The two-tier trigger policy for supervisory board members in Germany

December 2014 | EXPERT BRIEFING | RISK MANAGEMENT

financierworldwide.com

D&O damage cases are rife with conflicts of interest. In liability proceedings, an executive board tends to react according to the motto “attack is the best form of defence” and threatens the supervisory board with recourse claims for contribution predicated on connivance and co-responsibility. The separation of managerial and monitoring capacities in the German two-tier board system requires separate D&O policies for executive boards and supervisory boards through distinct insurance companies.

Conflicts of interest in D&O damage cases

Managers’ liability actions are increasingly permeated by third-party practice. Between supervisory board, executive board and insurer, this leads to extensive conflicts of interest which are highlighted during the course of a D&O damage case.

The supervisory board’s duty to prosecute

According to the German Federal Supreme Court’s ‘ARAG doctrine’, a supervisory board, by reason of its remit to monitor and scrutinise the executive board’s activity, has the duty to independently investigate the viability of a company’s compensation claims against executive board members. If the investigation yields the legal conclusion that the company does have viable compensation claims, the supervisory board must pursue them, and generally does so. The supervisory board runs the risk that, by virtue of its own initiation and pressing of the claim, the executive board members deplete the D&O money bucket (presumably as a result of a high defence burn rate alone) and that its members stand defenceless in later recourse proceedings. More often than not, executive board members extrajudicially confronted with the company’s claim, threaten supervisory board members with third-party notices once they have been served with a complaint.

Active defence against liability and base defence

Insurers are increasingly pursuing the path of active defence against liability. In this context, the insurer enters a liability proceeding by way of intervention as an intervenor on the defendants’ (executive board members’) side. The insurer is thereby capable of exerting direct influence on the liability proceedings. He (or she) is entitled to assert all means of challenge or defence. In the course of the intervention, the insurer serves the plaintiff corporation with a motion to dismiss, and furnishes pleadings. Through its base defence, the insurer takes control of the defence strategy. The executive board’s lawyers can subsequently submit additional individual pleadings and proffer evidence.

Third-party practice

The defendant executive board’s lawyers almost invariably counsel their clients to engage in third-party practice so as to preserve possible recourse claims. Third-party notices are not directed against the supervisory board as a collective body but rather against the individual members of the supervisory board. They are permissible provided that the defendant executive board members (the notifiers) believe that, in the event of an unfavourable outcome of the dispute at bar, they could assert a claim for contribution (recourse) against one or more members of the plaintiff’s (the company’s) supervisory board.

The board members’ recourse in the event of a contributory breach of duty by the supervisory board is effectuated in the internal relationship between the respective executive board members and the respective supervisory board members. This is accomplished in accordance with the proportionality of the actors’ individual degree of blame and the equitable liability quotas. It is predominantly in situations where the insurance sum is, or predictably will, be depleted, where the executive board members have an interest in the safeguarding of claims for contribution by means of third-party notices.

Recourse legal opinion

The notified supervisory board members’ lawyer produces a recourse legal opinion, and therein examines the central allegation of co-responsibility. In essence, the pivotal inquiry inescapably gaining centre stage is whether the executive board sufficiently and comprehensively informed the supervisory board (this will be the executive board’s argument), or, on the contrary, whether the supervisory board was not sufficiently informed, let alone deluded by the executive board (the supervisory board’s argument). The conflict is reflected in the business media with headlines such as: “The Supervisory Board Inquired Into Everything, Yet Unwittingly”.

The supervisory board’s duty to monitor

According to the general standard of § 111 Sect 1 AktG (German Stock Corporation Act), the supervisory board must monitor management. Professor Gregor Bachmann of Berlin University, a leading expert at the 70th German Jurists Day on the topic ‘Reform of Organ Liability?’, appositely couched the inherent crux of the duty to monitor in the following terms: “As the monitoring of management rests with the supervisory board, any mistake made by management can theoretically be converted into a mistake by the supervisory board.”

The D&O insurer between the battle lines

A third-party notice triggers an insured event under the company D&O policy, pursuant to which the executive board and the supervisory board are jointly insured. The notified supervisory board members must agree upon the choice of counsel with the D&O insurer and obtain a cover note for the lawyers’ fees (particularly for recourse legal opinions), notwithstanding that it is precisely this insurer that: (i) previously acted on the defendants’ (the executive board members’) side as an intervenor; (ii) filed a motion to dismiss the complaint; and (iii) possibly endorsed the third-party notice initiated by one of the defendants’ representatives.

If the insurer exerts his sole authority to conduct litigation (albeit under the caveat of refusal of coverage, depending on the outcome of the liability proceedings), then, in accordance with the legal precedents set forth by Civil Division IV of the German Federal Supreme Court in charge of insurance law matters, it shall protect the interests of the insured person in the same way a lawyer retained by that person would.

In the case of third-party notices, the D&O insurer shall refrain from simultaneously representing the opposing interests of defendant executive board members and notified supervisory board members. In this scenario, the insurer is ensnared in an inherent conflict of interest. The misery manifests itself in the insurer’s rights to information. If the insurer – citing to the notified supervisory board members’ insurance contract obligations – requests the surrender of a recourse legal opinion, then the supervisory board members’ lawyers apprehend that their submission to the request constitutes a violation of the attorney-client relationship. A confidential recourse legal opinion highlights both the incriminating and the exonerating moments of the potential breach of duty by their clients. If the recourse legal opinion is passed to the insurer, then there is also the risk that it will be deployed to defend the executive board members.

The German two-tier board system requires a protective umbrella for the supervisory board members

As previously outlined, in a damage event, members of the supervisory board must reasonably anticipate that executive board members will not refrain from going on the ‘counter attack’ by means of filing third-party notices. The separation of management and monitoring calls for a separation of D&O policies. Ancillary to an existing policy for executive (and supervisory) board members, a company should put up a protective umbrella for the supervisory board members via separate supervisory board D&O insurance coverage with an independent insurer (two-tier trigger policy).

Burkhard Fassbach is a partner at Hendricks & Co GmbH. He can be contacted on +49 (0)211 940 83 37 or by email: burkhard.fassbach@hendricks.eu.com.

Burkhard Fassbach

Hendricks & Co GmbH