The COVID-19 pandemic has a significant and immediate adverse effect on many companies in different industries. Many PE portfolio companies are particularly vulnerable given the typical high leverage finance structure and inherent need to maintain cash flow. To meet these challenges and mitigate liability risks, management and owners may need to take clear and immediate action (and refrain from certain other actions) in the interest of all stakeholders. The following sets out some key legal guidelines for management and owners when dealing with a Dutch subsidiary in distress.
Key guidelines for management of companies in distress
Liquidity & financing
- As a priority you should take action to monitor liquidity and safeguard liquidity and prepare cash flow forecasts based on multiple scenarios, from optimistic to worst-case. Assess and update these forecasts regularly and if a shortfall is expected, plan how to overcome it.
- At the same time review your financing documentation and verify whether a breach of covenants has occurred or is imminent and reach out to the financing parties to timely negotiate waivers.
- Furthermore, investigate possibilities to obtain additional funding in the short term, for instance by drawing under existing facilities. Please be aware that if new equity funding is required, Dutch statutory law does not require a shareholder to provide additional equity funding. Check your investment/shareholders agreements for the contractual arrangements in respect of additional and emergency equity funding.
- If the company is in financial distress, in exceptional circumstances a shareholder may be required to cooperate with an emergency equity financing by one or more other shareholders and accept a dilution of its equity interest.
- Based on the cash flow forecasts you should assess whether the company will be able to operate its business on a going concern basis. Cease trading and file for suspension of payments or bankruptcy if it is clear the company has run out of viable scenarios.
Force majeure & unforeseen circumstances
- Both the COVID-19 pandemic and the measures taken by various governments may constitute force majeure (overmacht). Assess whether there are force majeure or material adverse change provisions in existing contracts and ascertain what types of remedies are available. Force majeure events generally relieve the debtor of the duty of specific performance and the duty to pay damages. The creditor may, however, be entitled to terminate or alter the contract.
- Explore modifying or terminating, in whole or in part, existing contracts on the basis of unforeseen circumstance. A key question is whether the effects of COVID-19 on the relevant business have been incorporated, explicitly or implicitly, into the contract. Note that a high legal threshold applies and that Dutch courts were generally reluctant to uphold this legal basis in the context of the 2008 economic crisis.
Compensation of wage costs
- If you can demonstrate a 20% or higher expected turnover reduction as a result of COVID-19, consider applying for temporary reduction of wage costs. The Dutch government will then compensate up to 90% of employer’s wage costs – the applicable percentage corresponds with expected loss of turnover – during 3 months with an extension option for another 3 months. Two conditions apply: (i) the employer must continue to pay the employees 100% of their wages; and (ii) the employer cannot terminate employees for redundancy reasons while it receives the governmental support.
COVID-19 related tax measures
- The Dutch government has announced extraordinary tax measures to mitigate the economic impact of the COVID-19 crisis, including deferral of tax payments, reduction of interest payable on taxes due and reduction of advance tax payments on provisional tax assessment. We refer to our Tax Alert of 17 March and our Tax Alert of 19 March. Check if your company is eligible to benefit from these measures.
Personal liability exposure management board members
- To mitigate the risk of personal liability, management board members should be aware of the following:
- Do not enter into obligations towards a third party if the management knows or should know that the company will be unable to timely meet these obligations and provide sufficient recourse for a creditor’s resulting damages. The same applies when the management board has to decide whether or not to approve a dividend or other distribution.
- Beware of liability for selective payments, i.e. actively preventing the payment of certain debts whilst paying other debts (e.g. to the PE owner) and knowing that the company will not be able to meet its obligations going forward. Exceptions may apply: for instance if there are adequate reasons to justify such selective or discriminatory payments.
- Make sure the adopted annual accounts of the Dutch company are published within twelve months after expiry of the financial year and maintain the financial books and records of the company.
- Pay the premium of your D&O insurance.
- It is important to keep records of (i) the measures taken with respect to financial distress; (ii) the rationale behind such measures; and (iii) the relevant information supporting the measures. Realise that you are not primarily making these records for yourself. Your decisions and judgments may be scrutinized later with the ‘benefit of hindsight’.
Key guidelines for owners of companies in distress
- As a main rule, a parent company is not liable for the obligations of its subsidiary, but liability vis-à-vis third parties may nevertheless arise if the parent company has committed an unlawful (tortious) act towards such third party by violating its general duty of care.
- A parent company may be liable vis-à-vis creditors of the bankrupt company if the parent knew of the financial difficulties of the subsidiary but did not protect the creditors against the consequences of a bankruptcy of the subsidiary, e.g. by alerting the creditors, although the parent was able to do so. A few examples are:
- A parent company creates the impression that the subsidiary is financially stable.
- The parent company enables the subsidiary to continue its loss-making activities.
- The parent company is involved in limiting the recourse possibilities for the creditors due to e.g. a dividend distribution or a transfer of assets of the subsidiary.
- A dividend or other distribution by a Dutch company typically requires a shareholders resolution to that effect and always the approval of the management board. The management board must refuse such approval if it knows or reasonably should know that the company will be unable to meet its obligations when due after making the distribution.
More about the coronavirus
You can read more publications on the impact of the coronavirus on our website. Here you will also find a list of contacts within our office who can advise you with questions about the implications of the coronavirus for your company.