COVID-19 impact: selective payments

COVID-19 has deeply impacted society and the economy. In at least the short term, the effect of COVID-19 on business operations and business continuity already proves to be profound.

For many companies maintaining their business operations and remaining resilient under the current market conditions is or will be a very significant challenge. The current crisis might also raise questions regarding a company’s (and its management board) possibility to selectively pay (specific) creditors (in priority of others). Selective payments could provide the company with some financial leeway in the short term. Therefore, prioritising debt relief is of great importance for business continuity of the company.

Selective payments

In principle, (a director of) a company may freely determine which creditors of the company will be paid in the given circumstances, based on his or her own considerations (autonomy of payments). Payments made while there is still a real prospect of continuity of the company are governed by this autonomy. However, managing directors should be mindful with selective payments, as, under circumstances, selective payments impose a risk of personal liability.

The (financial) situation in which the company finds itself and whether the creditor being paid in priority over other creditors is an affiliated party of the company, are important factors in assessing whether a selective payment is unlawful.

The autonomy of payments may not uphold during financial distress of the company. The risk of personally liability for damages in tort for selective payments, arises if the relevant managing director has acted negligent in such way that a serious personal reproach can be made. For example, if the managing director knew - or should have known - at the time of the selective payment that this would harm other creditors and also that the company would not provide any recourse for their claim.

The closer a bankruptcy of the company approaches, the more the director must focus on the interests of the company's creditors in the performance of his or her duties. However, the mere fact that a selective payment was made at the time of impending bankruptcy, even after the company has filed for its bankruptcy, does not make such selective payment unlawful, if made while there are reasonable prospects of business recovery.

The test is more stringent with selective payments to affiliated parties. If the company has decided to terminate its activities and does not have sufficient means to satisfy all its creditors, (the management board of) the company is in principle not free to satisfy creditors affiliated with the company with priority over other creditors, this is only different if such payments are justified by specific circumstances. This specific restriction also applies to the satisfaction of non-affiliated creditors of the company if the managing director of the company has a personal interest in that payment.

Although the threshold for personal liability in respect of selective payments is high, managing directors should be diligent with selective payments. As such, it is important to properly document (via board minutes, letters, transcripts of (video) calls, financial projections, (external) advice) the management board’s considerations and substantiate why certain creditors have been paid in priority over others, to mitigate the risk of personal liability. For more information on director liability please see here.

See our Coronavirus (COVID-19) feature for more information generally on the possible legal implications of COVID-19.