Role and personal liability of supervisory board members in Germany

November 2016 | EXPERT BRIEFING | RISK MANAGEMENT

financierworldwide.com

Supervisory board members are facing increased liability risks which have been exacerbated in recent years.

Most cases involving liability of the supervisory board relate to an alleged failure of the board in the financial market crisis or a lack of compliance supervision with regard to corruption cases and cartel agreements. In former times, the widespread view in Germany that executive board members have an ‘inhibition to bite’ regarding the pursuit of claims for damages against supervisory board members can not generally be upheld today. Rather, the personal liability of supervisory board members has become a major focus in Germany. The driving forces are third party notices pursuant to the German Code of Civil Procedure served against supervisory board members by executive board members, which had been sued by the company in the first place as well as the pursuit of claims for damages in a company’s insolvency proceeding made by insolvency administrators. Furthermore, supervisory board members often have to fear special audit motions made by the shareholders regarding the question of whether the supervisory board has duly exercised its supervisory duty.

Pursuant to section 116 of the German Stock Corporation Act, the provision of section 93 is applicable with regard to the obligation to exercise due care and regarding the accountability of supervisory board members.

Section 93 has a twofold meaning. Firstly, clause one stipulates the obligations supervisory board members need to exercise due care. Supervisory board members must exercise care required to fulfil their duties in a prudent and diligent manner, in particular the duty to monitor. Secondly, section 93 subsection 2 of the German Stock Corporation Act is the basis for claims affecting the personal liability of board members. The risk of personal liability for supervisory board members arises from monitoring the executive board, which is a key duty beyond its personnel authority to appoint and dismiss executive board members, determine their compensation, and so on.

Supervision comprises backward-looking control of, and pre-emptive advice for, the executive board. The executive board is responsible for leading the company. Leadership decisions are subject to a review of their legality, controlling audits, the articles of association and whether they are commercially reasonable and expedient.

The supervisory board has rights to inspection and to information and disclosure. Each member of the supervisory board is obliged to gather a sufficient basis of information and knowledge to comply with his or her duties.

Another area where supervisory board members are subject to personal liability – often jointly and severally with executive board members – is in granting consent when such consent would not have been granted by exercising due care.

Increased duties of care

A special duty of care can arise for supervisory board members who have assumed a particular role on the board. The prevailing legal literature takes the view that the chairman of the supervisory board is subject to an increased level of accountability simply because of his capacity as chairman of the board as well as acting as a communication gateway to the executive board. The same principles apply to the chairman and the independent financial expert of the audit committee.

In the event that a supervisory board member is elected because of his specialist knowledge, the increased level of duty of care correlates with this special expertise. According to case law and legal literature, special expertise increases duties and intensifies liability.

For a company in financial crisis, the duty to monitor increases for each supervisory board member in relation to the nature of the crisis. The German Federal Supreme Court imposes rigorous requirements – the supervisory board must utilise all sources of information and knowledge available. The duty to monitor implies the need for increased control, in particular the demand for ad hoc reports from the executive board – for instance, restructuring expert opinions, liquidity planning, insolvency and over-indebtedness status – to increase the frequency of board meetings as well as installing a committee, and appointing outside counsel where appropriate. Should the supervisory board fail in these increased monitoring duties, the company may pursue claims against its members, and in the event of an insolvency proceeding, such claims may be made by the insolvency administrator. Breach of the duty to monitor can imply a personal liability for supervisory board members.

The stock corporation law is based on the principle of focusing liability and, therefore, supervisory board members are subject to internal liability toward the company. The statutory basis for a claim relating to breach of the duty to monitor is contained in sections 116 and 93 of the German Stock Corporation Act. The competency to examine claims and pursue claims against former and present supervisory board members rests with the executive board. The executive board must determine the facts and circumstance of the case and review the litigation risk with regard to the prospects of success.

The supervisory board members’ liability for damages runs parallel to the executive board members’ liability for damages. Supervisory board members have to indemnify the company for damages caused by a breach of duty.

Objective criteria are applicable with regard to the supervisory board’s duty of care. In other words, individual capabilities and knowledge are not relevant. According to case law, each supervisory board member must have the minimum knowledge and capabilities or develop such skills as required to understand and properly assess ordinary business procedures without external counsel. A reversal of the burden of proof pursuant to German law is applicable with regard to breach of duty. If the question of whether or not a supervisory board member acted prudently is in dispute, the burden of proof rests with the supervisory board member. This is particularly unfortunate for supervisory board members who have already left the board and therefore have no access to the company’s files. In contrast, the company has access to all relevant information, such as emails and electronic documents, or can gain access with time and expensive data screenings. The reversal of the burden of proof pursuant to the German Stock Corporation Act seems to be hopelessly antiquated and therefore should be abandoned by the German legislator. The right to information and disclosure which case law has granted for board members does not outweigh the information gap and causes unreasonable difficulties for a board member who ultimately depends on the company’s cooperation.

The scale of fault is basically governed by objective criteria and has to be attributed to each individual supervisory board member. The slightest negligence is sufficient.

In the framework of the assessment as to whether or not a breach of duty can be determined, the supervisory board members may benefit from the business judgment rule codified in section 93 of the German Stock Corporation Act. The requirements are as follows: (i) the existence of an entrepreneurial business decision; (ii) decision-making on the basis of appropriate information; (iii) in the best interests of the corporation; and (iv) the absence of any conflict of interests.

The company’s claims for damages against supervisory board members are in principle subject to a five year limitation period. Stock listed companies are subject to a 10 year limitation period. The same 10 year limitation period applies for the supervisory board members of credit institutions.

Dr Burkhard Fassbach is lawyer at MRH TROWE and Dr Carsten Wettich is a partner at Berner Fleck Wettich. Dr Fassbach can be contacted on +49 152 5438 6727 or by email: fassbach@fassbach.de. Dr Wettich can be contacted on +49 211 2006 7816 or by email: c.wettich@bernerfleckwettich.de.

Dr Burkhard Fassbach

MRH TROWE

Dr Carsten Wettich

Berner Fleck Wettich