A board member of a financially distressed company may, under certain circumstances, be held personally liable for the company’s debts if they fail to ensure that the company is either wound up or recapitalised in a timely manner. Until now, it has been unclear whether this liability period ends when the company is declared bankrupt, or if the board may remain personally liable for obligations incurred even after the bankruptcy. The legal position has now been clarified by a recent ruling from the Supreme Court of Sweden (HD).

The limited liability company structure allows entrepreneurs to conduct business without risking more than the invested share capital. Given that company management typically has an informational advantage over shareholders and creditors, Swedish legislation provides certain protective rules to prevent companies in financial distress from continuing operations at the expense of creditors and shareholders.

According to the applicable rules, the board is obliged to immediately prepare and have the company’s auditor review a so-called balance sheet for liquidation purposes (kontrollbalansräkning), if there is reason to believe that the company’s equity has fallen below half of the registered share capital.

The Balance Sheet for Liquidation Purposes

If the balance sheet confirms that equity has indeed fallen below half of the share capital, the board must present the document and the auditor’s opinion to a general meeting for a resolution on whether to enter into liquidation. If liquidation is not resolved, an eight-month grace period is triggered. Within that period, a second general meeting must be held and a new balance sheet presented. If this second balance sheet does not show that the equity deficiency has been remedied, the company must enter liquidation, and the board is obliged to apply for liquidation with the district court within two weeks.

If the board fails to prepare the balance sheet, hold a general meeting, or apply for liquidation when required, the directors become personally liable for the obligations incurred during the period of non-compliance (the liability period). Shareholders who vote to continue operations despite the legal requirement to liquidate may also be held personally liable.

The Liability Period

The liability period ends when the board takes the action it has previously failed to take. For example, if the board delays in preparing the first balance sheet, the liability ends once the document has been prepared and reviewed by the auditor. The period also ends if a liquidation application is submitted, if a balance sheet showing sufficient equity is presented at a general meeting, or if the company is declared bankrupt by a court or enters liquidation through a resolution or order by the general meeting, court, or the Swedish Companies Registration Office. Other circumstances may also bring the period to an end. For example, case law has held that an annual report presented at a general meeting that shows full equity coverage can also terminate the liability period.

However, whether the declaration of bankruptcy itself ends the liability period has remained uncertain—until now.

The Dispute Continued After Bankruptcy Was Declared

In the case recently reviewed by the Supreme Court on 12 July 2018, a company (AB1) was declared bankrupt in October 2014. AB1 had initiated legal proceedings against another company (AB2) in June that year. The dispute was ongoing when bankruptcy proceedings commenced. The bankruptcy administrator chose not to pursue the case, which was instead continued by AB1 in bankruptcy, represented by its sole board member. AB1 ultimately lost the case and was ordered to pay AB2’s legal costs.

AB2 subsequently sued the board member, arguing that no balance sheet for liquidation purposes had been prepared in time and that the director was personally liable for obligations, including the legal costs incurred after the bankruptcy. The director argued that the liability period ended when the bankruptcy was declared.

The Bankruptcy Order Terminated the Liability Period

The District Court held that the bankruptcy order terminated the liability period. The decision was appealed to the Court of Appeal, which reached the opposite conclusion and found the board member personally liable even for obligations incurred after the bankruptcy. The Court of Appeal reasoned that a bankruptcy order, unlike a liquidation resolution, does not prevent the board from incurring new obligations on behalf of the company.

The board member appealed to the Supreme Court, which sided with the District Court and absolved the director of liability. The Court found that a board member has very limited authority to incur new obligations on behalf of the company after bankruptcy and that the issue would primarily arise if the board chose to pursue an ongoing legal dispute.

The Court further noted that in certain cases, the board may be obliged to continue litigation that has a reasonable chance of success. It would be meaningless to prepare a balance sheet for liquidation after bankruptcy has been declared. The Supreme Court concluded that the problem of bankrupt companies lacking funds to pay litigation costs must be addressed through means other than the director liability rules, especially since there are no laws preventing financially weak companies or individuals from bringing legal proceedings.