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Executive directors’ liability

  /    /  Executive directors’ liability

Welcome to Penrose directors’ liability

Penrose specialises in Dutch company law and directors’ liability. We advise, assist and also litigate in legal proceedings in the Netherlands between creditors, directors, companies and shareholders in situations (potentially) involving directors’ liability. On this page we briefly describe when there may be a situations of directors’ liability.

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A company’s Board of Directors plays an essential role and had a wide range of tasks. For this purpose, the Board of Directors can draw up an internal distribution of tasks and delegate tasks. However, the Board of Directors as a whole remains ultimately responsible. If the Board of Directors manages improperly, the executive directors run the risk of being held personally liable.

The powers of the Board of Directors in a company are far-reaching: the Board of Directors determines the company’s policy and strategy. The Board of Directors is also authorised to commit the company to (long-term) obligations, manage the balance on the bank accounts and sell the company’s assets. In short, the Board of Directors controls the company’s capital, incurs debts and determines who is and is not to be paid.

But when does the Board of Directors act outside their remit? When does it become a matter of improper management, and which conditions must be met before an executive director is personally liable? The law and case law have developed standards of conduct for this purpose. In legal proceedings, the Dutch court will determine whether an executive director is personally liable on the basis of these standards. Although the number of liability proceedings against executive directors is increasing, the number of convictions remains relatively low. An executive director’s personal liability is subject to strict requirements.

 

Internal and external liability

There are two grounds on which executive directors can be held liable for damage caused during the performance of their duties. A distinction is made between internal liability (the executive director’s liability towards the company) and external liability (the executive director’s liability towards creditors).

If the Board of Directors does not use their administrative power properly, the company may be disadvantaged by their actions. The Board of Directors may misuse its powers or take unacceptable risks. Examples include an executive director who unduly favours himself or herself or someone else at the expense of the company, or an executive director who enters into a new obligation when the company is actually required to apply for a suspension of payments. Another example is an executive director who sells important parts of the company for too low a price (not in line with market conditions). Tn exceptional situations, the company that is confronted with this may hold the Board of Directors personally liable. For this legal form of liability towards the company, serious blame may be attributed to the executive director. Since the Board of Directors is a body and therefore part of the company, this form of directors’ and officers’ liability is referred to as internal liability.

Internal liability concerns the Board of Directors’ accountability to the company. Every executive director must be committed to the proper performance of their duties. If an executive director fails to perform their duties properly, they run the risk of being held responsible for fraud or negligence, for example, or even for fraud or negligence on the part of fellow board members.

In most cases, invoices from creditors and taxes and premiums due are paid by the company. However, the company may have debts that are not (or not fully) repaid. The executive directors of the company may be liable to the creditors for actions they have performed (or neglected to perform) in the course of their management duties. In general, executive directors are only called upon privately by creditors if the company’s assets do not offer sufficient opportunity for recovery (because the company does not have any liquid assets or has been declared bankrupt, for example). Since the creditors are not part of the company, this form of director liability is referred to as external liability.

The Dutch law offers various options for creditors to hold a director externally liable. Directors run liability risks if they do not enter the company in the trade register, allow the company to enter into obligations that the company cannot meet, fail to report inability to pay premiums or taxes due, or if the company’s bankruptcy is the result of grossly improper management.

Below are some examples of directors’ and officers’ liability that occur relatively frequently.

 

Executive director acts negligently

An executive director may be personally liable if they enter into an obligation on behalf of the company when they know or should have known that the company would not be able to fulfil this obligation and would not have the financial means to compensate the creditor.

By way of illustration: a director of a construction company who is so short of cash that wages can no longer be paid, concludes a new building contract and still has a client make a down payment of 10%. The following week, the company goes bankrupt, even though the director had already seen this coming when they had concluded the new building contract.

 

Executive director prevents fulfilment of obligations

An executive director may be personally liable if they frustrate the fulfilment of one of the company’s obligations. The director’s actions may be unlawful if they have allowed or ensured that the company fails to fulfil an obligation, resulting in the creditor suffering a loss.

By way of illustration: a creditor reports to the company for payment of their invoice, but:

  • the director refuses to pay the invoice without good reason (unwillingness to pay); or
  • the director pays all of the company’s invoices (including his or her own management fee) except for the invoice of this creditor, and the company is then declared bankrupt (selective payment).

 

Executive director in bankruptcy

An official receiver of a company that has gone into liquidation can hold the executive director liable for the negative balance if the director has improperly managed the company in the three years prior to the bankruptcy. Improper management has taken place if the Board of Directors has not kept records and/or if the company has not published annual accounts. In addition, the official receiver can prove improper management if it appears that no director would have reasonably acted in the same way under the same circumstances.

 

Insurance (D&O)

In the absence of proper management, directors’ and officers’ liability insurance (D&O) can cover a substantial part of the liability, both internal and external. D&O insurance is not the same as business liability insurance. Taking out D&O insurance can guarantee that in the event of improper management, the damage would be covered. In addition to the damage, the costs of legal assistance can also be covered. Damage caused intentionally (deliberately) is never covered.

At Penrose, Dutch lawyers specialised in directors’ and officers’ liability and bankruptcy are happy to work with you and answer any questions you may have. Our lawyers’ contact details are available here.

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