The discharge of legal representatives and managers of legal persons in bankruptcy: a real second chance?

Legal Insight

May 2021

Ioannis Psarakis, Lecturer, LL.M (III), PhD  Cand.

(republished from capital.gr)

1. The problem

A common practical problem that arises in the insolvency of legal persons is the following: while the company is insolvent - and therefore the servicing of existing debts is only to the extent that the (any) bankruptcy estate is sufficient - persons who hold (or have held in the past) executive positions in the management continue to be liable for all debts of a certain nature; these, more often than not, will be of a significant amount. A common example is debts to the tax and social security funds.

This, of course, creates serious disincentives for timely filing for bankruptcy, since a large part of the debt will still be borne by the representative of the company, even if it is in bankruptcy. Therefore, the latter, when at the critical moment he is called upon to weigh up his options (e.g. when he realises that servicing current debts is impossible or even that - based on the picture he already has - this is likely to happen in the near future), is likely to feel that it is in his best interest to try to 'save' the company. This will most often be a desperate attempt to improve its image and reduce its debts, in order to avoid being saddled with debts himself, thus putting his personal assets at risk. Of course, when the situation is like this (suspension of payments or shortly before the suspension of payments), the odds will usually not be in his favour: the debts will increase rather than decrease, further damaging him and the whole. Indeed, delaying the filing of a bankruptcy petition - and even though the necessary conditions for doing so have been met - (continues to be) a special offence under the new Bankruptcy Code.

The solution?

With Law no. 4738/2020 (the new bankruptcy code - hereinafter: nPTC), the institution of the second chance was re-established in our bankruptcy law - but with greater intensity.

We wrote about the second chance in Capital.gr in 2014 and 2017. Back then, however, we noted: "Only natural persons who had a sole proprietorship and not legal entities or any representatives of legal entities (SAs, LLCs, IKEs, etc.) are exempt, subject to the following paragraph for guarantor shareholders/partners".

With the NAPC, the concept of second chance is given a more realistic dimension and a more realistic substance closer to the reality of the transactions. Indeed, it is, as a result, a false description of a 'second chance' if the natural person who will often use a legal person as a vehicle - a business option which is of course not prohibited by law - continues to be liable for a large part of the debts of his 'vehicle'; and despite any bankruptcy proceedings against him.

2. The change of example

The very important paradigm shift was introduced by Article 195 of the NPC. According to the explanatory memorandum of the law, this decision was prompted, inter alia, by the finding that the personal liability of representatives of legal persons in case of bankruptcy of the latter acts as a disincentive to entrepreneurship and also prevents competent managers from taking over the management of companies in a difficult financial situation. All this, to the detriment of the development of the economy.

Thus, under the NPC regime, debts of the legal person which, under special provisions, are also borne by other persons ('jointly and severally liable persons' according to the legal term) are cancelled. As explained in the explanatory memorandum of the NPC, 'the specific provision of Article 195 takes precedence over [...] other provisions providing for the joint and several liability of the representatives of legal persons'.

A classic example of such a provision (i.e. a provision establishing "parallel" liability) is found in Article 50 of the Code of Tax Procedure (Law 4174/2013 - CFR), which establishes joint and several liability for income tax, withholding taxes (e.g. e.g. FTT and gaming taxes), any imposed tax (e.g. residence tax and special tax on TV advertising), but also VAT and ENFIA (including interest, fines and surcharges).

Joint and several liability is established in respect of a number of persons such as executive chairmen, directors or general managers, administrators, managing directors and even persons who effectively manage or administer a legal person or legal entity; provided that the debts in question became due during their term of office in one of the above capacities. In particular, in the case of debts that have been subject to a regulation and then the regulation is lost, both the person who had such a status at the date of the original due date and the person who had it "at the time when each instalment of the regulation became due or the regulation was lost" are jointly and severally liable (cf. Article 50 of the Tax Code and E.2173/2020 on tax debts).

For example: A legal entity that is required to file an income tax return for the tax year 2019, files it late on 1-1-2023. For the payment of the tax and the consequential interest amounts, the person who exercised management in the period in which the statutory deadline for payment of the tax expired pursuant to Article 68 of Law No. 4172 /If, however, the debt is subject to an instalment payment arrangement on 25-2-2023 and on that date the person who was in charge of the debt at the expiry of the statutory deadline for payment of the tax (A) is replaced by another person (B), A remains jointly and severally liable, but joint and several liability is also established for B who is in charge of the debt on the due date of the instalments under the rules governing the arrangement. If the instalments which became due during B's term of office are paid but the arrangement is lost after B's legal person is replaced in the management of the legal person by C, C, during whose term of office the arrangement was lost, is held jointly and severally liable, while A remains jointly and severally liable.

If the debts are established after a tax audit, the decisive factor is the year in which they were incurred.

Another provision which establishes joint and several liability of great importance in practice is that of paragraph 1 of Article 31 of Law 4321/2015 as regards contributions to insurance funds.

3. What happens in practice

With a. 195 of the NPC these persons are exempted from liability for debts that became due up to 3 years (the law refers to 36 months - note that before its adoption the provision provided for a period of only 12 months) before the cessation of payments (meaning: if bankruptcy was declared due to cessation of payments) or up to 3 years before the filing of the bankruptcy petition (if bankruptcy was declared due to imminent impossibility of performance).

A necessary clarification: a suspension of payments is defined as a situation in which a debtor is "generally and permanently" unable to meet his or her outstanding financial obligations, but not merely a temporary cash-flow shortage or even a temporary disruption of the applicant's payment rhythm. For example, a cessation of payments will be deemed to exist, for example, when - and the NAP introduces certain presumptions - the debtor has become in arrears with a number of basic debts (banks, suppliers, public utilities, tax authorities, tax authorities, social security funds) due to a lack of liquidity; or even with a major debt, even if other debts, usually minor but not necessarily, are being serviced regularly (there are many court decisions on this point as well). That date will also determine the date of cessation of payments to be set by the bankruptcy court.

An impending default, on the other hand, is defined as a situation in which it is foreseen that money debts that will become due in the near future - usually in the current and the next financial year - will not be able to be serviced in cash. This is a 'standstill' which has not yet occurred but is expected to occur in the future. In this case, the 36-month period starts from the date of the bankruptcy filing.

The determination of the time of the suspension of payments (i.e. the date) is important: the bankruptcy court may determine that it goes back up to 2 years before the filing of the bankruptcy petition (2 years being the earliest possible point in time at which the court can determine the suspension of payments). Thus, the legal representative's discharge may as a result ultimately extend up to 5 years before the date on which the bankruptcy petition is filed (2 years - the maximum period to which the suspension of payments may relate - and 36 months before the designated suspension of payments).

It should be stressed that the new provision also favours persons who held the above-mentioned positions in the past and not necessarily at the time of the declaration of bankruptcy. This is because, for example, according to Art. 50 CFR, those persons are defined as jointly and severally liable who, during the period in which the specific tax debts became due, held the specific positions of responsibility. Three years (up to five years) are again the outer limits.

Furthermore, pursuant to Article 263 para. 6 of the NPC, this exemption (i.e. that of section 195) also applies to representatives of a legal person declared bankrupt "in accordance with the provisions of Art. 3588/2007 or the previous bankruptcy law'. In this respect, this favourable treatment also has a certain retroactive effect, covering an even greater number of cases.

Equally important for those who are jointly and severally liable is the following: the beneficial effects of the exemption extend to the criminal aspect as well: according to the recently issued Decision of the Ministry of Finance - Labour and Social Affairs (44510 EX 2021 - Government Gazette B' 1516/15-04-2021), the debts to which the exemption applies are not taken into account for the prosecution of the legal representative or manager for the offence of non-payment of debts to the State. Moreover, following the exemption, such amounts shall not be taken into account for the purposes of issuing the legal representative or administrator with a certificate of good repute or a certificate of indebtedness.

Until now, the practice of the criminal courts has been to grant representatives of bankrupt companies a specific mitigating circumstance, resulting simply in a reduced sentence.

This is a very important development, taking into account the relatively recent tightening of the Criminal Code to the level of sentences of more than three years in terms of time served. It should be borne in mind that for non-payment of debts to the State of an amount exceeding €200,000 the penalty is at least 3 years.

4. Conclusion

The NPC is much more oriented towards the reality of transactions, compared to the previously applicable rules. Persons who until now would have continued to be liable for large debts despite the bankruptcy of the legal person are now exempt; provided, of course, that certain necessary conditions are met.

The main condition is that they must be bona fide; if they have acted in bad faith or have not cooperated properly in the bankruptcy proceedings, third parties may challenge the exemption. In addition, the bankruptcy must not have been caused by fraudulent acts and they must not have committed the criminal offences of theft, fraud, embezzlement or forgery under the Penal Code or the criminal offences of the NPC (bankruptcy and preferential treatment of a creditor). However, in the latter cases, according to the most correct approach, partial (not full) discharge will be possible, i.e. for debts not directly linked to the above-mentioned offences.

Moreover, in relation to what we have alluded to above about the choice of the managing director not to file for bankruptcy in time although the circumstances are already ripe for this (according to the law "without undue delay and in any event within 30 days at the latest"), this is the bankruptcy offence of procrastination. The commission of this civil offense may cost the discharge. In addition, the option for a director to continue an already effectively "bankrupt" company in the hope that e.g. VAT debts during his term of office - and therefore his own debts - will be reduced, is becoming less attractive; this is because the debts in question no longer follow him anyway under the NPC (i.e. within the time limits set out above).

Moreover, the period of time over which the exemption extends - potentially up to five years - is considered sufficient. Having said this, however, we must draw attention to the possibility that a future legislative amendment may shorten this period, for example by restoring it to 12 months, as it was in its original version.