D&O Germany: Liability of Directors for Prohibited Payments after Insolvency

The German D&O market is currently flooded with claims by insolvency administrators against directors of insolvent companies because of so called "prohibited payments (to creditors) after insolvency occurred”. The reason is not that there are statistically more insolvencies in Germany. It is just that insolvency administrators (“IA”) have increasingly become aware of the existence of D&O insurance and they have learned to play the “D&O-card”.

At the time insolvency proceedings are commenced, the court appoints an IA to represent the company. His principal duty is to liquidate the company's assets in order to satisfy the claims of the company’s creditors. Liability claims, which the company may have against former directors insured under a D&O policy, are of particular interest to IAs.

Usually IAs focus on liability claims for prohibited payments after insolvency as they are easy to prove and very difficult to defend for the following reasons:

1. German law requires directors to constantly monitor the financial situation of the company. As soon as insolvency occurs (over-indebtedness or illiquidity), directors have a maximum of three weeks to restore solvency and to restructure the company. If they fail to do so, they have to file for insolvency immediately. During this period, only payments by the company that are absolutely necessary for the continuation of the business are allowed. After the three week period, no more payments are permitted.
   
   
2. The term "payment" is not interpreted technically but widely, and may include every payment which reduces the company's assets. Furthermore, it does not only comprise outgoing payments, but under certain circumstances may include payments into a company's bank account with a negative balance.
   
   
3. Any payment which breaches this rule can result in directors being held liable, regardless of the fact that it may not even have caused damage to the company. The main reason for this strict approach is because all creditors must be treated equally. No creditor should be satisfied to the disadvantage of others, because the respective payment reduced the assets available for insolvency distribution. For example, a payment of £1,000 from a bank account to a creditor may free the company from a corresponding liability, i.e. it causes no damage to the company. However, it still reduces the assets available for distribution for which the director shall be liable.
   
   
4. Usually IAs have an advantage when it comes to knowing the financial position of the company. Moreover, from an ex post perspective it is easier to examine the moment insolvency occurred. Thus, in many insolvency cases, IAs will be able to allege that the company became insolvent months before the directors filed for insolvency, which will be backed by an expert opinion or by circumstantial evidence.
   
   
5. In order to defend the claims, directors will have to explain, for example why: (1) the company was not insolvent, (2) contrary to the general rule, individual payments were allowed (e.g. there was no reduction in the company's assets because the company received something of equal value in return), or (3) there are good reasons that the directors did not realise that the company had become insolvent (no default).
   
   
6. The details are complex and many relevant questions have not yet been answered by the German Courts. What is clear is that directors will not succeed in defending claims brought by IAs without the help of legal and financial experts, and without considerable financial funds to pay these experts.