Bankruptcy and Director Liability

Bankruptcy and Director Liability in Switzerland

In Switzerland, the bankruptcy of a company generates considerable legal consequences for its directors. The Swiss legislative framework provides specific mechanisms for establishing the liability of directors and managers in the event of insolvency. The Federal Act on Debt Enforcement and Bankruptcy (DEBA), the Code of Obligations (CO) and various Federal Supreme Court decisions strictly govern the obligations of directors and the sanctions applicable in case of breaches. Faced with these complex issues, directors must know their responsibilities and the risks to which they are exposed. Our law firm accompanies entrepreneurs in risk prevention and the management of financial crisis situations, offering expert advice on these sensitive matters where personal and professional assets may be threatened.

Legal Framework: Director Obligations in Financial Difficulty

Swiss law places the emphasis on early detection of financial difficulties. As soon as half of the share capital and legal reserves are no longer covered (art. 725 para. 1 CO), the board of directors must convene an extraordinary general meeting and propose restructuring measures.

If the situation deteriorates to the point of proven over-indebtedness, article 725 para. 2 CO imposes a strict obligation: the board of directors must notify the court, unless creditors accept to subordinate their claims to those of other creditors.

• Capital loss: mandatory intervention once half of the share capital is lost
• Over-indebtedness: obligation to notify the court without delay
• Deferral of bankruptcy: possible only under strict conditions

Swiss courts apply these provisions strictly, as evidenced by the consistent case law of the Federal Supreme Court which sanctions directors who have delayed taking necessary measures when faced with deteriorating financial situations.

Civil Liability of Directors

In Swiss law, the civil liability of company directors is primarily governed by article 754 of the Code of Obligations. This fundamental provision establishes that members of the board of directors and all persons involved in the management or liquidation are liable to the company, shareholders and corporate creditors for the damage they cause by intentionally or negligently breaching their duties.

Conditions for Liability

To engage the civil liability of a director in the context of a bankruptcy, four cumulative conditions must be met:

• Damage suffered by the company, shareholders or creditors
• Breach of the director's legal or statutory duties
• A causal link between this breach and the damage
• Fault, whether intentional or through negligence

In the context of a bankruptcy, liability actions are generally brought by the bankruptcy administration, acting on behalf of the body of creditors. Individual creditors may sometimes act directly, but only for the direct damage they have personally suffered.

Typical Breaches in the Context of Insolvency

In bankruptcy situations, certain breaches are particularly scrutinised:

• Delay in filing for bankruptcy despite manifest over-indebtedness
• Continuation of a loss-making activity without reasonable prospect of recovery
• Distribution of fictitious dividends or repayment of capital during a period of difficulty
• Management acts manifestly contrary to the corporate interest
• Failure to maintain proper accounts

The limitation period for the liability action is five years from the day on which the aggrieved party had knowledge of the damage and the person responsible, but at most ten years from the day on which the damaging act occurred.

The financial consequences can be considerable as directors are liable on their personal assets. In certain cases, courts have ordered directors to cover the entirety of the bankruptcy deficit, engaging millions of Swiss francs of personal liability.

Criminal Liability in the Event of Bankruptcy

Swiss criminal law contains several specific provisions concerning reprehensible conduct related to company bankruptcy. These offences, grouped under the term "offences in bankruptcy and debt enforcement", are mainly defined in the Swiss Criminal Code (SCC) at articles 163 to 171.

Specific Insolvency-related Offences

• Fraudulent bankruptcy (art. 163 SCC): fictitious reduction of assets to the detriment of creditors
• Simple bankruptcy (art. 165 SCC): when insolvency was caused or aggravated by mismanagement
• Violation of the obligation to keep accounts (art. 166 SCC)
• Preferential treatment of certain creditors (art. 167 SCC)
• Misappropriation in attachment proceedings (art. 169 SCC)

These offences are prosecuted ex officio and may result in sentences of up to five years' imprisonment in the most serious cases.

General Economic Offences

Beyond offences specific to bankruptcy, other criminal provisions may apply:

• Breach of trust (art. 158 SCC): violation of the duty to protect the financial interests of another
• Fraud (art. 146 SCC): particularly in case of deception of creditors
• Forgery of documents (art. 251 SCC): falsification of accounting documents

Preventive Measures and Risk Management

Faced with substantial liability risks, directors of Swiss companies must implement effective preventive strategies.

Implementing Appropriate Governance

• Establishment of clear and documented decision-making processes
• Regular board meetings with detailed minutes
• Creation of specialised committees (audit, risk, remuneration) for significant structures
• Precise definition of delegations of authority and responsibilities
• Implementation of effective internal control systems

Swiss case law recognises the Business Judgment Rule, according to which courts do not substitute their judgment for that of directors if the latter made a reasonable business decision, having been duly informed and without a conflict of interests. Documenting the decision-making process is therefore fundamental to benefit from this protection.

Financial Monitoring and Warning Signals

• Implementation of a financial dashboard with key indicators
• Regular monitoring of cash flow and updated forecasts
• Periodic analysis of compliance with banking covenants
• Independent review of accounts beyond legal obligations
• Alert system in case of deterioration of financial ratios

Directors and Officers (D&O) liability insurance constitutes a tool for transferring financial risk. However, these policies generally contain exclusions, particularly in cases of intentional fault or serious violations of legal obligations.

Alternatives to Bankruptcy in Swiss Law

• The composition moratorium (art. 293 et seq. DEBA): protection period allowing the development of a recovery plan
• The composition agreement: arrangement between the debtor and creditors (dividend composition, asset assignment composition, mixed composition)
• Deferral of bankruptcy: possible when prospects for recovery exist
• Out-of-court restructuring: direct negotiations with principal creditors

Defence of Directors Facing Liability Actions

In case of a liability action, several defence strategies may be considered:

• Demonstrating the absence of a breach of the duty of diligence and loyalty
• Contesting the existence of damage or its assessment
• Challenging the causal link between the alleged fault and the loss
• Invoking prescription or lapse of actions
• Asserting the distribution of responsibilities within the governing bodies

Our law firm accompanies company directors confronted with these delicate situations. We intervene from the first signs of difficulty to establish a protective legal strategy. Liability proceedings often unfold over several years, requiring a long-term defence strategy integrating the civil, criminal and sometimes administrative aspects of cases.

Frequently Asked Questions on Director Liability in Bankruptcy