The board's scope for action in the event of a liquidity shortfall – step by step

What does a liquidity shortfall mean in practice?

A liquidity shortfall arises when the company lacks sufficient funds to meet its ongoing payment obligations. The situation may be temporary or more long-term, but it always means that the board must take active steps and decide whether, and in what form, the business should continue to operate. At this stage, the question also arises as to whether the company is insolvent or at risk of becoming so in the near future – that is, whether the illiquidity is more than temporary. This assessment is crucial, as it affects both the available courses of action and the legal risks associated with various decisions.

Liquidity shortfall in an otherwise solvent company

The board's scope for action is, comparatively speaking, greatest when the company is indeed illiquid but still solvent, with its equity intact. In this situation, the board has both the opportunity and the obligation to take active steps to remedy the liquidity problems. The board's responsibilities derive primarily from the Companies Act and are aimed at safeguarding the company's interests, which typically coincide with creating long-term value for shareholders. Commercially justified risk-taking is permitted within the framework of the so-called business judgement rule. Courts generally adopt a cautious approach to retrospectively questioning such decisions, provided they have been taken on an informed and prudent basis. It is, however, important to emphasise that the board bears ongoing responsibility for the company's financial position. Shortcomings in monitoring, control or reporting may in themselves constitute grounds for liability at a later date.

Capital deficiency and formal obligations

If the company's financial position deteriorates and there is reason to believe that its equity falls below half of the registered share capital, specific formal obligations under the Companies Act come into effect. The board of directors must then act in accordance with a specific procedure.

Prepare a balance sheet for the purpose of assessing solvency. The board of directors must immediately draw up a balance sheet for review and have it examined by the company's auditor. The same obligation arises if, in the event of attachment, the company is found to lack sufficient assets to settle the attachment claim in full.

Convene a general meeting. If the balance sheet reveals a capital shortfall, the board of directors must convene an initial general meeting as soon as possible. The meeting shall consider whether the company should go into liquidation.

Convene a second general meeting. If the first meeting resolves to continue operations, a second review meeting shall be held within eight months to reconsider the question of liquidation. A new review balance sheet, audited by the auditor, shall be presented prior to this meeting.

Decision on liquidation. If the new review balance sheet shows that the company's equity has not been fully restored and the meeting does not resolve to proceed with liquidation, or if the second review meeting is not held on time, the board of directors is obliged to apply to the district court for liquidation.

Failure to act in accordance with these rules may result in the board being held personally liable for debts arising during the period of such failure.

At this stage, the board still has considerable scope to take measures to restore the company's capital, for example through capital injections, restructuring of the business or other commercial arrangements. However, this presupposes that decisions are taken on the basis of sufficient information and that the board has a clear understanding of the company's financial situation and the legal framework.

Unlawful transfers of value. In a situation of capital deficiency, the rules on creditor protection in connection with transfers of value set out in Chapter 17 of the Companies Act also take on particular significance.

A transfer of value refers, for example, to profit distributions and business transactions that result in a reduction in the company's assets and are not of a purely commercial nature for the company.

The basic principle is that such measures are only permitted if, following the transaction, there is full coverage for the restricted equity (the so-called 'amount limit'). In addition, the prudence rule applies, which means that a transfer of value may only take place if it appears justifiable in view of the requirements that the nature, scope and risks of the business place on the size of the equity capital, and taking into account the company's consolidation needs, liquidity and financial position in general.

Transfers of value that contravene the rules on creditor protection must, as a general rule, be repaid by the recipient. If a shortfall arises in the repayment, those who participated in the decision may be held liable for the shortfall, known as liability for covering the shortfall.

Insolvency – limited scope for action

When a company is no longer able to pay its debts and this inability is not temporary, the company is deemed to be insolvent. In this situation, the board's remit shifts from developing the business to protecting the body of creditors. The scope for action is significantly limited and governed by the principle of equal treatment of the company's creditors.

No undue favouring of individual creditors. Payments to selected creditors, such as related parties or strategically important suppliers, carry significant risk. Such transactions may be set aside in bankruptcy proceedings and, in certain cases, lead to criminal liability.

Increased risk in asset disposals. Sales at below market value, debt write-offs or other transactions without a clear commercial basis may be deemed, under company law, to constitute unauthorised transfers of value, or even a breach of creditors' rights.

Restrictions on day-to-day operations. Even continuing a loss-making business without realistic prospects of improvement may, in serious cases, result in criminal liability for negligence towards creditors.

Specific risks relating to taxes and duties. If the company continues its operations despite being unable to pay taxes and duties, directors' liability may arise. This typically entails personal liability for payment on the part of the board of directors.

To avoid personal liability for payment, the board of directors should therefore apply for bankruptcy or company reorganisation no later than the day on which the tax or duty falls due.

What does this mean for you?

Liquidity problems do not mean that all options have been exhausted, but they do require active and structured action on the part of the board. At the right time, the crucial question is rarely whether something may or may not be done, but rather how and on what grounds measures are taken.

In many cases, it is precisely at this stage that the difference between various courses of action is greatest – and where well-considered action can help to preserve value and create the conditions for a solution.

Do you have any questions about the board's responsibilities or need guidance in a situation involving liquidity challenges? Please contact one of our experts in insolvency law and financial restructuring.

The authors

Johan Attenius is one of the law firm's ten insolvency practitioners and corporate reorganisation specialists, and is also chair of Lindahl's insolvency and reorganisation practice group.

Disa Johnsson is an associate with expertise in insolvency law and is a member of Lindahl's insolvency and reorganisation practice group.