Auditor's Liability
Liability of Board Members
Code of Best Practice
In the wake of the financial collapse of Swissair, the liability of board members and auditors has been the subject of much discussion in Switzerland. To date, there have been few instances of board members or auditors being sued for damages caused by a violation of their duties. However, this may well change in the years ahead. The Swiss Federal Supreme Court recently had to decide three cases in which corporate bodies were sued for violation of their duties.
A Supreme Court decision delivered on July 12 2001 (BGE/ATG 127 III 453 ss) concerned an auditor's liability. An employee of Company Z, who was entrusted with the management of the X Corporation, embezzled about Sfr1 million between 1988 and 1992. The defendant, Y, was auditor of the X Corporation during this period and was sued by the X Corporation for breach of his duties as an auditor. The Supreme Court held that the Corporation Law which was in force before July 1 1992 was applicable to the question of the auditor's liability, while the revised Corporation Law which took effect on July 1 1992 applied to the question of the joint and several liability of the corporate bodies. The Supreme Court confirmed that the liability of the auditor presupposes four conditions:
- that the corporation has suffered damages;
- that the auditor has failed to fulfil his duties imposed by law;
- that there is an adequate causal relationship between the auditor's failure and the damages; and
- that some fault is attributable to the auditor.
These four conditions must also be fulfilled under the new Corporation Law, which states in Article 755 of the Swiss Code of Obligations:
"All persons engaged in the audit of the annual accounts...are liable not only to the company, but also to each shareholder and the company's creditors, for damage caused by an intentional or negligent violation of their duties."As the defendant did not undertake the customary auditor's examinations and hence violated the duties imposed on him by law, the Supreme Court held that the four conditions mentioned above were fulfilled and, therefore, found the auditor liable for the damage caused by his omission. However, assuming that the company itself had committed a fault by not supervising and instructing the managing Company Z with greater care, the Supreme Court upheld the lower court's decision to reduce the amount of compensation by one-third. In addition, the fact that the defendant had received only modest payment for acting as the company's auditor was also considered as a reason for reduction.
Two other recent decisions concern the liability of the members of the board of directors according to Article 754 of the Swiss Code of Obligations. They illustrate that the liability of corporate bodies cannot depend on the formal expression used to describe their function within the company. Both cases were decided by the Supreme Court on October 29 2001 and are based upon the same facts.
On November 24 1988 the F Corporation bought all shares of the E Holding Corporation, which had wholly owned the E Corporation since December 10 1987. On December 12 1988 the F Corporation and the E Corporation signed a contract in which they undertook to restructure the E Corporation. In addition, the F Corporation contracted to buy the E Corporation's software at the price of Sfr3 million. A sum of Sfr1.5 million was to be paid by the end of 1988, with the remainder payable in annual instalments of Sfr300,000. In July 1990 the E Corporation and the E Holding Corporation went bankrupt. According to the fact-finding of the lower court, none of the sums outstanding under the contract were ever paid.
In the first decision (4C.214/2001) the Supreme Court had to consider whether the defendant, as the only board member of the F Corporation, could be sued by the creditors of the subsidiary E Corporation according to Article 754 of the Swiss Code of Obligations, even though he was an individual and not a formal corporate body of the E Corporation. The version of Article 754 in force until July 1 1992 stated that all persons engaged in the administration, management or control of a company are liable not only to the company, but also to each shareholder and to the company's creditors, for damage caused by an intentional or negligent violation of their duties. The Supreme Court found that following the F Corporation's takeover of the E Corporation on November 24 1988, the board of the F Corporation was actually handling the reorganization and business transactions of both companies. The Supreme Court pointed out that, as the only board member of the F Corporation, the defendant played an active role in this process. Although he was not elected as a corporate body of the E Corporation, he acted as one; he was therefore an informal, de facto corporate body of the subsidiary and liable to its creditors pursuant to Article 754. The Supreme Court ruled that the defendant had violated his duties to the subsidiary by not ensuring the payment of the Sfr3 million.
In the second decision (4C.208/2001) the defendant, who was a manager and shareholder of the F Corporation, was sued by the creditors for breach of his duty as an informal, de facto corporate body. As in the first case, the defendant was not a formal body of the F Corporation but a manager of the company. However, this fact alone was not adjudged sufficient to bring the defendant within the scope of Article 754. The Supreme Court based its decision on the defendant's lack of decision-making power, and also on the fact that he was responsible for neither the reorganization nor the financial issues of the company.
In September 2001 an team of experts appointed by Economiesuisse (the Swiss Business Federation) presented their draft for a Swiss Code of Best Practice to the public. This draft will help executives of joint stock companies to control and run their companies according to the principles of corporate governance, which are designed to ensure a system based on checks and balances between shareholders, the board of directors and senior management. It remains to be seen whether the code will influence company and commercial case law. It is likely that the code will be a source for the interpretation of blanket clauses, especially with regard to the duties of corporate bodies.
For further information on this topic please contact Markus Doerig or Istok Egeter at Badertscher Doerig Poledna by telephone (+41 1 266 20 66) or by fax (+41 1 266 60 70) or by email ([email protected] or [email protected]). The Badertscher Doerig Poledna website can be accessed at www.bdp.ch.