Very few managing directors, board members or authorised signatories (hereinafter “managers”) are aware of the sharp sword of Damocles hanging over them due to their liability for breaches of duty in the performance of their functions.
Duty of care of a prudent managing director
Every managing director is obliged to act with the diligence of a prudent and conscientious managing director. This encompasses, on the one hand, the necessary loyalty to the company and, on the other hand, the so-called business judgement rule, i.e., the necessary knowledge and due diligence to enable the managing director, when making business decisions, to reasonably assume in good faith that they are acting on an informed basis and at the same time in the justifiable interests of the company. The managing director’s liability towards the company cannot be limited in any way.
When a court determines whether the managing director has acted with the diligence of a prudent managing director, it bases its assessment on the diligence that another, so-called reasonably prudent person would have exercised in a comparable situation. However, the burden of proof that the duty of care of a prudent managing director has in fact been met rests with the managing director himself. If he breaches this duty, he is personally liable for the damage incurred by the company.
What does this mean in practice? The managing director may, for example, be liable to the company for failing to assert its claims in court properly and in a timely manner, with the result that these claims can no longer be enforced.
For the sake of completeness, it should be noted that the managing director also has a number of further duties in connection with (impending) insolvency. However, this is a topic for a separate article.
Surrender of benefits and compensation
If the managing director fails to act with the diligence of a prudent managing director, he is obliged to surrender to the company everything he has acquired in this way. Furthermore, the company may require him to compensate for the damage caused by his actions. The managing director’s position is made more difficult by the fact that he must prove that he did not act negligently. Naturally, the managing director may engage the services of accountants, solicitors or other advisers, as he cannot be expected to be an expert in all areas relating to business operations.
However, the obligation to pay damages is not unlimited. Of particular significance is the damage which the managing director could have foreseen as a result of the breach of his duties. If he was unaware of the risk and was not required to be aware of it, he is generally not held liable for indirect or consequential damages, and he is not required to pay compensation for these. Any damages may be regulated contractually between the company and the managing director. However, a prerequisite for this is that such a contract is approved by the general meeting of shareholders or, in the case of sole shareholders, by the sole shareholder.
How can the managing director protect themselves – and how can the company?
Managing directors are clearly in a weaker position when it comes to liability issues. In their own interests, they should therefore carefully weigh up all actions taken in the course of their duties and always secure and archive the documents on which they have based specific decisions, such as economic and legal analyses. It is also advisable for the managing director themselves or the company to take out insurance on their behalf that minimises these risks.
Criminal law aspects
It is often overlooked that managing directors also bear far-reaching criminal liability. This ranges from fraud and breach of trust to causing harm to creditors or bringing about insolvency. However, a breach of the duty of care expected of a prudent managing director is most commonly associated with the criminal offence of breach of duty in the management of third-party assets. The court assesses whether the managing director has fulfilled their duties in the management of third-party assets by, amongst other things, determining whether they acted with the care expected of a prudent managing director. As the duty of care of a prudent managing director is a broad concept without clear boundaries, managing directors can once again only be advised to carefully review all their actions and to archive all documents on the basis of which they have made specific decisions. The risk of a custodial sentence cannot be covered by any insurance.