Norway Insolvency Trends: Increasing Number of Companies in Financial Distress – Key Issues for Board Members

Introduction

Rising interest rates, local and global market fluctuations and volatile exchange rate movements have over the last years significantly increased financial stress across various business sectors in Norway, putting an increasing number of companies at risk of insolvency.

Following the increase in companies in financial distress, voluntary debt settlement arrangements and the use of the recently introduced Reconstruction Act, are rising. The development has also led to an increase in bankruptcies in certain sectors, of which the construction, restaurant and service industries have been particularly hard hit, reflecting both broader economic difficulties and sector-specific challenges.

In addition to the financial challenges faced by many businesses, we are experiencing an increased focus on corporate governance in both Norwegian law and European Union law, underscoring the importance of adequate corporate governance in the business. Over recent years, rulings from the Norwegian Supreme Court and developments in legal theory have underscored key principles relevant to boards of directors and executives in Norwegian companies. Notably, these include the duty of loyalty that boards of directors owe to their creditors, contractual partners, and stakeholders.

These developments have heightened the focus on the board’s decision-making and ongoing oversight of the company, resulting in a rise in claims and lawsuits against directors and executives in Norwegian private limited liability companies. This rapid development comes at the same time as the number of foreign board members in Norwegian private limited liability companies increases as a result of the ongoing internationalisation of Norwegian business.

The development may indicate a higher risk of claims and lawsuits against both Norwegian and foreign directors and executives. Recent developments in case law show, however, that the risk of liability caused by negligence in these roles may be drastically reduced if some simple measures are taken.

Companies in financial distress

The board and general manager put to the test

When facing financial difficulties, the board of directors and the general manager are placed in the headlights of the company itself, the stakeholders and the creditors. According to case law, all board members are measured and compared to what a reasonable board member acting diligently would have done in the same situation. This applies also to foreign board members and board members who are employed within the group that the company is part of.

Foreign board members should, therefore, be aware that they are expected to take an active part in the considerations of the board of directors and that they may be held personally liable for their actions and omissions in the same way as any other director.

Increased focus on safeguarding the creditors’ interests

Recent case law has underlined the importance of shifting the focus towards the interests of the creditors when the company is in financial distress. Claims and lawsuits resulting from failing to inform the creditors of the financial realities of the company have increased over recent years.

Even if the company will not be able to cover its creditors for some time, decisions from the Norwegian Supreme Court over the last years show that the company may take measures to reverse the company’s financial development without informing their creditors, provided, however, that there are realistic prospects for continued operation and handling of the company’s debt.

Risk evaluation and monitoring 

The evaluation and monitoring of inherent risks is important in any company, and the importance has accelerated due to the development of new technology, legislation, best practice standards for the board’s considerations and the increased focus on directors’ and officers’ liability. Notably, the importance of risk assessments and monitoring of the company’s financial situation is of vital importance for companies facing financial distress.

The board of directors and the general manager must make sure that the company has sufficient systems for identifying, assessing and handling inherent risks and that other relevant control systems and routines are in place. While the board is not expected to have detailed knowledge of every specific risk, it must ensure that these systems are current and effectively implemented by management and employees.

Further, the board of directors must make sure that the company’s financial situation is monitored. If the company is in financial distress, the board of directors must participate in more detail in the ordinary course of business. The directors must be directly involved and cannot delegate the rescue operation to the day-to-day management.

Recent Supreme Court rulings show that the board of directors may make decisions that later prove to be wrong without facing the risk of liability, provided that the board of directors had proper grounds for their decision-making, and the board’s considerations and discussions can be substantiated.

Proactive approach to new legislation

The board of directors must also act proactively with regard to new legislation affecting the company’s rights and obligations. The Act relating to Enterprises’ Transparency and Work on Fundamental Human Rights and Decent Working Conditions (the “Transparency Act”) entered into force on 1 July 2022. The aim is to encourage businesses to respect basic human rights and fair working conditions when producing goods and providing services. It also seeks to give the public access to information about how businesses handle negative impacts on these rights and conditions.

The Transparency Act applies to larger Norwegian enterprises offering goods and services in or outside Norway, as well as foreign enterprises offering goods or services to Norway that are liable to tax to Norway. The Act includes, among other things, a duty to carry out due diligence in accordance with the OECD Guidelines for Multinational Enterprises and to publish a transparency report every year.

The Transparency Act is based on the European Union Corporate Sustainability Due Diligence Directive that entered into force this year. The thresholds are, however, significantly lower than the thresholds of the Directive. In case of repeated infringement, infringement penalties may be imposed on both the company and physical persons acting on behalf of the company, such as the board of directors and the general manager.

Increased use of the Norwegian Reconstruction Act

The Norwegian Reconstruction Act, a restructuring scheme like Chapter 11 processes in the United States, entered into force as temporary legislation to mitigate the consequences of the COVID-19 pandemic for Norwegian businesses. After experiencing a slow start, the number of reconstruction openings by Norwegian courts has risen rapidly over the past years as the possibilities under the scheme have become more known. 

Companies that are facing, or likely to face in the future, serious financial problems can request an opening of reconstruction negotiations by the courts. The purpose of a reconstruction negotiation is a reconstruction with a voluntary arrangement of the debt or a compulsory settlement, and during a restructuring, the company will be protected from bankruptcy proceedings and other enforcement.

The Reconstruction Act provides the debtor with a wide range of possibilities to find a way out of the financial distress, provided that the company has sufficient cash flow after a successful reconstruction process. Consequently, the main condition for opening reconstruction proceedings is that the reconstruction is likely to give a better outcome than bankruptcy.

The Reconstruction Act is temporary and currently valid until 1 July 2025. The reconstruction scheme is, however, expected to be made permanent in new legislation with inspiration from the European Union Directive on Restructuring and Insolvency.

Liability of directors and executives in insolvent businesses

Increasing number of claims against directors

There has in recent years been a significant increase in claims against board members and executives in bankrupt companies. After bankruptcy proceedings are initiated, directors are often accused of not acting quickly enough to prevent the bankruptcy, or of initiating proceedings too late. Claims against the directors personally can either result from actions or omissions causing financial loss for single creditors or for the company. The directors may also face claims from shareholders arguing that they did not act in the best interests of the shareholders. This is, however, less common.

Supreme Court rulings from the last years highlight the importance of being open towards the creditors on credit risk. The question of when the company became insolvent and at what time the board of directors should have filed for bankruptcy has also been a recurring topic in the courts. These considerations are challenging and are from time to time misunderstood not only by directors and executives but also by lawyers, accountants, judges and even the Supreme Court itself. Consequently, the board should always seek legal advice in insolvency-related questions.

There are also several other grounds for claims against the board of directors, some of which are discovered after bankruptcy, while others occur during the ordinary course of business. Such grounds may be directors confirming capital changes with the Norwegian Register of Business Enterprises based on incorrect financial information, misleading customers and suppliers to enter into new agreements or to continue deliveries even though the company is in a critical financial condition, negotiating with creditors on debt settlement without seeking qualified legal advice, insufficient bookkeeping, lack of financial oversight, or failing to comply with legal requirements.

Lack of documentation from board meetings and decision-making processes is common in these cases. However, technological advancements now make it easier than ever to document the board of directors’ deliberations and decisions.

The role of technology

The Norwegian Private Limited Liability Companies Act and the Public Limited Liability Companies Act are technology-neutral, and the board of directors may therefore decide how to handle the matters most efficiently.

In addition to the digitalisation that affects the board of directors directly, Norway is at the forefront of implementing digital solutions in communication with the public, contract parties, banks, suppliers and public authorities, which the board of directors is expected to make use of for efficient communication.

The directors have access to updated information anytime and anywhere, and the board of directors can discuss matters orally or in writing without having to meet physically. Technological advancements not only facilitate examination of the board’s work but also enable directors to access and document their considerations more readily than before.

These technological advancements are likely to impose stricter requirements on both the work and documentation of the board of directors and day-to-day management. At the same time, technology provides directors with more accurate, comprehensive documentation and sound bases for their decision-making.

Causality and directors’ liability

The boards of directors in companies undergoing bankruptcy proceedings are from time to time accused of filing for bankruptcy too late, causing direct losses for creditors. Recent rulings by the Supreme Court show that the board of directors will not be held personally liable towards separate creditors which have incurred financial losses because the board of directors have failed to declare bankruptcy if it turns out that the net debt towards the creditor was reduced in the period between when bankruptcy proceedings were initiated and the time when bankruptcy proceedings should have been initiated.

Practical steps to avoid liability as a director or general manager

Key steps to safeguard the running operations

Despite the increased risk of director’s liability, the development in case law shows that the risk can be mitigated by making sure that the directors maintain proactive governance, legal compliance, and strategic risk management to safeguard their positions. The following key steps should be taken: 

• maintain continuous oversight: stay informed of the company’s financial health, performance, and risks on an ongoing basis, and regularly review reports, financial statements, and key operational metrics;
• strategic planning and budgeting: ensure the company engages in sound financial planning and budgeting, with a focus on sustainable growth, liquidity, and risk management;
• monitor and investigate red flags: identify, map, and promptly investigate any questionable or high-risk situations, including irregularities in financial reporting, operational risks, and legal concerns;
• evaluate solutions to potential insolvency: in cases of financial distress, assess all possible solutions, including restructuring, reconstruction, downsizing, or other strategic measures, to avoid insolvency;
• report financial irregularities: promptly report any signs of irresponsible capital management or liquidity issues to the full board and relevant stakeholders, and ensure compliance with all legal reporting obligations;
• initiate creditor engagement: if insolvency risks become significant, proactively initiate negotiations with creditors or file for reconstruction to protect the company and its assets;
• seek external legal and financial advice: when faced with complex financial or legal issues, especially near insolvency, obtain independent legal and financial advice to ensure compliance with the law and protect the board from personal liability; and
• document board deliberations and decisions: ensure that all board meetings, discussions, and decisions, especially those related to financial distress and potential insolvency, are thoroughly documented, including the rationale behind decisions, consideration of alternatives, legal compliance checks, and risk assessments; adequate documentation helps demonstrate that directors acted diligently and can mitigate the risk of personal liability in case of future disputes or investigations.

D&O insurance: a necessity

As a result of the increase in claims and lawsuits against directors and officers in Norwegian companies, D&O (Directors & Officers) insurance has become a necessity in most limited liability companies, regardless of the size of the company.

However, taking out D&O insurance itself is not enough, as D&O insurances often tend to deviate from the actual needs of the insured. To avoid any risk of insufficient coverage or denial of insurance coverage when directors and officers are met with claims and lawsuits, directors and officers should review the insurance policy thoroughly with the assistance of an insurance lawyer to make sure that the insurance policy is valid and that it has sufficient coverage in light of the company’s operations and inherent risks.

Following the increase in the use of D&O insurance, the number of disputes regarding the interpretation of the insurance policies has also escalated. In our experience, D&O insurance policies often come with ambiguous wording which can be avoided with some simple changes. It is, therefore, vital to make sure that the insurance policy and terms and conditions are both understandable for the insured and unequivocal.