In the current economic situation, when increasing number of companies suffer loss and are in financially challenging situation, the issue of actual management`s responsibility thereof has become more topical than ever. Accordingly this article will further evaluate to what extent the management can be held liable for the company`s business, the means of that, as well as possibility to limit such liability.
In accordance with Latvian Commercial Law (“Commercial Law”) the executive management institution of a company is the Board (Valde), which shall manage and represent the company in its business. This includes representation of the company towards any third parties, as well as operations with the company`s assets. The Board may consist of one or more Board members, which can only be private individuals with legal capacity, provided that they have expressly consented for the respective position.
The Board members are elected either by the shareholders (in case of private limited liability company (sabiedrība ar ierobežotu atbildību) or the Supervisory Board (Padome) (in case of joint stock companies (akciju sabiedrība)).
Accordingly the Board owes a fiduciary duty to the company, as well as its electing body. The general the concept of fiduciary duty encompasses conducting the affairs of the company with sufficient care equivalent to that of a prudent and careful manager. Therefore, the standard of slight negligence is applicable to any breaches of such duty.
The duties of a prudent and careful manager generally include the following responsibilities of the Board members:
- to observe the requirements or the legal enactments and regulations;
- to observe the articles of association of the company;
- to observe lawful decisions of the shareholders’ meeting;
- to perform fiduciary duties to the company;
- to perform fiduciary duties to the shareholders;
- to furnish the corresponding state authorities, as well as shareholders with true and accurate information;
- to act with highest level of diligence and care, when adopting decisions with regard to the company`s operations and management; and
- to perform its duties duly and timely in order to minimize the business risks.
To be more specific, the company is entitled to damages from the Board whenever the Board has acted in contravention to the articles of association or the decisions of the shareholders meeting. Besides the liability may be imposed if the Board has acted in breach of generally binding legislation, e.g., the Board has not fulfilled its duties to communicate the requisite information to the Commercial Register or tax authorities.
The duty of care that the Board member must exercise when fulfilling the duties of the Board member must be pointed out as one of the main duties of the Board member. Therefore, in each transaction or action the board member must act with maximum efficiency – precisely, in accordance with the law, timely and responsibly.
Consequently, the Board members are jointly and severally liable to the company for damages caused to the company whenever they have breached their fiduciary duty and have failed to fulfill the requisite standard of care. The claims against Board members can be brought either by:
- the shareholders` meeting, which accordingly shall adopt a decision by simple majority. In such case the claim shall be brought on behalf of the company and maintained by the Supervisory Board, whereas if the company does not have Supervisory Board (which is optional for private limited liability companies), by accordingly appointed representatives;
- the minority shareholders representing at least 1/20 of the share capital or at least LVL 50 000 (approx. EUR 71 000); or
- the creditors, which are not able to get satisfaction of their claims from the company, provided that also in this case the claim is brought on behalf of the company and thus any recovered amounts will directed firstly to the company and only then to the creditors.
It shall be noted that the claim can be brought to the current Board members, as well as towards those that have left their positions, if they have caused loss during the office.
Consequently, there are three preconditions for satisfying the damage claims:
- the wrongful conduct of the Board member (act or failure to act);
- existence of the loss in the determined amount, provided that the loss can be direct as well as indirect;
- causal link between the wrongful act and loss, whereas in accordance with the latest court practice it is presumed that the guilt is already included in the objective evaluation of the wrongful act.
It shall be emphasized that in such case, i.e., when bringing a damage claim against the Board member, it is the Board member that has to prove that he/she has acted as “prudent and careful manager” not causing the damages to the company.
In addition to the general fiduciary duty and the standard of care, the Commercial Law contains non-competition restriction for the Board members, whereas the Board members shall not, without a consent from the shareholders’ meeting, become the complementary in a partnership or a shareholder with additional liability in the capital company that is involved in the business area of the company, to conclude agreements related to the company’s business on behalf of themselves or third parties, as well as to be the Board members in the competing companies, unless they form the same group. Upon the breach of those prohibitions, the company is entitled to damages or recognition of the transactions as concluded on behalf of the company, entitling the company to all claims thereof.
Furthermore, taking into account that Commercial Law, as well as other legislative acts impose on the Board members certain administrative duties, such as notifying the Commercial Register on corporate changes etc., it is possible that for failure to fulfil that the Board members may be held administratively liable.
If looking even further, the Board members may be brought to criminal liability in case there is malicious misuse of the authority, as a result of which the company has suffered substantial loss, as well as for brining the company to insolvency by wilful or negligent acts. Nevertheless, it shall be noted that, although every person is entitled to submit to the corresponding institutions information on the basis of which criminal proceedings may be commenced, the decision on such proceedings will be taken by the relevant institutions, after evaluating the grounds of potential criminal violation.
However, several problems, which the company can encounter when bringing a claim against the Board members for damages caused to the company, have to be pointed out. First of all, review of the claim by the court can be lengthy due to the workload of the courts and the receipt of the final decision, which is non-appealable can take up to five years. Second of all, as already mentioned, one of the conditions for bring a damages claim is the existence of damages and determination of the amount thereof, which may be complicated to show and sustain in practice. Therefore, in situations when the company concludes a service agreement (not an employment agreement) with the Board member, the company should consider inclusion of the contractual penalty in the agreement, which could be triggered in case the Board member fails to fulfil specific duties.
However, under certain circumstances the Board`s liability may be limited or even released. One of such possibilities is to receive the shareholders` decision with regard to potentially risky matters, as the Board members will be regarded as released from the liability if they have acted in accordance with a lawful decision taken by the shareholders’ meeting. Accordingly the Board members may request the shareholders to decide on certain issues that generally would be within the Board`s competence, in such way shifting the liability thereof to the shareholders. However, it shall be noted that such alternative would be available only in case of private limited liability companies, as Commercial Law states that the shareholders of private limited liability companies may decide on any issues that are within the competence of other institutions, whereas for joint stock companies there is no such option. Besides, the shareholders’ meeting may specifically release the Board members of the liability for particular issues, although it does not restrict the rights of the minority shareholders to bring such claim.
It must be pointed out that insurance companies offer civil liability insurance to the Board members. The insurance can be acquired by the Board member or by the company by conclusion of a relevant agreement. Such insurance normally provides for civil liability insurance of the Board member for losses caused to the company or third parties for which the Board member is liable in accordance with the legal norms in force and which the Board member has caused when fulfilling his duties of a Board member.
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