Company Directors: What could go wrong?

Concerns by directors and officers about the risks of personal liability have increased over the years, most probably as a consequence of the more regulated and complex business environment they are confronted with daily.

The recent global financial crisis has put directors and officers of both public and private companies under regulatory scrutiny like never before, and legislators have introduced new rights of action allowing claimants to bring civil claims.

Securing a good Directors & Officers Liability Insurance (D&O Insurance) certainly is one the most effective ways to protect individual directors against claims. But managing the risk also involves D&Os becoming well aware of their regulatory obligations.

The subject is obviously already abundantly covered in Luxembourg and in our capacity as insurance broker we do not intend to provide here a comprehensive overview of the matter. It is however worth remembering, by way of introduction to our upcoming “D&O insurance” newsletters, some of the framework principles applicable to the liability of directors and officers.

A complex and evolving legislative and regulatory landscape

Directors and officers are agents of the company (contrat de mandat). As a consequence, they do not enter into any personal engagement concerning the company’s obligations and the actions of a director should be treated as being the actions of the company itself. This principle, set out in article 58 of the Luxembourg Law of 19 august 1915 on commercial companies (the Companies Act), is the first line of defense available to directors & officers, allowing them to protect their own personal assets from claims against the company. Nonetheless, the shelter from personal responsibility is far from absolute. Directors will indeed be held personally liable towards the company or third parties for their own errors, negligence or even omissions in the performance of their duties.

To put it simply, a distinction is made between three sources of general civil liability:

  • In first instance, directors are accountable to the company for mismanagement in the performance of their contractual duties (article 59(1) of the Law of 19 august 1915). The company is in principle the only party entitled to invoke such contractual liability, in his quality as principal in the agency relationship. Eventually, it will have to take action against each of the directors separately, as the liability here is not joint and several. Frequent errors of mismanagement include not attending to the board meetings, lack of supervision of delegates, entering into contracts on terms detrimental to the company, various omissions and negligence such as dismissal of an employee without valid reason or even not providing for adequate insurance;
  • Article 59(2) of the Law also establishes an aggravated liability of directors & officers to both the company and third parties (such as creditors) for breach of the Law or the company’s articles of association. This action may be founded either in contract or in tort, depending on whether the claimant is the company or a third party. The law here provides for a rebuttable presumption of joint and several liability of the board of directors. To avoid liability, the directors must prove that they did not commit any tort and that they gave notice of the alleged facts to the general meeting of shareholders as soon as they knew them. Such liability may for instance be invoked when directors delay the approval or filing of the annual financial accounts, do not convene the general meeting of shareholders, or breach the statutory distribution of competencies between the company’s bodies.
  • Finally, in limited circumstances, directors & officers may be held liable to third parties for damage under the general rules of tort law (article 1382 of the Civil Code), but only when the directors have engaged in tortious conduct (as opposed to a mere management fault). Some examples here include the abusive continuation of a loss-making activity or the undertaking of obligations that the company is obviously not able to meet.

Next to those general civil liability principles, directors and officers can incur many other liabilities under specific laws.

Firstly, the Luxembourg tax administration may hold managers personally liable for the payment of the company’s own taxes. As far as direct taxes are concerned, the source law is to be found in articles 103, 109 & 118 of the General Tax Law (Abgabenordnung). The tax authorities must notably prove that the managers refrained from paying the taxes (such as the withholding tax on salaries and wages for instance) in a fault-based way. Newly appointed directors are even liable for events occurred prior to the start of their mandate, if they were made aware of them. Same applies in the frame of indirect taxes. Following the 2017 Luxembourg Tax reform, directors are now also jointly liable for the VAT due by the company in the event of a culpable breach of VAT compliance obligations and/or non-payment of the VAT (articles 67-1 to 67-4 of the VAT law). All those liabilities are primarily imposed on the directors in charge of the day-to-day management of the company, whether de jure or de facto. The issue of directors and officers being held liable for company’s taxes is certainly not limited to Luxembourg and many other jurisdictions, including Belgium, Germany and Italy, have introduced similar provisions in their tax legislations.

Directors and officers are furthermore exposed to various administrative and/or criminal fines and penalties.

In the tax field again, the law distinguishes between three forms of tax offenses in the area of both direct and indirect tax: simple tax fraud (avoidance of taxes or benefit from undue reimbursements); aggravated tax fraud (when the amount of tax evaded is substantial); and tax swindle. Whereas simple tax fraud is subject to administrative sanctions to be imposed by the tax authorities, the other two offences are criminally prosecuted. Those entrusted with the daily management of the company would be well advised to closely monitor the fulfillment of any of the company’s tax obligations.

In another vein, directors and officers may also be subject to criminal sanctions and administrative fines for breach of laws on privacy protection. The foregoing applied in Luxembourg for instance to directors who violated the right of privacy of employees (such as the secrecy of correspondence), or to directors whose company used a video-surveillance system without the prior approval of the NCDP (National Commission of Data Protection).

The law of 10 August 1915 on commercial companies also imposes, next to the civil liability regime, criminal penalties on the directors and other officers in case of abuse of company assets, abuse of power and votes, failure to call a general meeting or non-presentation of accounts. Other more specific legislations do just the same, such as securities laws (prospectus legislations, market abuse), insolvency laws (reckless or fraudulent bankruptcy), money laundering laws, environmental laws and anti-trust laws.

And liability does not end there: today, the duties and liabilities of corporate directors at companies in Europe is a factor both of domestic and European legislation. Initiatives such as the General Data Protection Regulation (severe penalties against directors for non-compliance with the higher organizational standards in terms of their use of personal data), the e-Privacy Directive, the Cybersecurity Directive, the Environmental Liability Directive will put even more pressure on the directors and officers in the near future.

An increased regulatory and shareholder scrutiny

Directors and officers now face more scrutiny than ever before, especially from regulators. Regulatory investigations and enquiries are considered to be the greatest risks facing directors in most jurisdictions.

In Luxembourg for instance, the CSSF is playing an increasingly active role by ways of on-site inspections, formal requests, recommendations, injunctions and even fines imposed on directors & officers. One need only look to the annual reports published by the CSSF on its website (http://www.cssf.lu/en/documentation/publications/annual-reports) to find out the many real case examples of investigative measures and sanctions conducted by the regulator against directors and officers. The CSSF has been constantly recruiting new agents over years, notably in the area of supervision. No doubts therefore that the pressure won’t be reducing in the next years. While much of this has indeed been felt already in the financial sector, other new sectors are targeted as well, including energy, high tech, telecommunications, pharmaceuticals, manufacturing, real estate development and construction.

Shareholder litigation is another rising issue, the numerous examples of class action claims against directors and officers, especially in listed companies, speak for themselves. Derivative or securities actions – where shareholders sue directors or officers on behalf of the company – are the most common form of shareholder litigation in most European countries. Mergers and acquisitions (M&A) and initial public offerings (IPOs), where there are increased reporting requirements, are common causes, with claimant typically challenging the price, process, deal protection provisions and disclosures.