The careless director

What?

Decision 4A_292/2022 of the Supreme Court vividly describes how a member of the Board of Directors of a public limited company (let’s call him “Benno” here) fell into a liability trap.

Benno and his friend were both 50% shareholders in the company and both had a seat on the board of directors. It was agreed that the friend would manage the business as CEO. As a result, Benno did not take care of the business. He therefore did not realise that the company was becoming overindebted. Consequently, he failed to file for the company’s bankruptcy in good time. In the period between the onset of over-indebtedness and the deposit of the balance sheet by a third party, the company accumulated debts totalling millions. Two suppliers successfully held the two members of the Board of Directors liable for their losses (around CHF 2,700,000 and CHF 3,000,000).

Our friend tried to evade liability by claiming that, according to the agreement with his friend, co-shareholder and co-board member, he had no responsibility for the “day-to-day business” and accounting. He had always been told by his friend that everything was in order and that he could trust this. Therefore, he had neither caused the damage nor was he at fault.

The Supreme Court did not listen to Benno’s line of argument. On the contrary, it branded his carelessness in breach of duty in clear terms:

• The company had been disorganised since its foundation, had no internal control system and did not have sufficient bookkeeping. This had led to inconsistencies, errors, omissions and delays in the preparation and auditing of the financial statements and even to the fact that there were no financial statements at all for the two financial years prior to the bankruptcy.

• The lack of proper accounting was the reason for the delay in notifying the judge of the over-indebtedness and he knew that the accounts had not been properly kept.

• It should be emphasised that Benno could not absolve himself of any responsibility on the grounds that he had not taken care of the day-to-day running of the business but had regularly checked with his friend about the state of the business.

• It was appropriate to recall that a member of the Board of Directors must exercise all due care. Benno could not hide behind the fact that he had relied on the reassuring words of his friend. Nor could he excuse himself by saying that he did not have the relevant information, as the duty of members of the Board of Directors is precisely to obtain the necessary information. He could have enquired about the situation with the external accountant or the auditors and could have taken organisational measures to rectify the administrative and accounting problems.

The liability claim under Art. 754 CO requires four elements: damage, a breach of duty, a causal link between the damage, a breach of a duty and fault. The Federal Supreme Court confirmed that even slight negligence is sufficient to justify the liability of a board member and that only exceptional circumstances can rule out fault.

This decision emphasises the importance of the objective assessment of fault and the duty of the members of the Board of Directors to proactively inform themselves about the financial situation and accounting of the company. There is no basis for the assumption that the statements of third parties can be relied upon. Instead, the court emphasises the need to carry out independent investigations and take corrective action if there are signs of irregularities.

So what?

For Benno, his liability (in these high amounts) was perhaps surprising because he had overlooked the following features of responsibility:

• Not only the company or the shareholders can hold the member of a board of directors liable, but also creditors who have suffered a relevant loss as a result of the late filing for bankruptcy.

• The agreements on the division of duties with his co-administrator and co-shareholder were not relevant. The duties of the member of the Board of Directors are objectively defined.

• Any fault, even a minor one, is sufficient to trigger liability.

He is therefore liable for the full amount of damages – there is no reduction in compensation for “minor negligence”.

Do What?

The decision of the Federal Supreme Court warns board members to exercise caution and to actively analyse the financial situation of their company. It makes it clear that a passive attitude or simply relying on the statements of third parties is not enough to exculpate oneself from liability.