When should the management take the blame? about management liability
In the wake of the financial crisis, focus has turned to the question of management liability. The increased number of bankruptcies has made it essential to know who may be held liable for losses suffered due to a company’s bankruptcy. Furthermore, a lot of companies have started seeking preventive measures to make the best possible basis for their management to give their utmost. These are some of the issues that will be addressed in this newsletter.
First of all, the question of management liability will be defined and delimited. In short, the term covers situations where an executive officer (or just EO) or a member of the board (called directors) of a limited company is held personally liable as a result of his or her performance of management duties.
Management liability must not be confused with the issue of when an EO or a director can be rightfully dismissed from his or her position in the company. Furthermore, management liability must be distinguished from the question of authorization; i.e. the question of when a company is bound by its management’s dispositions.
Usually, it is one or more of the company’s creditors that summon a member of the management for personal liability. However, managers actually risk being liable towards the company itself, its bankruptcy estate, the shareholders or anyone else who has suffered a loss due to the poor management.
Personal liability for failure of management
Management liability is a so-called fault-based liability. This means that a creditor or any other claimant raising a claim against a manager of a company must prove to have suffered a loss caused by negligent or intentional conduct by the said manager. The assessment of fault is made for each manager individually and is independent of any fault shown by the rest of the management.
The question of a manager’s personal liability depends to a great extent on whether he or she has performed all duties properly and in accordance with the Danish Companies Act, the company’s articles of association, the EO’s employment agreement, any other internal guidelines etc.
The most popular organizational legal structure of Danish limited companies involves a management structure, where a board of directors constitutes the co-called supreme governing body that is responsible for the overall and strategic management. The board is assisted by one or more EOs, who execute the board’s strategy and make day-to-day decisions.
In principle, all members of the management are subject to the same standard of liability. Thus, no particular consideration is giving to the fact that a director might be a family member, an employee representative or in any other way is non-professional. This is an often overlooked issue that might end with unpleasant and unexpected claims.
In the following we will introduce three typical examples of situations, where the management is at particular risk of being held personally liable.
1. The Board of Directors is not informed about essential circumstances
The EO is responsible for keeping the board informed of the business of the company. As the board will rarely consist (exclusively) of employees or others being present in the company on a regular basis, the directors are deeply dependent on getting all relevant information from the EO in order to make the best decisions for the company. This means that the EO actually risks incurring personal liability solely for not keeping the board sufficiently informed.
In this context, the directors are also at risk of a personal liability claim. This might be the case if they e.g. do not take all reasonable efforts to keep themselves abreast, if they fail to act on circumstances of unusual nature or if they neglect their duty to supervise the EO and to make sure that he performs his duties properly and as directed.
2. The passing of incorrect information to the creditors or the bank
If a third party suffers an economic loss due to wrong or missing information given by the management, the managers risk having to cover any loss with money from their own pocket. The management should not encourage the bank or others to grant the company a loan or give credit on the basic of incorrect or insufficient information. On the contrary, the management is legally obliged to give a true and fair view of the situation in the company.
3. Uninformed decisions
It may be obvious, but the managers may be held liable for loss caused by headless risky decisions. However, if risky decisions are taken on the basis of all necessary investigations and analyses of risks, the management will not automatically be held liable if the decision turns out to be wrong or if it results in the company and / or its creditors suffering losses. On the contrary, this might as well be an expression of diligent corporate governance.
We have prepared a list of some of the measures that companies may use in order to minimize the risk of personal liability for its management. Such measures often help to create a better working environment for the managers and it might provide the necessary security for them to be able to make right – and often difficult – decisions for the company.
- Well-defined and clear guidelines. The board should always prepare clear guidance to the EO, e.g. specifying how and when the EO must inform and notify the board. This helps the EO to ensure that essential and sufficient information is passed to the board to a proper extent.
- Documentation. Minutes should be prepared after all board meetings and any executive board meetings. This might facilitate a better defense if a manager is faced with a claim for damages.
- The composition of the management. Be aware of non-professional members of the management. A company should appoint its leaders on grounds of qualifications and not because of family or friendly relations.
- Insurance. It may be considered taking out insurance covering personal liability of the management. This kind of insurance usually covers all current and the future members of the management.