the same time long-term steps (capital injection, restructuring processes. Throughout, the effect of the measures must be continuously monitored. If, after a short period, it becomes apparent that the situation is not improving sufficiently, the board must be willing to escalate the efforts – either by trying new combinations of measures, or recognising that bankruptcy is unfortunately unavoidable and filing for bankruptcy. Dragging out time without progress benefits no one; on the contrary, it may increase the personal liability of the board if a necessary bankruptcy petition is delayed.
The board is also responsible for ensuring that the measures adopted are in fact implemented in practice. It is of little use to pass resolutions on cost cuts if no one follows up to ensure that the costs are actually reduced. In times of crisis, the board must “ensure that words are turned into action” – either through the general manager or by involving itself more closely in the implementation. Follow-up and control of the measures implemented should be a standing item on the agenda of every board meeting going forward.
Advice to protect the company and the board members
In summary, there are some key principles and pieces of advice the board should follow to give the company the best chance of surviving a crisis, while at the same time enabling the board members to protect themselves against personal liability:
- Have continuous oversight of the finances: Monitor liquidity, revenues, expenses and forecasts closely. If you detect negative trends, take action early – do not wait. Early warning and intervention can be the difference between saved operations and bankruptcy.
- Implement measures proactively: As soon as you see that the equity or liquidity may become unsound, discuss possible measures. Even smaller adjustments implemented early can avert greater problems later. Be forward-looking – it is easier to steer the ship before it hits the iceberg.
- Document everything thoroughly: Ensure written resolutions, justifications and minutes for all important decisions. Systematic documentation will show afterwards that the board acted responsibly and on the basis of the information it had. This protects you if liability later becomes an issue.
- Avoid new high-risk commitments: Do not incur new major obligations for the company (new loans, expensive agreements, etc.) unless you are reasonably certain that the company can fulfil them. It may be tempting to “bet” on a rescue contract, but if you are in doubt as to whether it can be borne financially, you should refrain. Acting recklessly when you are already struggling can trigger personal liability for damages.
- Communicate strategically and honestly: Be open with key stakeholders (banks, key suppliers, employees) that the situation is challenging, but also communicate that the board has a plan. Openness combined with a credible plan creates trust. Do not conceal critical information from contractual counterparties – they must be told if the company’s ability to perform is uncertain. At the same time, avoid unnecessarily negative signals externally that may trigger panic. It is a balancing act, but the key is orderly and realistic communication.
- Comply with the statutory duty to act if the equity becomes unsoundly low.
- Ensure implementation or face the consequences: After the general meeting – make sure that something actually happens. Approved capital contributions must be paid in, a planned downsizing must be implemented quickly, etc. If the owners are unwilling or unable to carry out the necessary steps, the board must take responsibility for not continuing to run the company on the wrong basis. This means considering filing for bankruptcy (bankruptcy petition) in time, or resigning from the board position if you are prevented from acting responsibly. It is hard to give up, but sometimes the right thing for the board to do is to stop further operations in order to avoid worsening the situation further.
Ultimately, the board’s responsibility is real and extensive. In times of crisis, it is more important than ever to be active, knowledgeable and responsible board members. It is far better to err on the side of caution than to be criticised afterwards for passivity. By following the advice above, the board helps ensure that the company can get through a demanding period in the best possible way – while at the same time reducing the risk, under Norwegian Law, of becoming personally liable for any losses.
