To be a managing director – it is a socially prestigious and sought-after position. However, the price one pays for it is numerous duties, which could become dangerous if not properly understood or adhered to, particularly in times of crisis or conflict, when informal agreements suddenly count for nothing. Here you can find out which The pitfalls of the liability jungle pose a threat and how you can successfully avert.
Who is liable?
Firstly, the managing directors appointed as part of the corporate structure – that is, by a resolution of the shareholders – are liable. However, so-called de facto managing directors are also liable. A de facto managing director is defined as anyone who, with the company’s knowledge, actually performs the duties of a managing director without having been appointed as such. Such a person should therefore also be fully informed of their existing obligations.
Where several managing directors have been appointed, it is not only the managing director responsible for the duty in question who is liable. All managing directors are jointly and severally liable. The division of management responsibilities into specific areas therefore does not mean that a managing director can avoid liability for breaches of duty in other areas.
Scope of liability
In the event of a breach of duty, the managing director is liable without limitation with his or her entire personal assets.
Liability towards third parties cannot be unilaterally limited or even excluded. Such a limitation is possible only in the internal relationship with the company and only in respect of certain obligations.
In the worst-case scenario, therefore, the managing director risks personal bankruptcy if he or she breaches a duty.
Liability even for slight negligence
To make matters worse, a managing director who breaches his duties is liable not only for wilful misconduct and gross negligence, but also for any instance of slight negligence.
A dangerous reversal of the burden of proof
If a claim for liability is brought against the managing director, he faces a dangerous reversal of the burden of proof. This means that the managing director must demonstrate and prove that his conduct did not, in fact, constitute a breach of duty.
It is true that the managing director has a wide margin of discretion in many business decisions – this is analogous to the so-called ‘business judgement rule’ set out in section 93(1), second sentence, of the German Stock Corporation Act (AktG). However, to this end, he must demonstrate that his business decision was properly prepared and taken exclusively in the interests of the company. This requires the managing director to document the basis for his decisions on an ongoing basis and in a manner that is transparent.
Furthermore, the managing director must prove that he is not at fault, that is to say, that the damage would have occurred in exactly the same way even if he had acted lawfully in an alternative manner.
In order to meet the strict standards of proof required in legal proceedings, you must document your compliance with your obligations and your business decisions on a regular basis and in detail.
Long limitation periods for claims for damages
Many claims for damages arising from a breach of a managing director’s duties are not subject to the standard three-year limitation period set out in Section 195 of the German Civil Code (BGB), but to a longer
Limitation period.
For example, claims arising from a breach of the managing director’s duty of care are only time-barred after five years, in accordance with section 43(4) of the German Limited Liability Companies Act (GmbHG). The liability risk therefore also applies to events that occurred some time ago.
Who can claim compensation?
Depending on the nature of the breach of duty, claims for damages may be brought against the managing director by the company, the shareholders or third parties.
A managing director who breaches his duties is therefore liable not only to internal liability but also – in certain circumstances – to external liability!
Claim for damages by the company
The good news is that a breach of most duties results in internal liability, meaning that the managing director is liable to the company and not to third parties.
In particular, the managing director’s liability arising from the key duty set out in section 43(2) of the German Limited Liability Companies Act (GmbHG) is an example of such internal liability. A managing director who breaches a duty arising therefrom through negligence or even wilfully is obliged to compensate the company for the loss incurred.
In principle, for the company to assert such a claim, a resolution by the shareholders is required (Section 46(8) of the German Limited Liability Companies Act (GmbHG)).
However, even then, difficulties may arise: individual shareholders may also assert a claim for damages on behalf of the company, based on the ‘actio pro socio’ principle under partnership law, insofar as the majority shareholders, in breach of their duty of loyalty, refuse to enforce the claim against the managing director.
However, a shareholders’ resolution is not required if the company is in insolvency and the claim is brought by the insolvency administrator (Federal Court of Justice, judgment of 14 July 2004 – VIII ZR 224/02). The claim is then enforced immediately and without any further conditions. The shareholders may then
Above all, you must no longer waive the right to call upon the managing director (see point 9 below).
Collaboration between the managing director and the majority of shareholders, who sympathise with him and therefore refrain from bringing a claim, cannot therefore prevent the managing director from being held liable with any certainty. (See also below)
Claim for damages by a shareholder
In certain circumstances, the managing director is directly liable to the shareholders. This is particularly the case where there is a special legal relationship between the managing director and a shareholder, or where a shareholder claims damages which do not also constitute damages to the company.
Managing directors may face a significant liability risk when investors come on board or in the context of the sale of the company. This is particularly the case when the shareholders are required to provide certain guarantees regarding the company’s day-to-day operations to the new investor or purchaser. It is often argued that
In particular, existing investors point out that, as mere financial backers, they do not have extensive insight into the day-to-day running of the business, and therefore demand that the directors provide the shareholders with the same guarantees.
Claims for damages by third parties
Finally, there are certain circumstances in which the managing director may also be liable to third parties – such as the company’s creditors – for damages.
Liability for false appearance (liability arising from a false impression)
The most important example of such a duty to indemnify is, above all, liability for false appearance, whereby the person who has created a false legal appearance is liable.
The managing director is therefore liable for false statements in business correspondence. This applies in particular to situations where the managing director, contrary to Sections 35a and 4 of the German Limited Liability Companies Act (GmbHG), uses business correspondence that does not indicate the limited liability of the GmbH – that is, where the legal form suffix is missing.
The managing director is then directly liable to the creditors in accordance with section 179 of the German Civil Code (BGB), as he has given the impression that at least one natural person is liable without limitation for the company’s debts (Federal Court of Justice, judgment of 3 February 1974 – II ZR 128/73).
Liability arising from culpa in contrahendo (c.i.c.)
Furthermore, the managing director may be liable to third parties even if, during the contract negotiations, the managing director has taken advantage of a special relationship of trust which significantly influenced the subsequent conclusion of the contract (Section 311(2), second sentence, of the German Civil Code (BGB)).
This is already the case where the managing director offers a personal guarantee – going beyond the normal trust in good faith – in respect of the liabilities and the performance of the transaction, or the accuracy and completeness of his statements, which are decisive for the other party’s decision to enter into the contract
This is of some significance (Federal Court of Justice, judgment of 13 June 2002 – VII ZR 30/01).
Liability in tort
Like any other person, a managing director is directly liable in tort to third parties if, through wilful misconduct or negligence, he unlawfully infringes a third party’s life, physical integrity, health, liberty, property or any other right (Section 823(1) of the German Civil Code (BGB)).
However, the managing director may be held directly liable in tort, in particular, if he breaches a protective provision in favour of a third party (Section 823(2) of the German Civil Code (BGB)). Protective provisions are, above all, provisions punishable by criminal penalties. Of particular significance for the managing director in this context is a breach of the duty to file for insolvency, which, pursuant to Section 15a(4) of the Insolvency Act (InsO), is a criminal offence.
Finally, in exceptional cases, the managing director may also be held directly liable if a third party has suffered loss or damage as a result of the actions of the company’s employees. However, for the managing director to be held personally liable, it must be established that he has culpably breached the organisational and supervisory duties incumbent upon him, and that these duties constituted a kind of guarantor role designed to protect the third party from any risk to or infringement of their protected interests.
The Federal Court of Justice (BGH) has recognised such personal liability in a case where a managing director, upon resale, accepted a
rendered the prohibition on assignment ineffective (Federal Court of Justice, judgment of 5 December 1989 – VI ZR 335/88).
When is liability typically invoked?
A breach of a managing director’s duties does not necessarily mean that the managing director will be held liable. As the assertion of liability claims by the company generally constitutes a
As this requires a resolution by the shareholders, and the company often has no interest in holding the managing director – who is of great value to the company – liable, the company often chooses not to pursue such a claim.
On the one hand, however, such a waiver may be invalid (see below) – and on the other hand, the managing director may also easily lose the shareholders’ favour.
The following scenarios are typical examples of when the service is used:
Liability in the event of a crisis or the company’s insolvency
The managing director will regularly be held liable when insolvency proceedings are commenced in respect of the company’s assets.
If the managing director has breached his duties and the company is therefore entitled to damages, this claim will – if not already pursued by the company itself – be asserted and enforced by the insolvency administrator in any event. This is because the insolvency administrator is required to, by
to increase the insolvency estate through a promising lawsuit against the managing director.
However, the managing director is liable not only for past breaches of duty, but also for those directly related to the company’s insolvency. In particular, the managing director may face liability under section 64 of the German Limited Liability Companies Act (GmbHG) if, for example, he or she makes payments
made, even though the company was already over-indebted or insolvent. The same applies to payments made by the managing director to shareholders which were bound to result in insolvency.
A falling-out with the shareholders
The risk of the company taking legal action against the managing director also increases if objective or personal differences arise between the managing director and the majority of shareholders. In order to
In order to get rid of an unpopular managing director, people often look for evidence of a breach of duty.
New corporate structures resulting from the entry of investors
The shareholders’ goodwill may also change if the shareholder base changes, for example, if new investors join as shareholders following an investment. For instance, a due diligence process may uncover past breaches of duty which, due to the changed majority structure, can then be enforced.
Is it possible to waive claims for damages?
It is, in principle, possible to waive the right to assert a claim, as – apart from certain important exceptions – the shareholders have the discretion to determine the extent of directors’ liability (Federal Court of Justice, judgment of 16 September 2002 – II ZR 107/01).
This waiver applies only to those claims that arise in the internal relationship between the company and the managing director and whose enforcement is subject to a resolution by the shareholders.
A waiver is frequently granted in the context of the discharge of the managing director pursuant to section 46(5), alternative 2, of the German Limited Liability Companies Act (GmbHG). In such cases, the company can no longer assert a claim for damages to the extent that the underlying incidents were recognisable at the time the resolution was passed, had they been carefully examined
were.
However, the possibility of waiving a claim for damages or discharging the managing director from liability, important and practical limitations set.
In particular, the shareholders cannot waive an existing claim; consequently, the managing director cannot be discharged from liability if, through his misconduct, he has breached a mandatory provision of the Protection of creditors has breached it and that liability is necessary to satisfy the creditors.
The provisions on raising and maintaining capital (Sections 30 and 31 of the German Limited Liability Companies Act (GmbHG)), for example, are designed to protect creditors. If, for example, the managing director authorises payments to the shareholders in breach of Section 30 of the GmbHG, the shareholders cannot waive the resulting claim for reimbursement.
Applies in the event of Insolvency If the decision to bring claims for damages against the managing director is transferred to the insolvency administrator, the latter will not, as a rule, waive liability
be prepared. Under certain circumstances, the insolvency administrator may even retroactively challenge a waiver of liability previously declared by the company (by way of a shareholders’ resolution).
No comprehensive cover under D&O insurance
Managing directors often believe they are in the clear once they have taken out D&O insurance. But beware! A Directors and Officers – Insurance does not provide comprehensive cover.
Whilst D&O insurance generally covers all financial losses, both internally and externally, that are attributable to a breach of duty by a director, there are numerous exceptions to this principle.
For example, insurance cover does not apply in the event of intentional or wilful breaches of duty.
Furthermore, some providers include various exclusions in their insurance terms and conditions, which, if they apply, will limit or even cancel the insurance cover.
In particular, claims for own damages are only covered to a limited extent. Own damages refer to claims that the company has against a managing director who is himself a shareholder in the company. In such a case, the shareholder-managing director will have to bear a proportionate share of the costs.
As a general rule, claims for damages arising from tax-related matters and personal injury are not covered by the insurance either.
In particular, a so-called ‘exclusion of services’ is often made a condition. This means that financial losses caused in the course of the managing director’s operational activities are not covered by the insurance.
The sum insured will also usually be subject to a claim limit. In this respect, the insurance only provides cover up to the limit. If claims occur frequently or if individual claims are particularly high, the claim limit can be reached quickly. This results in a gap in insurance cover.
Above all, the insurance period is often strictly limited. Whilst claims made within the insurance period are covered, a time limit is usually agreed within which claims for compensation must be made – known as the ‘post-agreement period’. If you miss this deadline, you will lose your insurance cover.
After all, the insurance company may, under certain circumstances, refuse to pay out if contractual obligations to disclose information to the insurance company have been overlooked or not complied with.
Consequently, even D&O insurance does not fully protect a managing director against claims being brought against them or against being held liable with their entire personal assets.
Conclusion
As a managing director, you have various duties. A breach of any one of these duties may result in full and unlimited personal liability. The sheer number of these duties further increases your liability risk.
As a director, you therefore run the risk every day of being held personally liable with your entire private assets should you breach a director’s duty. Even slight negligence is sufficient for this to apply. You may be held liable even if you are not a formally appointed managing director, but merely perform the duties of a managing director and act as such in your capacity as a so-called de facto managing director.
A claim may be brought by the company itself, by the shareholders or by external third parties. Although it is possible for the shareholders to waive their right to bring a claim, there are important exceptions to this principle. Particularly in the event of insolvency, the likelihood is
high that they are utilised.
In order to be able to prove in a liability lawsuit that you acted in accordance with your duties and prepared business decisions, it is essential that you have documented your actions in detail. This is particularly important should you leave the company
should be used, as you will then only have restricted access to the company’s documents.
Contact at GWGL:
Dr Conrad Grau (grau@gwgl-hamburg.de)