9 practical tips to avoid directors' liability

For directors of legal entities, the risk of personal liability is a real concern. The law has several bases on which a director can be held liable under circumstances.

This contribution briefly discusses the main forms of directors' liability, followed by some practical recommendations to limit this risk.

Forms of directors' liability

In practice, a distinction is made between internal liability, liability in bankruptcy and liability towards third parties.

Internal liability

Internal liability means the liability of a director towards the legal entity. The most common basis is improper performance of duties, which may involve the internal division of duties within the board. Other examples include liability in connection with dividend payments, repurchase of own shares and capital reduction.

Improper performance of duties requires that the director can be blamed seriously. In principle, directors are collectively liable, but an individual director can exculpate himself by proving that he cannot be blamed seriously and that he was not negligent in taking measures to avert the consequences of the shortcoming.

Liability in case of bankruptcy

In case of bankruptcy of a private limited company, section 2:248 of the Dutch Civil Code applies; in case of a public limited company, section 2:138 of the Dutch Civil Code. Paragraph 1 of these articles provides that each director is jointly and severally liable for the deficit in the bankruptcy if:

• the board has manifestly discharged its duties improperly; and
• improper performance of duties is likely to be a major cause of the bankruptcy.

The receiver may hold the board liable for mismanagement in appropriate cases. Again, a director can disclaim liability by demonstrating that the improper performance of duties is not attributable to him and that he was not negligent in taking measures. In addition, the court may moderate an individual director's liability, taking into account, among other things, the length of time he has served as a director.

Paragraph 2 of sections 2:248 and 2:138 of the Dutch Civil Code contains a presumption of proof: if the management board has not complied with the obligations to keep proper accounting records or to file the annual accounts on time, improper management is presumed and is presumed to be a major cause of the bankruptcy. This presumption is rebuttable, but will be difficult to rebut in practice if it is based on the lack of proper records.

Liability towards third parties

There are many different forms of directors' liability towards third parties. For example, liability due to a misleading presentation in the financial statements (so-called balance sheet liability) or liability for overdue taxes, social security contributions or pension contributions.

An individual creditor can also hold a director liable for damages suffered in tort. Liability in tort requires a serious fault on the part of the director. Roughly speaking, a division can be made into two categories:

• a director entered into an obligation on behalf of the legal entity, which he should have known that the legal entity would not be able to fulfil;
• a director has caused or allowed the legal entity to breach an agreement it previously entered into.

An example of the first category is a director who has ordered goods from a supplier while knowing that the legal entity will never be able to pay for them. An example of the second category is making selective payments or siphoning off assets.

9 practical tips / recommendations

The risk of personal liability can never be completely eliminated, but it can be significantly reduced through careful action. Below are some recommendations to limit the risk of directors' liability:

1. Know the contents of the articles of association - and act in accordance with the provisions in the articles of association, in particular the purpose statement and the provisions on the powers of the board. Ignoring a statutory provision may lead to directors' liability;
2. Ensure that there is a clearly defined division of tasks within the board and also lay down this division of tasks in the articles of association of the legal entity. The division of tasks within the board can play a role in warding off liability;
3. Intervene if there is improper performance of duties and take the necessary measures to avert the consequences of improper performance of duties. These aspects can also play a role in averting liability;
4. Apply annually to be discharged from liability by the general meeting of shareholders (note: this so-called 'discharge' only relates to internal liability);
5. Make sure the administration is up to date and that the annual accounts have been filed (on time). A director will otherwise have to prove that there was a cause of the bankruptcy other than his improper performance of duties;
6. Do not enter into new obligations on behalf of the legal entity where it is known or should have been known that the legal entity will not be able to fulfil them and, moreover, that the legal entity has no recourse for any resulting damage;
7. Do not make any more payments once it is clear that bankruptcy is inevitable and do not wait too long to file for bankruptcy. Once bankruptcy is inevitable, a director must consider the interests of creditors;
8. Where appropriate, report in good time to the competent authorities that the legal entity can no longer meet its obligation to pay taxes, social security contributions or pension contributions;
9. Ensure that board decisions and considerations are well-founded and well-documented, so that it can always be reconstructed (in retrospect) which considerations were behind which decisions.

Have you been found liable as a director or do you want to avoid it? Robbert Vriezen would be happy to help you. Contact us today for personal advice.