Statutory bodies are obligated to act in the performance of their functions with necessary loyalty, sufficient knowledge and diligence, i.e. in such a way that when making a business decision they could be reasonably in good faith anticipating that they acted on an informed basis and in the justifiable interests of the business corporation. The Business Corporations Act (further only as “BCA”) thus speaks about the so called business judgement rule.
Obligations toward the company; informed behaviour
The statutory body is obliged to compensate the company for (i) damage which it caused by (ii) the breach of the duty of due care, if (iii) there is a causal link (nexus causalis) between the breach and such damage. Whilst the origin of the damage and the causal link between the act and damage must be proved by the company, the burden of proof that the member of the body acted with due care (this means behaviour in line with the law) rests on the statutory body. The prevalent doctrine so far presupposes that in case of a duty to compensate the damage this is a contractual and not a statutory duty; this has a significant meaning for the statutory body, because in the case of contractual duty, it is much more difficult to attain exemption from liability than it is in the case of a statutory duty: In such a case, it is not enough to prove that the breach of an obligation, respectively the law was not caused even by negligence; it must be proved that the statutory body was prevented from carrying out its contractual duty by an extraordinary, unforeseeable and insurmountable obstacle created independently of his/her own will (Sec 2913 of the Civil Code, further only as “CC”); put simply, an exemption will only occur in case of force majeure, which might, in our opinion, also include the current state created by the pandemic, bearing in mind of course the peculiarities of any specific case.
But beware: Exemption will not occur if the statutory body was in default of performing its contractual duty already at the moment when the obstacle arose, or if it was entrusted with overcoming the extraordinary event, eventually authorized to it (although this seems to be difficult to imagine in the given context). When assessing the due care but also exemption from liability (that the due care was not
exerted), the business judgement rule comes back into play, i.e. it is necessary to judge whether the statutory body acted reasonably in its decision having regard to the information it could have available at the moment of making its decision, as well as in the justifiable interest of the company. In any case, how the statutory body acted will be judged and not the actual result of such act. Therefore, it is not a responsibility for result.
Tip: We urgently suggest to the statutory bodies to monitor not only the legislation, which changes during pandemics almost daily (for more see: https://www.vlada.cz/cz/media-centrum/aktualne/vyhlaseni- nouzoveho-stavu-180234/ or rather also our newsletters), but also the economic situation of the company, so that they can recognize as fast as possible the state of crisis and respond to it. Further, it is also necessary to ensure the ordinary fulfilment of obligations of the statutory body, such as for example preparation of financial statements.
Obligations towards third persons
A shareholder can theoretically demand compensation of damage caused to the company also directly against a member of the statutory body, if he/ she was damaged in the amount of his/ her participation at the company. The Statute speaks about the so-called reflective loss (Section 213 CC).
Further, the Act provides for liability of the director/ board of directors for the obligations of the company, and that against the shareholders and creditors of the company for the case that the member of the statutory body did not cover damage to the company caused by a breach of obligations when in their functions and the creditors cannot enforce their claims against the company (for reasons of insufficient property). The extent of liability is limited by the amount of damage that the member of the statutory body is obligated to compensate. The creditor or shareholder would in such case have to prove that (i) the statutory body is obligated to cover the damage, (ii) the company has a due claim for compensation of damage against the statutory body and (iii) the creditor / shareholder could not enforce compensation of the damage against the company, whilst the company is for example in the financial insolvency.
Tip: Consideration deserve the agreements on postponement of payments, event. relief from payment. For the possibility of such postponement and relief against financial offices see https://www.vlada.cz/cz/media-centrum/aktualne/vyhlaseni-nouzoveho-stavu-180234/.
Exemption from responsibility by following instructions?
Director, eventually the board of directors is bound by the orders of the general meeting only of strategic and fundamental importance, the instructions must not concern the ordinary issues of management of the company, which must be decided individually by the director / board of directors.
However, the law on commercial companies provides for the possibility that the statutory body requests instructions from the general meeting or the sole shareholder of the company concerning the management of the company´s business. This will not free him/ her of the obligation to act with due care, especially the obligation to inform the general meeting on the subject of its decisions and to make informed decision (Section 51 par. 2 of the BCA). However, if the statutory body will follow the instruction of the general meeting given in accordance with the law, it can be anticipated according to expert opinion that the statutory body will not be responsible for the results, if before issuing the instruction it informed the statutory body of the subject matter of the decision.
Tip: A decision concerning the management of the company´s business that might have a significant impact on the future development of the company should be discussed in the current situation at the general meeting, eventually with shareholders, in order to prevent liability of the statutory body. However, it is necessary to remember that the statutory body must offer to the general meeting / shareholders solutions and offer sufficient information so that the general meeting / shareholders are able to choose from these.
What to do in the case of (imminent) financial insolvency? When does financial insolvency occur?
If it is not possible to improve the liquidity of the company by delaying payments or by payment relief, in case of financial insolvency or excess debts it is necessary to initiate insolvency proceedings immediately.
The legal entity or physical entity is considered to have excess debts if a debtor has several creditors and the total of their liabilities exceeds the value of their property; when estimating the value of the debtor's property, the further management of their property or the further operation of their company is also taken into account, provided that given all circumstances it may be reasonably assumed that the debtor will be able to continue with the management of their property or the operation of their company (Section 3 par. 4 of the Insolvency Act, further only as “IA”). Financial insolvency on the other hand occurs when (i) the debtor has more creditors and (ii) mature financial liabilities for more than 30 days overdue and (iii) they are not able to fulfil such liabilities, which is presumed mostly when they stop making payments for the substantial part of their financial liabilities, or they have defaulted for more than 3 months overdue, (Section 3 par. 2 IA). A certain improvement for the debtor as of 01.07.2017 is the statutory regulation of the presumption of financial insolvency, when the “coverage gap” (i.e. difference between the amount of their due financial liabilities and the amount of their available funds) amounts to less than one tenth of the amount of their due financial liabilities, or if the liquidity development outlook drawn up under the implementing legal regulation shows that the coverage gap will drop below one tenth of their due financial liabilities in the period for which the liquidity development outlook is drawn up (Section 3 par. 3 IA). The presumption of financial insolvency thus occurs only when the debtor is unable to pay at least 90 % of the due financial liabilities: if the debtor is therefore able to pay 91 % of liabilities, financial solvency is presumed; if the debtor can, however, pay at only 80 %, it will not suffice.
Before the financial insolvency happens, but at the moment when it is predictable that financial insolvency is imminent, it is possible to consider not only an out of court settlement with creditors but also moratorium, which can be suggested by a debtor that is an entrepreneur (self-employed) at the insolvency court even if the action to initiate the insolvency proceedings was not also submitted. A moratorium serves primarily to provide temporary protection to the debtor (in a maximum duration of 3 months with the possibility of extension by 30 days) before the creditors and during that time to enable restructuring of the debtors business outside of the insolvency proceedings and, in case it is necessary, to prepare a reorganization plan for the reorganization. Big advantage: For the duration of the moratorium it is not possible to issue the decision on insolvency; at the same time, the effects associated with the commencement of insolvency proceedings and other protective measures in favour of the debtor shall remain for the period of the moratorium.
The bankrupt party (the legal entity or natural person) or its statutory body is obligated to submit a petition without unnecessary delay after he/she found out or under due care should have found out about its own insolvency (financial insolvency or excess debts).
Attention: According to the actual governments draft on some measures to alleviate the impacts of the epidemy coronavirus SARS CoV-2, there should be also a change to the Insolvency Act, and that, in particular, concerning submitting the petition:
The above mentioned provision on submitting the petition without unnecessary delay “will not apply
from the day of the effectiveness of this Act till the expiry of 6 months (no later than by
31.12.2020)” from the date when the extraordinary measures against the epidemy were ended. This
will not apply if the insolvency occurred prior to accepting this measure during the epidemy, or if the
insolvency was not caused primarily as a result of circumstances related to the extraordinary
measures during the epidemy, which would make it more difficult or impossible for the debtor to fulfil
his financial obligations.”
Further, also blocking of the creditor´s petitions should apply: “Petitions submitted by the creditor from
the day of the effectiveness of this act till 31.08.2020 will not be taken into consideration.”
The government´s draft also mentions the possibility of suspending the implementation of the
restructuring plan and some alleviating measures in the discharge.
We will keep you updated on when the law will be accepted and how it will evolve further. We highlight the fact that these measures mean only the delay of insolvency proceedings, during which it is possible to be solving the financial situation by other measures, for example by moratorium.
If the obligated entity does not submit such petition in time, it will be responsible for the damage caused to the creditor, which is caused to him by the late submission of petition; this means in the amount of a difference between the insolvency established amount of the registered claim and the amount that the creditor received in the insolvency proceedings. It is possible to be exempted from such duty only in the case when the bankrupt party and/or its statutory body prove that the late submission of petition did not have an effect on the amount determined to satisfy the claim, or that the obligation to submit petition was not fulfilled because of such circumstances which arose independent of his/ her will and which he / she could not avert even by exerting all possible efforts that could be reasonably demanded of him / her.
The concrete method of dealing with insolvency depends on various factors: the discharge comes to mind strictly for legal entities and natural persons that do not have debts from their business. Discharge shares with restructuring – as compared to the bankruptcy order, which implies liquidation of a company – forgiveness of debts. These two methods differ from each other in that the discharge can be used only in the case of debtors who do not pursue business activities and do not have debts as a result of business activities (the Act provides for certain exceptions), whilst restructuring is only available for businesses.
Which other kinds of obligations of the statutory body will apply in insolvency according to the law on commercial companies?
In the event of insolvency of a company, the insolvency court may decide, upon the petition of the insolvency administrator or creditor, that a statutory body member or past member will responsible for the discharge of the obligations of the company if (i) it was decided that the company is in insolvency and (ii) the statutory body member or past member knew or should have and could have known that the company is in imminent insolvency and contrary to due care did not do all that was necessary and reasonably to be expected of him/her (this means submitting petition or implementing remedying measures). This expressly does not apply to, so called, crisis managers (Section 68 BCA). Warning: According to the most recent case law of the Supreme Court this liability measure is of a sanctioning nature. The court defines the type of debts this does concern (and eventually to what extent). This liability will persist and it is possible to establish even after the business corporation was cancelled and is liquidated, due to absolutely insufficient property (SC 27 Cdo 1319/2018).
In the case of insolvency proceedings initiated at the petition of a creditor, the past member of the statutory body can be called upon by the insolvency administrator to return its own remuneration/consideration he/she received from the company in the last two years prior to when such decision became legally effective (Section 62 of the BCA), provided that the past member of statutory body knew or should and could have known that the business corporation faces an imminent threat of bankruptcy under another legal regulation and, in breach of the duty of due care, failed to take all necessary and reasonably foreseeable steps to prevent the bankruptcy.
If you are dealing with any of the above stated issues or have any other questions connected to the current situation, please do not hesitate to contact us. We remain at your disposal.
Thomas Rechberger, Ph.D. , Partner, Taylor Wessing Prague ,firstname.lastname@example.org
Mgr. Barbora Skolková, Senior Associate, Taylor Wessing Prague email@example.com
23rd March 2020
10th August 2020
17th June 2020