Liability for debts

Directors’ liability for the Company’s debts

The Directors' liability for company debts (Liability for Debts) is perfectly consolidated in the Spanish Jurisprudence.

In every economic crisis, thousands of debtor companies close, whether in bankruptcy, dissolved, liquidated or simply abandoned. In such cases, creditors sue the debtor companies. And in many cases, the result is unsuccessful. All this, without ignoring the frustration, in many cases the feeling of deception, of overconfidence… And also, the costs and the long waiting of a whole judicial procedure.

This is aggravated in those cases where creditors are aware that the administrators did nothing to prevent it. Or even that the result is the consequence of a deliberate plan. In some cases, even the debtors have benefited from it. And the hardest thing to deal with: in some cases, the debtors start the same activity with another company. With the frustrating surprise that they now have personal assets far in excess of the amount owed by the company.

What can be done about these situations of default by the administrators? Will the creditors have to give up collecting their credit for the dissolution of the debtor company?

There is, fortunately, a way for the creditor to claim the company’s debts from the directors. However, this is only possible if a series of requirements are met and if said directors have not fulfilled their responsibilities.

In order to understand these mechanisms, we will study in this paper the regulation and the actions that can be taken against the directors.

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1-     The individual liability action against the Directors

To initiate this individual action the company has to be immersed a cause of dissolution. And that despite incurring in a dissolution clause, the company remains active for commercial purposes.

In accordance with Article 363 of our Corporate Enterprises Act:

Article 363. Causes for dissolution

“1. A corporate enterprise shall be dissolved:

a) Upon interruption of the activity or activities that constitute its corporate purpose; in particular, inactivity for over one year shall be deemed to constitute interruption.

b) Upon termination of the mission that constitutes its corporate purpose;

c) Where achievement of the corporate purpose is manifestly impossible.

d) Due to governing body standstill, rendering it impossible to conduct business.

e) Due to losses that reduce its equity to an amount lower than one half of the share capital, except where the capital is increased or decreased as required and application for insolvency protection is not warranted;

f) Due to a capital reduction to a sum below the legal minimum, except as in compliance with a legal provision.

g) Because the par value of non-voting stakes or shares exceeds one half of the paid-up capital and the due proportion is not recovered within two years.

h) For any other cause established in the by-laws”.

It is more than likely that the company, at the time of the start of the defaults, has incurred some cause of these causes of dissolution. And that the administrator, being aware of this, has not avoided it by adopting the appropriate measures.

This leads us to the provisions of Article 367 concerning the joint and several liability of directors:

“Article 367. Joint liability of the directors

  1. Directors who fail to convene the mandatory general meeting within two months to adopt a decision on dissolution shall be jointly and severally accountable for corporate obligations incurred after the legal cause for dissolution is forthcoming. Directors who fail to apply for a court ruling to dissolve the company or, as appropriate, to institute insolvency proceedings within two months of the date scheduled for the meeting, if not held, or from the day of the meeting, if the dissolution proposal is defeated, shall be equally liable.

  2. In such cases, corporate obligations constituting the object of claims shall be regarded to be subsequent to the legal cause for dissolving the company unless the directors can substantiate that they are dated prior thereto”.

2- How does jurisprudence apply these articles?

While the previous articles seem clear, the important thing is to know when that responsibility is born. And on the other hand, if it affects, in order to exercise the individual action, the creditor’s knowledge of the company’s insolvency.

The jurisprudence reiterates that the birth of this responsibility operates when there is a cause of dissolution. And not when the debt arises, without prejudice to the fact that this is subsequent to the cause of dissolution for losses. The Supreme Court, in a recent Order dated September 12, 2018, insists on this:

“[…] The most recent doctrine of this chamber is expressed in STS 144/2017 of 1 March (RJ 2017, 676)[…]:

[…] The judgments of this Chamber 246/2015 of 14 May and 456/2015 of 4 September determined the relevant time milestones for the exercise of the social administrator’s liability action for social debts. They declared these sentences:

[…] the responsibility of the administrators for the social debts is born : (i) when a cause for dissolution exists and not when the debt is incurred, even if such debt subsequently gives rise to the cause of dissolution by loss (therefore, the administrator against whom the action is directed cannot be the one who was in office when the debt was incurred, but the one who was in office when the cause for dissolution was incurred and who did not fulfil the duties of promoting the dissolution); (ii) the Meeting has not been convened within two months to adopt the resolution of dissolution or any other resolution to restore the balance of the assets; and (iii) the judicial dissolution has not been requested within two months from that date. […]

“Since the cause for dissolution occurred after the entry into force of Law 19/2005 of November 14 (RCL 2005, 2199), article 105.2 LSRL (RCL 1995, 953) is applicable in the wording given by this Law”.

“3.- The issue at stake in the appeal of what criterion should be used to consider that the social obligation is prior or subsequent to the legal cause of dissolution, is the moment of the birth of the obligation or the time when the obligation is due, liquid and enforceable. (…)”

“This criterion is in line with the one followed by this Chamber to attribute to the corporate director joint and several liability for the existing corporate obligations while his position is in force, and, on the contrary, not to attribute him liability for the obligations arising after he has ceased to hold office, despite the fact that the breach of the duty to promote the dissolution and liquidation of the company due to a legal cause for dissolution has occurred while his appointment was in force (rulings 585/2013 of 14 October and 731/2013 of 2 December).”

“Therefore, it is not necessary that the debt is due and liquid and enforceable, because if the obligation arose while the director was in office, he is jointly and severally liable with the company, even if he left office before the obligation was due and liquid and enforceable (…)”.

On the other hand, regarding the creditor’s knowledge of the company’s difficult situation, it seems that nothing is affected. The mere knowledge of the insolvency does not imply bad faith that makes it impossible to exercise the action of liability. The exception is when the creditor who intends to bring the action is or has been the director of that company. Supreme Court Decision No. 1314/2018 reads as follows:

“In ruling 733/2013, of 4 December, although we admit that there may be cases in which the claim for this responsibility, in view of the concurrent circumstances, would be contrary to the requirements of good faith, we make it very clear that “the mere knowledge of the situation of economic crisis or insolvency of the company on the part of the creditor at the time his credit is generated does not deprive him of the right to bring the action for liability provided for in article 262.5 of the Consolidated Text” (…)

“Without prejudice to the fact that in some cases, and due to the concurrence of other circumstances (such as those described in the Ruling of 1 March 2001, in which the creditor who exercised the action was a partner and had been an administrator of the company at the time the credit claimed was generated, or in Ruling 395/2012, of 18 June, in which the creditor who exercised the action was a co-administrator who also held 40% of the share capital), If it can be understood that the exercise of the action by a creditor is an act contrary to the requirements of good faith, it must be remembered that mere knowledge of the economic crisis or insolvency of the company by the creditor at the time his credit is generated does not deprive him of the right to exercise the action for liability provided for in Art. 262.5 of the consolidated text. On the contrary, when contracting in these circumstances, the creditor is aware of the legal guarantee that the above-mentioned provision makes the administrator jointly and severally liable for payment of the credit because he did not promote the dissolution, if there was a legal cause for doing so”.

Therefore, they could not only exercise the direct action when the creditor exercising this action has been the partner. Or the creditor has been the director of the company at the time when the claimed credit was generated. In these cases, the Supreme Court understands that the exercise of this action constitutes an act contrary to the requirements of good faith.

Finally, it is interesting to underline in this article that these responsibilities against the directors should not be extended without limit. Otherwise, it would go against the basic corporate principles of capital companies. Moreover, it is unfeasible to connect the liability of the director with the objective fact of breach of the contractual relations of the company. The recent Ruling of the Supreme Court, number 60/2019, leaves no doubt about this:

“However, Judgment 242/2014 of 23 May (RJ 2014, 2943) warns of the risk, which must be avoided, of indiscriminately extending the contractual liability assumed by the company to its directors, in the event of non-compliance by the company:

“It is not possible to apply indiscriminately the individual liability of directors for any breach in the framework of the obligatory relationships arising from contracts, since, as this Chamber has pointed out [STS 30 May 2008 (RJ 2008, 3192)] it would mean forgetting and going against the fundamental principles of capital companies, such as their legal personality, their autonomy in terms of assets and their exclusive responsibility for corporate debts, or forgetting the principle that contracts only produce effect between the parties that grant them, as proclaimed in art. 1257 CC.”

“The liability of the directors cannot in any case be connected to the objective fact of the non-fulfilment or defective fulfilment of the contractual relations, becoming guarantors of the social debts or in cases of failure of the company that have derived in economic disorders that, in case of insolvency, can trigger other type of responsibilities in the framework of other and other rules”.

“And it is precisely for this reason that it could happen that, even if there was a breach by the promoter company of the obligation to provide an individual guarantee, its director would not have incurred in any liability, as it was proved that there was no breach of his duties of diligence. That must be the conduct subject to prosecution in an individual liability action: not the contractual breach of the company, but the breach of the duties of diligence of its director in relation to the fulfilment of a serious legal requirement, in accordance with the aforementioned case law”.

3 – Conclusions

In conclusion, it should be noted that:

  • There are mechanisms that allow the creditor to claim the company’s debts from the directors.
  • For this, it will be necessary for the society to be in cause of dissolution. And that despite incurring in a clause of dissolution, the company remains active, for commercial purposes.
  • The origin of that responsibility operates when a cause for dissolution is present and not when the debt is incurred. If the obligation arises while the director is in charge, he is jointly liable with the company. The origin of that responsibility operates when a cause for dissolution is present and not when the debt is incurred. If the obligation arises while the director is in charge, he is jointly liable with the company.
  • The individual action may be brought even if the creditor was aware of the difficult economic situation of the company. But it cannot be exercised if the creditor is or has been a director or partner of the company. To accept this would be contrary to the requirements of good faith.
  • It should be noted that these liabilities against directors have limitations and should not be confused with those against the company.

If this article has been of interest, we also suggest you to read the following article published on our website:

A Practical Guide to Directors Liability

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