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Expanded Liability for Directors of Bankrupt Corporations

December 12, 2019

November 1, 2019, saw the coming into force of several amendments to the Bankruptcy and Insolvency Act (“BIA”). One notable change is the broadening of the scope of directors’ liability with respect to certain pre-bankruptcy transactions.

Previously, under section 101 of the BIA, directors faced potential liability in connection with the payment of dividends (other than stock dividends), and the redemption or purchase for cancellation of the corporation’s shares by a bankrupt corporation, if such a transaction took place within the year prior to bankruptcy and either (i) at a time when the corporation was insolvent or (ii) the transaction, rendered the corporation insolvent. Directors could raise a due diligence defence by showing that the corporation was neither insolvent at the time of the transaction nor rendered insolvent by it and that they had reasonable grounds to believe that.

The recent amendments expand the scope of liability such that directors are now potentially liable in the event that, within the one year period prior to bankruptcy, the corporation pays termination or severance pay or incentive or other benefits to any officer, director, or other person who manages or supervises the management of the corporation’s business. As was previously the case, for directors to be liable in respect of such transactions, they must have (a) occurred either at a time at which the corporation was insolvent or (b) rendered the corporation insolvent. Additionally, the payments in question must be conspicuously over fair market value and be made outside the ordinary course of business.

While the due diligence defence remains available to directors, the BIA continues to put the onus of proving (i) that the corporation was solvent at the time of the transaction and remained so after it; and (ii) that the directors had reasonable grounds to believe that this was the case, on the directors themselves.

It remains to be seen how trustees and courts will interpret this new provision, but it clearly calls for an added degree of caution on the part of directors of companies in challenging financial straits.

Tags: Litigation