Balancing Interests During Bankruptcy

September 2024

Hussain Mahdi of EDB Bahrain, along with Gaby Samir El Hakim and Maha Alkhabbaz of the National Bank of Bahrain provide an overview of the liability of the Board of Directors under the Bankruptcy Law in the Kingdom of Bahrain.

Bankruptcy is a critical event that can significantly impact a company and its stakeholders, including the Board of Directors (the “Directors”), who are responsible for carrying out decisions regarding a company’s management.

The Reorganization and Bankruptcy Law No. 22 of 2018 (the “Bankruptcy Law”) is a key legislation in the Kingdom of Bahrain. It covers two forms of bankruptcy proceedings (reorganisation and liquidation) and facilitates corporate restructuring and value preservation. The Bankruptcy Law specifies key criteria to file bankruptcy proceedings: an inability to pay debts within thirty days from the date they fall due, or an imbalance between the value of a company’s financial obligations and assets.

The Bankruptcy Law aims to restructure viable companies and effectively address non-viable ones impacting the economy. However, a key challenge in implementing the Bankruptcy Law involves determining Directors’ liabilities during bankruptcy, including the nature, timing, parties involved, breaches, enforcement, defenses, remedies, and the parties which can take legal action to enforce the obligations under such Law. A key challenge in holding Directors liable is the lack of clear principles outlined in the Bankruptcy Law regarding Directors’ duties during the period leading up to insolvency, especially when a company is facing imminent or unavoidable insolvency.

Responsibilities of the Directors

Directors play a crucial role in overseeing the management and strategic decisions of a company, including its financial affairs. The Directors owe a general responsibility and fiduciary duty to the company, its shareholders, and stakeholders, and they are required to act in the best interest of these parties in their day-to-day management.

Once bankruptcy proceedings commence, the obligations of Directors will differ both in scope and focus from those applicable prior, as the Bankruptcy Law places emphasis on maximising value and preserving the estate for distribution to the creditors.

While there is no direct legal responsibility placed on Directors solely because of a bankruptcy judgment, the actions of the Directors leading up to the bankruptcy may come under scrutiny. It is possible that the Directors bear responsibility for delaying the start and/or prolonging the duration of bankruptcy proceedings. If Directors act in a manner that is not in the best interest of the company, such action can be questioned by the Bankruptcy Trustee and remains subject to inquiry by the Bankruptcy Court. These acts may include engaging in transactions at undervalue, providing preference to certain parties, and executing transactions with the intention to hinder creditors.

It is essential to clarify that Directors may retain an active role in managing their company during bankruptcy proceedings, especially in cases of reorganisation. However, the extent of that involvement may be subject to the conduct of Directors in the period prior to the commencement of bankruptcy proceedings, and their cooperation with the Bankruptcy Court and the Bankruptcy Trustee.

Civil Liability

When a company faces an actual or imminent inability to meet its obligations as they become due, the Directors play a crucial role in providing strong management. This often involves making difficult business decisions and exercising judgment that is vital for the company’s survival and to enable them to take appropriate steps to address financial distress and avoid further decline.

The Bankruptcy Law emphasises the importance of directors taking prompt action to face financial difficulties. This encourages early action by imposing an obligation on the Directors to initiate formal bankruptcy proceedings within 30 days after insolvency occurs.

If it is proven that the bankruptcy has occurred due to acts of negligence or if there has been a delay in initiating bankruptcy proceedings, the Directors may be held jointly and severally liable for the debts incurred, and this could lead to financial responsibility and legal repercussions. Article 18 of the Commercial Companies Law provides the Directors shall be liable to the full extent of their personal funds for any damages sustained by the company, shareholders, or creditors in various circumstances, including fraud, gross negligence, the provision of false information regarding the company’s capital, utilising the company’s funds as personal funds, and acting in violation of the Commercial Companies Law or the company’s constitutional documents.

Voluntary Negotiations

The Bankruptcy Law sets provisions which facilitate voluntary negotiations between debtors and key creditors before resorting to bankruptcy proceedings. However, the utilisation of this option remains limited in Bahrain and the GCC. Balancing the encouragement of early action against granting Directors the opportunity to engage in an out-of-court debt restructuring mechanism through voluntary negotiations is complex.

To enhance the effectiveness of voluntary negotiations, Directors should be given sufficient time to engage in discussion with creditors and settle debts without being pressured to initiate bankruptcy proceedings. The development of further laws and/or regulations that account for the necessary time and process of engaging in voluntary negotiations whilst upholding the requirement to file bankruptcy proceedings can assist in the implementation of this section of the Law.

Director Liabilities and Responsible Conduct

The lawmakers in Bahrain acknowledge the potential drawbacks of expanding Directors’ liabilities in legislation, as it may encourage Directors to prematurely shut down a viable business that could have otherwise remained operational. Therefore, the Bankruptcy Law stands out within the region by not adhering to the presumption of mismanagement solely based on a company’s financial distress. This recognition is crucial as it prevents capable Directors from prematurely leaving a company during challenging times, allowing for potential reorganisation and the opportunity to restore profitability.

Conclusion

In conclusion, while the issuance of a bankruptcy judgment does not automatically assign direct responsibility to the Directors, they may face civil liability and loss of privileges if negligence or fraud is proven to have contributed to the bankruptcy.

It is essential for Directors to fulfill their duties diligently and ethically to avoid such consequences and to uphold their responsibilities to the company and its stakeholders.

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