When a company runs into difficulties: how the position of the management body changes
Financial difficulties in a company are not merely an economic problem. Beyond a certain point, they trigger specific legal duties on the part of the management body and substantially alter its position. The relationship between losses, cash-flow strain, grounds for dissolution, likelihood of insolvency and insolvency properly so called marks out different thresholds for action. The “Ley de Sociedades de Capital” —the Spanish Companies Act, the LSC— and the “Ley Concursal” —Spain's Insolvency Act— impose duties to convene a general meeting, to promote dissolution or to petition for insolvency proceedings, and the preventive restructuring regime introduces the likelihood of insolvency as a category in its own right. Proper documentation of the management body's decisions and early action widen the alternatives for preserving the business and significantly reduce liability risks.
1.From losses and cash-flow strain to grounds for dissolution
In a capital company, losses and cash-flow strain are commonplace features of business life. Not every loss, and not every liquidity difficulty, amounts to a ground for dissolution or to insolvency. Article 363 of the “Ley de Sociedades de Capital” —the Spanish Companies Act, the LSC— sets out the grounds for dissolution. Among them, letter e covers losses that reduce net assets to less than half the share capital, unless the latter is increased or reduced to a sufficient extent, and provided that it is not appropriate to petition for a declaration of insolvency. Letter d adds the paralysis of the company's governing bodies such that they cannot function, and other letters cover cessation of activity, completion of the corporate object, the manifest impossibility of achieving the corporate purpose, the reduction of capital below the statutory minimum and an excess of non-voting shares or quotas —“participaciones”—.
The existence of a ground for dissolution is not a mere accounting fact; it triggers specific duties on the part of the management body. Article 362 provides that capital companies are to be dissolved where a ground laid down by law or by the articles exists and has been duly established by the general meeting or by a court decision. Article 365 imposes on directors the duty to convene the general meeting within two months from the date on which a ground laid down by law or by the articles arises, so that the meeting may adopt the resolution to dissolve or, if it appears on the agenda, those resolutions needed to remove the ground. Article 366 adds that, where the meeting is not convened, is not held or does not adopt any of the resolutions contemplated, any interested party may apply for judicial dissolution, and that the directors are obliged to apply for it where the shareholders' resolution is against dissolution or cannot be obtained.
Breach of these duties has severe consequences. Article 367 provides that directors who fail to comply with the obligation to convene the meeting or to apply for judicial dissolution are jointly and severally liable for the company's obligations arising after the ground for dissolution came about. That liability extends to de facto directors and to those holding senior management powers. The provision includes an important exemption: directors are not liable for subsequent debts if, within two months from the date on which the ground arose, they have notified the court of the existence of negotiations with creditors with a view to reaching a restructuring plan or have petitioned for a declaration of insolvency. If the restructuring plan is not reached, the two-month period resumes from the moment the notification ceases to produce effects.
This shows that the step from economic difficulties to a ground for dissolution is a clear legal threshold. Once it is crossed, inaction on the part of the management body ceases to be an option and becomes a source of personal liability.
2.Likelihood of insolvency, imminent insolvency and actual insolvency
The “Ley Concursal” —Spain's Insolvency Act— introduces further categories that refine the analysis. Article 2 defines the objective precondition for insolvency proceedings. Insolvency may be actual or imminent. A debtor is in a state of actual insolvency where it cannot regularly meet its obligations as they fall due. A debtor is in a state of imminent insolvency where it foresees that within the following three months it will be unable to meet its obligations regularly and punctually. The likelihood of insolvency, a category developed in the 2022 reform, refers to a debtor that will be unable to meet the obligations falling due over the next two years, and serves as the precondition for preventive restructuring plans.
The likelihood of insolvency and imminent insolvency do not in themselves trigger the duty to petition for insolvency proceedings, but they do open the door to pre-insolvency instruments. Article 585 allows the debtor, a natural or legal person carrying on a business or professional activity, to notify the court of the opening of negotiations with creditors, or of the intention to begin them immediately, with a view to reaching a restructuring plan that makes it possible to overcome the situation. That notification may be made where there is a likelihood of insolvency, imminent insolvency or even actual insolvency, provided that a petition for creditor-initiated insolvency proceedings —a “concurso necesario”— has not been admitted for processing. The notification produces significant effects on individual enforcement actions and on directors' duties, and is coordinated with the exemption under article 367 of the LSC.
Actual insolvency, by contrast, does trigger the duty to petition for insolvency proceedings. Article 3 of the Insolvency Act provides that a debtor in a state of insolvency must petition for a declaration of insolvency. The petition must be founded on the debtor being in a state of insolvency, and article 6 requires it to be filed through a “procurador” —a court representative— and a lawyer, accompanied by a report, an inventory, a list of creditors and, where applicable, information on employees. Failure to comply with the duty to petition in time may have consequences for the classification of the insolvency as culpable and for the liability of the directors.
The insolvency reform has also introduced a special procedure for micro-enterprises, applicable to debtors facing a likelihood of insolvency, imminent insolvency or actual insolvency. Article 686 imposes on the debtor the duty to apply for the opening of the special procedure within the two months following the date on which it became aware, or ought to have become aware, of the state of actual insolvency, and presumes such awareness where any of the facts indicative of a state of insolvency has occurred.
The relationship between grounds for dissolution and insolvency is a close one. Article 363 e of the LSC makes dissolution for losses conditional on it not being appropriate to petition for a declaration of insolvency. This means that, where the losses are the expression of actual insolvency, the appropriate route is insolvency proceedings and not corporate dissolution. The management body must assess, with diligence, whether the difficulties can be redirected through corporate measures or whether a state of insolvency has been entered into that requires recourse to insolvency proceedings or to restructuring.
3.Duties of care and loyalty in situations of crisis
Running into financial difficulties does not suspend the general duties of directors; it intensifies them. Article 225 of the LSC lays down the general duty of care. Directors must discharge their office and comply with the duties imposed by statute and by the articles with the diligence of an orderly businessperson, having regard to the nature of the office and the functions attributed to each of them. They must devote adequate time to the role and adopt the measures necessary for the sound management and control of the company. In the discharge of their functions, they have the duty to require and the right to obtain from the company the appropriate and necessary information to enable them to comply with their obligations.
Article 226 introduces the protection of business judgement. In the field of strategic and business decisions, which are subject to discretion, the standard of care is taken to be met where the director has acted in good faith, without a personal interest in the matter, with sufficient information and in accordance with an appropriate decision-making procedure. This rule is particularly relevant in situations of crisis, where decisions on restructuring, financing, the sale of assets or the entry of new shareholders are strategic and may be questioned after the event. Documenting the information obtained, the alternatives considered and the procedure followed is key to benefiting from this protection.
The duty of loyalty, set out in article 227, requires directors to discharge their office with the loyalty of a faithful representative, acting in good faith and in the best interests of the company. Breach of the duty of loyalty gives rise to the obligation to compensate the harm caused to the company's assets and to return any unjust enrichment obtained. Article 228 specifies basic obligations flowing from the duty of loyalty, such as not exercising powers for purposes other than those for which they were granted, keeping confidential information secret, refraining from taking part in decisions in which there is a conflict of interest, discharging their functions with personal responsibility and independence, and adopting measures to avoid situations of conflict.
In a crisis, these duties bear on decisions such as the choice of advisers, negotiation with creditors, the choice between restructuring and liquidation, the sale of business units or the adoption of employment measures. Loyalty requires the company's interest to be placed above that of particular shareholders, specific creditors or directors, and requires the avoidance of transactions that unduly favour specially related parties to the detriment of the insolvency estate.
4.Documenting the management body's decisions
The need to document the management body's decisions properly becomes more acute in situations of difficulty. Experience shows that many liability claims turn on the absence of evidence as to the information available, the alternatives considered and the procedure followed. Proper documentation serves several functions. First, it makes it possible to establish that the directors acted with the diligence of an orderly businessperson, obtaining sufficient information and following a reasonable process. Secondly, it facilitates the reconstruction of the intention and purpose behind the decisions, which may be relevant in the interpretation of resolutions and in the assessment of loyalty. Thirdly, it provides a basis for the protection of business judgement, by showing that the strategic decisions were adopted in good faith and under an appropriate procedure.
Documentation is not confined to board minutes. It includes economic and legal reports, scenario analyses, advisers' proposals, communications with creditors, business plans, viability studies and any other document that reflects the decision-making process. The office of secretary to the board, although not regulated in detail in unlisted companies, plays an important part in drawing up minutes that record not only the resolutions but also the deliberations and the reasoning behind them. It is good practice to include in the minutes references to the reports considered, to the alternatives discarded and to the reasons for the decision.
In the insolvency and pre-insolvency field, documentation additionally acquires evidential weight before the insolvency judge and before the insolvency administrator. The report accompanying the insolvency petition must set out the debtor's economic and legal history, the activities carried on, the establishments, the causes of the state of insolvency and, where the debtor is a legal person, the identity of the shareholders, directors, general managers and, where applicable, the auditor. The inventory of assets and rights, the list of creditors and the information on employees are also documents that reflect the situation and the earlier decisions. The quality of this documentation may influence the classification of the insolvency and the assessment of the directors' conduct.
5.Acting earlier to widen the alternatives and reduce risks
The central idea is that acting earlier considerably widens the alternatives available for preserving the business and reduces risks. While the difficulties are confined to cyclical losses or cash-flow strain, the management body can adopt ordinary management measures: cost adjustments, renegotiation of contracts, the search for financing, changes in commercial strategy. Where the losses reach the threshold of article 363 e, the response must be more structural: a capital increase or reduction, contributions from shareholders, the sale of assets, a reorientation of the business. Where a likelihood of insolvency or imminent insolvency is detected, notifying the opening of negotiations for a restructuring plan makes it possible to gain time, to stay certain enforcement actions and to negotiate with creditors solutions that avoid insolvency proceedings or make them more orderly.
If actual insolvency is awaited without these routes having been explored, the alternatives narrow. Insolvency proceedings may become unavoidable, and the capacity to restructure is limited by the loss of creditors' confidence, by the deterioration of the company's position and by the possible presence of acts liable to be set aside. The directors' liability is aggravated if it is found that they unduly delayed the insolvency petition or the adoption of dissolution measures, or that they carried out acts harmful to the insolvency estate.
The insolvency reform has reinforced the logic of early action. Restructuring plans make it possible to intervene at the stage of a likelihood of insolvency, with tools such as debt restructuring, the conversion of claims into share capital, the sale of business units or the modification of the corporate structure, under limited judicial supervision. The exemption under article 367 of the LSC for directors who notify negotiations or petition for insolvency proceedings in time is a clear incentive not to delay decisions.
6.Conclusion: from economic management to legal liability
When a company runs into difficulties, the position of the management body changes. Losses and cash-flow strain cease to be an exclusively economic problem and become a legal problem calling for specific decisions. The ground for dissolution through losses, the likelihood of insolvency, imminent insolvency and actual insolvency are thresholds that trigger duties to convene the general meeting, to promote dissolution, to notify negotiations and to petition for insolvency proceedings. The duties of care and loyalty intensify, and proper documentation of decisions becomes an essential protective tool.
Acting earlier, at the stage of a likelihood of insolvency or of an incipient ground for dissolution, widens the alternatives for preserving the business, makes it possible to use preventive restructuring instruments and reduces the risks of joint and several liability for corporate debts or of a culpable classification of the insolvency. Waiting until insolvency is manifest and the grounds for dissolution are entrenched narrows the room for manoeuvre and exposes the management body to criticism for inaction. Managing a business crisis is therefore an exercise in legal anticipation as much as in economic response.
