When is it understood that an obligation arises for the purposes of determining the responsibility of the company administrators for company debts following a legal cause of winding up?

Published on 30th Jun 2016

The Supreme Court Judgement 986/2016 of 10 March 2016 has established the basis for determining what is meant by “obligations” for the purposes of the liability of administrators for company debts following the occurrence of a legal cause of winding up.

Paragraph 1 of Article 367 of the Consolidated Capital Companies Act (“LSC”) provides, verbatim, the following:

“Company administrators will jointly and severally respond to company obligations subsequent to the occurrence of a legal cause of winding up where they fail to comply with the obligation to call the general meeting within a period of two months in order to adopt, where appropriate, the winding up resolution. This is also the case for administrators who do not apply for judicial winding up or, where applicable, insolvency proceedings of the company, within two months from the date scheduled for the holding of the general meeting, when it was not held, or from the day of the meeting, when the resolution would have been contrary to the winding up”.

The Civil Chamber of the Supreme Court (“SC”), in Judgment number 986/2016, interprets said Article in the context of a purchase option contract over certain real estate properties. Derived from this is the obligation on the part of the grantor company to return to the option holder company (the appellant in this case) the price of the purchase option as well as an advance on the price, as a result of the option holder company exercising the resolutory condition agreed in the contract.

Firstly, it must be noted that the interpretation of at what point it should be understood that a company finds itself in cause for winding up is not discussed in this Judgment nor, therefore, is it a point of discussion in this article, but rather what is meant by company obligations, for the purposes of determining on what date they arise and, thus, if they occur prior to or following the occurrence of a legal cause of winding up. Nevertheless, is it true that it is not always easy to establish at what point a company finds itself in legal cause of winding up, which plays an important role in determining whether or not such liability exists.

That being said, in the factual situation analysed, prior to its elevation to the SC, the Provincial Court (“PC”) understood that the time to take into account when deciding when a company obligation arises is that in which the obligation is contracted, i.e. the time of signing the purchase option contract. The PC believes that the legislator, when referring to the obligations being “subsequent to the occurrence of the legal cause of winding up“, is intended to hold “administrators accountable solely for their decisions to continue to contract after learning that the company had offered indications that it could not guarantee with their assets the responsibility that may arise from these new debts“. That is to say, according to the PC, it is trying to avoid administrators from incurring new contractual obligations once the legal cause of winding up occurs.

On the contrary, the SC understands that the time to consider the case analysed is that in which the option holder company made use of the resolutory power and required the grantor company to fulfil its restitutionary obligation. The SC goes beyond the interpretation of the PC to the extent that it considers that the purpose of the said article is “to encourage the winding up or the application for insolvency proceedings of the company upon the occurrence of legal cause for one or other of the solutions. This is because, to not adopt appropriate measures to achieve the winding up and liquidation of the company or its declaration of insolvency, if the company continues with their company activity with substantially less equity to its share capital, which is presumed insufficient to meet their company obligations, thus the administrators must jointly and severally respond to all obligations subsequently arising, both those of contractual nature and of a different origin.”

Thus, the SC extends the scope of the joint and several liability of Article 367 LSC which, according to the PC it is referred to new contractual obligations, to any other non-contractual obligations that are subsequent to the occurrence of the legal cause of winding up, such as those arising from tort or vicarious liability, etc.

In short, the administrator that advises the company that they will fall into cause for winding up must not only refrain from singing new contracts but also from continuing with their company activities. If after the time marked by Article 367 LSC none of the actions referred to therein have been filed (or they do not file another action, if practicable, which ultimately removes the company from said situation through the granting of an equity loan, an increase or reduction of capital, or both – known in Spanish as “operación acordeón“-, or new contributions from shareholders, etc.), said administrator will automatically be liable for the obligations (contractual or ex lege), following the arising of the cause of winding up.

With this interpretation of the SC, the obligation of the administrator to file any of the solutions found in Article 367 LSC if he/she seeks to avoid his/her joint and several liabilities has become more pronounced, if possible. Considering that although it is relatively easy to ensure that no new contracts are signed, it is not so easy to control any obligation that brings cause of a contractual relationship previously established to arise, even when the administrator did not manage the company at the time the contract was entered into.

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* This article is current as of the date of its publication and does not necessarily reflect the present state of the law or relevant regulation.

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