The Bottom Line
- Heightened Personal Risk: Directors face a greater risk of being held personally liable for new financial commitments if they knew, or should have known, that bankruptcy was practically unavoidable.
- Limited “Business Judgment” Defense: The freedom to take entrepreneurial risks is not a blank check. This ruling narrows the scope of that defense for decisions made when a company is already in severe financial distress.
- Stronger Creditor Position: Creditors now have a clearer path to pursue directors personally if they can demonstrate that new obligations were taken on at a time when the company could no longer realistically meet them, thereby harming the interests of existing creditors.
The Details
This landmark decision from the ‘s-Hertogenbosch Court of Appeal provides a crucial clarification on directors’ liability in the “twilight zone” leading up to insolvency. The case involved the CEO of a struggling tech company who, despite clear signs of impending failure, entered into a significant new supply contract. When the company inevitably filed for bankruptcy weeks later, the new supplier was left with a substantial unpaid claim and subsequently sued the CEO personally, arguing that the contract should never have been signed. The lower court had initially dismissed the claim, citing the need to protect entrepreneurial freedom.
The Court of Appeal, however, overturned that decision, establishing a stricter standard. It reasoned that a director’s duties evolve as a company’s financial health deteriorates. While directors normally owe their primary duty to the company and its shareholders, this duty shifts towards protecting the interests of the collective creditors once insolvency becomes a near certainty. The court held that entering into new obligations that the director knows the company cannot fulfill constitutes a serious breach of this duty of care, effectively creating a new, preferred creditor at the expense of existing ones.
Crucially, the ruling distinguishes between legitimate, albeit risky, business decisions and actions taken when there is no reasonable prospect of recovery. The key test articulated by the court is whether a “reasonably prudent director,” facing the same financial information, would have concluded that bankruptcy was unavoidable and that the new commitment would likely go unpaid. By continuing to trade and take on new debt in such a situation, the director moves from calculated risk-taking to acting negligently towards creditors, thereby opening the door to personal liability for the resulting damages.
Source
Source: Gerechtshof ‘s-Hertogenbosch
