Directors' Liability: DIRECTORS UNDER FIRE

UIA paper
1. Januar 2000

1. General: Statutory Basis of Directors´ Liability

It will be typically the Managing Director (Geschäftsführer) of the Private Limited Company (Gesellschaft mit beschränkter Haftung - "GmbH") and the members of the Executive Board (Vorstand) of the Stock Company (Aktiengesellschaft - "AG") who will be concerned of Directors" liability. (Thus this outline is limited to these two corporate forms.)

Basically, Austrian statutory corporate law allows for two "routes" to hold Directors liable for damages caused by them:

a) Liability of a Director towards his own company:

· A Director has to reimburse to the company damages caused by not applying the diligence of a managing director when conducting the business of the company.
· The burden of proof is on the Director.
· If the tasks are allocated to specific Directors (Ressortverteilung), the other Directors" liability is reduced (to monitoring the responsible Directors if mismanagement is to be suspected).
· The company cannot validly waive its right of reimbursement to the extent it otherwise cannot pay its creditors.

Most frequently this route is applied when the Director enters, on behalf of the company, in a business transaction which is unreasonable (i.e., beyond the scope of the Business Judgement Rule).

b) Liability of Directors towards third persons:

· Here, the liability is based on tort law, i.e., if a Director breaches a provision of law that is aimed at protecting the third party against the loss inflicted upon it - Schutznorm.
· The burden of proof is on the third party.

Most frequently this route is applied when a creditor cannot collect its claim against the company due to the Director"s failure to initiate in due time bankruptcy proceedings over the insolvent company"s assets.

2. Practical examples of Directors" Liability

a) The most common example, again, is the Directors" failure to, in due time, initiate bankruptcy proceedings. This obligation arises when the company is either illiquid (beyond temporary payment difficulties) or over-indebted (i.e., the value of the liabilities exceeds the value of the assets, both calculated at liquidation value and, in addition, no turn-around can be realistically expected).
Upon occurrence of such a situation, the Austria Bankruptcy Act grants the Directors a 60-day period for either applying for a court settlement (debt relief proceedings, Ausgleich) or to initiate bankruptcy proceedings.
In its claim for compensation against the non-conforming Director, the creditor can claim the difference of the quota it ultimately receives, on the one hand, and the amount it would have received had the Director initiated the court proceedings in due time. (If the claim came into existence after this point in time, the creditor can even request the Director to reimburse the full claim with the argument that the creditor, if the Director had conformed with its obligation, never would have entered into a transaction with the company, in other words, never would have become a creditor of the insolvent company.)

b) Austrian law is very strict on the preservation of the assets of a corporation (GmbH, AG). It declares void any redistribution of capital which is not explicitly provided for in the law, i.e., in the context with the distribution of profit, the formal decrease of capital and the liquidation of the company).
Now, if the Director, on behalf of the company, and a shareholder enter, directly or indirectly, into a transaction which is not at arms length, it is not only the shareholder but also the Director who is liable for the restitution to the company of the funds unlawfully disposed of (examples: sale of land to or from the shareholder, services by the company for the private sphere of the shareholder, security the company, as a subsidiary, establishes for a claim of the parent company).

c) Austrian tax and social-security law explicitly provide for the liability of the Directors for taxes and contributions if the Directors, after the company became insolvent, do not "treat equal" the creditors of the company and, as a consequence, cause a disadvantage to the authority it would not have suffered in case of "equal treatment".

d) Another example (belonging to the first "route") is a Director who, on his own account, enters into a transaction or acquires a participation in the field that belongs to the (regular) business of the company and thus breaches his statutory duty not to compete with the company. The company can sue the Director for damages or for rendering accounts on and passing on the profit resulting from the transaction/participation contradicting the non-compete clause (which is laid down in the statutory company law).

3. Indemnification of Directors

a) As already mentioned, any indemnity, waiver, etc of the company vis-à-vis its Directors is void to the extent the reimbursement by the Directors is necessary to pay all creditors of the company.

b) Third persons, however, may validly grant to the Directors such an indemnity. In practice, a Director would typically get such a coverage from a parent company that nominates a Director of the subsidiary to "turn around" the bad financial situation of the subsidiary, or by a bank proposing the same job to a Director in order to save its unpaid loans.

c) The indemnity of a third party, however, is considered void in case it includes pecuniary penalties (fines) levied upon the Director (such reimbursement being considered against bonos mores by the Austrian courts).

4. Directors & Officers Liability Insurance

More recently, D&O insurances are offered also in Austria, in particular by international or US insurance companies. The market, however, has not yet broadly developed and companies are hesitant to "socialize" this kind of liability risk.


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