Canada: Directors fiduciary duty in a pandemic: You need a protocol!
COVID-19 has had and will continue to have impacts on virtually every corporation in Canada and globally.
In light of the impact of the COVID-19 pandemic in Europe and Germany, the German Government has issued a number of sovereign measures on the basis of the Law on Infection Protection in order to slow down the further spreading of the pandemic. Initial restrictions such as the cancellation of larger events were followed by further restrictive measures such as the closing of retail stores that do not sell essential items, restriction of access to public institutions (including courts of law) and finally, lockdown in the federal states of Bavaria and Saarland. Such a grave intervention into public life has direct and indirect consequences for those affected:that is why the legislature has now issued an extensive new law. Below, we summarized the key features of the “Law for the mitigation of the consequences of the COVID-19 pandemic on civil, insolvency and criminal procedure law”.
The new law provides extensive protection for consumers who, because of the COVID-19 pandemic, are not able to fulfil their liabilities when due without putting at risk their own economic livelihood or that of their dependants. Debtors affected in such way are granted a right to refuse, until June 30, 2020, performance of obligations entered into before March 8, 2020. The provision does not cover loan agreements, lease agreements and employment agreements.
The protection also covers micro enterprises within the meaning of the Commission Recommendation of May 6, 2003 as regards to the definition of micro enterprises if the enterprise cannot render performance or cannot render performance without putting at risk the economic basis of their business. In this case, too, the right to refuse performance also relates to claims from continuing obligations entered into before March 8, 2020 and can be exercised until June 30, 2020.
The moratorium gives debtors the opportunity to refuse temporarily or cease performance without being affected by adverse legal consequences such as default, legal prosecution of the primary claim or the emergence of secondary claims. The unwritten rule “man has to have money” has thus been temporarily suspended. This does, however, not apply if – taking into account all circumstances of the individual case – the right to refuse performance would lead to undue hardship for the creditor.
As a general rule, the law assumes – in accordance with the decisions of the German Federal Court of Justice on the risk distribution in lease relationships – that even in case a store is closed due to an administrative order, the tenant's obligation to pay full rent remains unaffected.
The law provides that lease agreements for land or premises may not be terminated because the tenant does not pay rent on the due date in the period of time from April 1, 2020 to June 30, 2020 (the government could extend the period until September 30, 2020 by executive ordinance) and the non-payment is caused by the consequences of the COVID-19 pandemic. In deviation from the first drafts prepared last weekend, the connection between the pandemic and non-performance will no longer be assumed but has to be substantiated; this means that while the tenant is not required to furnish full evidence, a conclusive explanation has to be provided.
The special provision for lease agreements is required since the right to refuse performance in civil law contracts as set out above shall only apply to obligations entered into after March 8, 2020. Regarding obligations to pay rent, the German Federal Court of Justice does, however, assume that these were entered into at the point in time the lease agreement was signed. In existing lease agreements, tenants would therefore not be able to claim a right to refuse performance.
The suspension of the termination right for default – which does not preclude other termination causes, in particular for behaviour-related reasons – will initially be limited until June 30, 2022. As a consequence, tenants will have to pay outstanding rentals incurred between April 1, 2020 and June 30, 2020 (or, as the case may be, September 30, 2020) by June 30, 2022.
A deferral of rent payments from April to September 2020 as initially planned was not implemented following comments from trade associations.
In addition to the protection of tenants, the legislation also provides protection for borrowers. Borrowers may defer lenders’ claims from loan agreements entered into before March 8, 2020 for a period of three months following the due date. While the first drafts of the new law imposed these rules irrespective of the consumer status of a borrower, the current version limits the moratorium to consumer loan agreements. The deferral right shall apply if the borrower suffers revenue losses due to extraordinary circumstances caused by the COVID-19 pandemic and such losses render the payment of the owed amounts an unreasonable burden. As a consequence, in a case of dispute, the burden of proof for an unreasonable burden in relation to the payment of interest or principal lies with the borrower. The right to refuse performance in this context applies to claims becoming due between April 1, 2020 and June 30, 2020. In addition, lenders may not accelerate loans for default until September 30, 2020. This does, however, not apply if – taking into account all circumstances of the individual case – the deferral right or the exclusion of termination would lead to undue hardship for the lender.
With the COVID-19 Suspension of Insolvency Act (COVInsAG), the legislature has implemented certain rules in the area of insolvency law, in detail:
If a business is insolvent or over-indebted, the managing directors are obliged in accordance with Sec. 15a Insolvency Code to file for the opening of insolvency proceedings within three weeks after occurrence of an insolvency event; failure to do so is a criminal offense. Further liability risks result from the prohibition of payments in case of insolvency under corporate law (Sec. 64 sentence 1 Limited Liability Company Act, Sec. 92 para. 2 sentence 1 Stock Corporation Act, Sec. 130a para. 1 sentence 1, also in connection with Sec. 177a sentence 1 Commercial Code and Sec. 99 sentence 1 Cooperative Societies Act).
Due to the current economic situation, businesses are at considerable risk of having to fulfil contractual obligations (payment of wages and rent for business premises) while not generating revenue. Since an end of the pandemic cannot be foreseen, it is not possible to make reliable prognoses required for the evaluation of the duty to file for insolvency. The law thus provides in Sec. 1 COVInsAG that the obligation to file for insolvency in accordance with Sec. 15a Insolvency Code (and Sec. 42 para. 2 Civil Code) is suspended until September 30, 2020. The suspension does not apply unconditionally: Businesses are still obliged to file for insolvency if the insolvency is not caused by the COVID-19 pandemic or if there is no prospect of improvement of the financial situation. Directors now benefit from the statutory presumption that if the business was solvent as at December 31, 2019, a later insolvency was due to the pandemic and there is prospect of removing the illiquidity. This statutory presumption helps reduce uncertainties as regards the proof of causality and predictability of further developments.
The right for creditors to file an insolvency petition will also be limited: Creditor petitions filed within the three months from entry into effect of the new law require that the reason for opening insolvency proceedings occurred on or before March 1, 2020 (Sec. 3 COVInsAG).
In addition to the suspension of the obligation to file for insolvency, the law provides for a limitation of liability for directors in relation to payments during the suspension period (Sec. 2 para. 1 no. 1 COVInsAG). Payments made during this period, which serve the continuation or resumption of business operations or the implementation of a restructuring plan, shall be deemed consistent with the care of a prudent and diligent manager. This provision creates a high level of legal certainty for the corporate bodies affected.
Furthermore, the law creates incentives to add liquidity to the businesses affected and to maintain business relationships. To this end, liability and clawback risks for lenders providing new loans during the suspension period are reduced. In accordance with Sec. 2 para. 2 no. 2 COVInsAG, repayments and securitization of new loans in this period shall not be deemed as a detrimental act towards insolvency creditors. This shall also apply to the repayment of shareholder loans as far as they have been granted in this period. Also, in accordance with Sec. 2 para. 2 no. 3 COVInsAG, the granting of loans and securitisation in the suspension period shall not be deemed an improper contribution to delaying insolvency. In this context, it has to be taken into account that these reliefs do not apply if the preconditions for the suspension of filing for insolvency are not met. It is therefore recommendable to properly document solvency as at December 31, 2019 as well as the prospect of improvement of the financial situation.
Finally, contesting legal actions during the suspension period is generally excluded as far as the contesting insolvency administrator is not able to show that the beneficiary of the legal act was aware of the lack of suitability of the restructuring and financing endeavours of the debtor in order to remove insolvency.
Since it might be necessary to maintain the suspension of the obligation to file for insolvency for a longer period of time – depending on the duration of the pandemic – the law authorises the Federal Ministry of Justice in Sec. 4 COVInsAG to prolong the provisions on the suspension of insolvency filings by way of a legislative decree without parliament’s approval until March 31, 2021 at most.
The COVID-19 pandemic also affects corporate law to a considerable extent. In order to enable company forms affected by the limitation of public gatherings to remain capable of acting, the law provides for considerable temporary alleviations for holding general meetings of stock corporations (AG), partnerships limited by shares (KGaA) and European Companies (SE). Comparable provisions were put in place for cooperatives, associations and homeowners’ associations.
The deadline for holding general meetings is extended from eight months to the entire business year. Due to the lack of jurisdiction of the German legislator, this does not apply to the SE which, according to current law, still has to hold the general meeting within six months (Art. 54 para. 1 SE Ordinance).
Much more relevant are, however, the changes for the implementation of the general meeting. Even without a relevant provision in the articles or rules of procedure, directors of listed companies are allowed to hold annual general meetings – as well as any extraordinary general meetings – in virtual form without the shareholders being physically present. This requires audio and video transmission as well as the shareholders being able to ask questions and vote electronically. Furthermore, the deadline for convening general meetings is shortened to 21 days. In addition, the corresponding resolutions will be largely uncontestable.
In order to avoid misuse of these derogations and to uphold the supervisory competence of the supervisory board, a decision of the directors to this effect requires the supervisory board’s approval.
In the context of the transformation law, for mergers and all types of divisions (demergers, spin-offs and split-offs) the effective date for closing balance sheets of the transferring entity is extended from a maximum of eight months (Sec. 17 para. 2 sentence 4, Sec. 125 sentence 2 German Transformation Act) to a maximum of 12 months before filing the transformation measure with the commercial register, in order to provide more flexibility for the timelines for transformation measures.
The principle of publicity of the main trial in accordance with Sec. 169 sentence 1 Court Constitution Act and Art. 6 I of the European Convention on Human Rights is a fundamental provision in criminal procedure. This includes in particular that each person has the right to (criminal) proceedings in a public main trial within a reasonable period of time. However, opening court proceedings to the public may result in the further spreading of the coronavirus. Until now, Sec. 229 of the Code of Criminal Procedure provides that the main trial in criminal proceedings may under normal circumstances be interrupted for no longer than three weeks; in exceptional cases for one month at most. An extension of this period is only admissible in cases of illness, parental leave or maternity protection of a party to the proceedings for up to two months. If these time requirements are not complied with, the criminal main trail has to start again.
The “Law for the mitigation of the consequences of the COVID-19 pandemic on civil, insolvency and criminal procedure law” now provides for the current elements of inhibition to be supplemented for all cases requiring measures to delay the spreading of the virus. This goes way beyond the current elements of inhibition provided for in the Code of Criminal Procedure, since now suspected cases or symptoms that are not tested for COVID-19 suffice for inhibition as long as they require a person to adhere to domestic quarantine. In these cases, inhibition shall apply for a period of at most two months and ten days. There is some uncertainty in this respect, since the explanatory memorandum assumes an inhibition period of three months and thus deviates from the proposed wording for the law.
COVID-19 has had and will continue to have impacts on virtually every corporation in Canada and globally.
As business resumes in the workplace and circumstances change, American companies must be ready.