There are many different forms of liability of directors. A distinction can be made between internal liability, liability in case of bankruptcy and liability towards third parties.
internal liability
Internal liability means the liability of a director towards the legal entity or (in bankruptcy) the bankruptcy trustee. The most common form of internal liability is liability based on improper performance of duties (see below). Other forms of internal liability are liability upon payment of dividend and upon purchase of own shares and capital reduction.
In the event of improper performance of duties (article 2:9 of the Dutch Civil Code), it is required that the director can be seriously blamed. In principle, the directors are collectively liable, but an individual director can excuse himself by proving that he cannot be seriously blamed and that he was not negligent in taking measures to avert the consequences. The division of tasks within the board can play a role in this.
liability in case of bankruptcy
In case of bankruptcy of a legal entity, among other things article 2:248 of the Dutch Civil Code is of importance. Every director is severally liable towards the estate (for the deficit in the bankruptcy), if:
- the management board has manifestly failed to fulfil its duties; and
- it is likely that improper performance of duties is an important cause of the bankruptcy.
The trustee in bankruptcy may hold the management liable for the deficit in the bankruptcy. The claim of the trustee in bankruptcy has to relate to improper performance of duties in the period of three years preceding the bankruptcy. An individual director may excuse himself, but the judge may also reduce the amount of his liability if he considers it excessive in view of the time during which the director in question was in office during the improper performance of duties.
In paragraph 2 of article 2:248 of the Dutch Civil Code it is determined that the board has improperly fulfilled its task, if the board has not complied with the obligations to keep proper records or to timely deposit the annual financial statements. In certain cases, it is assumed that improper performance of duties is an important cause of the bankruptcy. This is a refutable presumption. In practice, it is very difficult to refute this presumption, especially if the presumption is based on the failure to keep proper records.
liability towards third parties
There are many different forms of directors' liability towards third parties. For example, liability due to a misleading presentation in the financial statements (so-called 'balance sheet liability') or liability for overdue taxes, social security contributions or pension premiums. In this context, I will suffice with directors' liability based on tort.
Besides the trustee in bankruptcy, an individual creditor may also hold a director liable for damages suffered in tort (article 6:162 of the Dutch Civil Code). For liability based on tort also applies that the director must be seriously at fault. However, case law in this area is very casuistic. Roughly speaking, a subdivision can be made in two categories:
- a managing director has entered into an obligation on behalf of the legal entity, of which he should have known that the legal entity would not be able to fulfil its obligation;
- a managing director has caused or allowed the legal entity to fail to perform an agreement previously entered into by it.
An example of the first category is a director who has ordered goods to be sold on, knowing that the legal entity would never be able to pay for them. An example of the second category is a selective payment in the view of the bankruptcy. In principle, a selective payment is not unlawful towards the other creditors. This changes as soon as it becomes clear that bankruptcy is unavoidable.
9 practical tips to avoid liability of directors
The foregoing means that in bankruptcy there is always a certain risk that the directors will be held liable. That risk simply cannot be eliminated. Below are 9 practical tips to avoid directors' liability:
- know the contents of the articles of association - and act in accordance with the provisions of the articles of association, in particular the definition of the purpose and the provisions on the powers of the board. Ignoring a provision of the articles of association may lead to directors' liability;
- ensure that there is a clearly defined division of tasks within the board and lay down this division of tasks in the articles of association of the legal entity. The division of tasks within the board may play a role in averting liability;
- intervene in the event of improper performance of duties and take the necessary measures to avert the consequences of improper performance. These aspects can also play a role in averting liability;
- annual request to be discharged from liability by the general meeting of shareholders (note: this so-called 'discharge' only concerns internal liability;
- ensure that the administration is up to date and that the annual financial statements have been filed (on time). Otherwise, a director will have to prove that there is another cause for the bankruptcy than his improper performance of duties;
- do not enter into new obligations on behalf of the legal entity if it is known or ought to have been known that the legal entity will not be able to meet them and, moreover, if the legal entity does not offer recourse for the damage resulting therefrom;
- do not make any more payments as soon as it is clear that bankruptcy is inevitable and do not wait too long before filing for bankruptcy. As soon as bankruptcy is unavoidable, a director has to take into account the interests of the creditors;
- where appropriate, notify the competent authorities in due time that the legal person can no longer fulfil its obligation to pay taxes, social security contributions or pension contributions;
- ensure that management decisions and considerations are well-founded and well-documented, so that it is always possible (in retrospect) to reconstruct which considerations have formed the basis of which decisions.