By law, every Austrian stock corporation (Aktiengesellschaft; AG) must have a supervisory board (Aufsichtsrat; SB). This is not the case, however, in a limited liability company (Gesellschaft mit beschränkter Haftung; GmbH). For an Austrian GmbH, a SB is required only if applicable thresholds (most importantly, the workforce of the GmbH and controlled subsidiaries exceeds 300, or in some cases 500) are triggered. If a SB must be established, the works council is generally entitled to nominate 1/3 of its members. In practice, however, many investors are reluctant to establish an SB.

This reluctance is particularly due to: (i) unfamiliarity with co-determined boards (13 jurisdictions within the EU and US company laws lack co-determination), (ii) lack of clarity of the economic impact of co-determination, and (iii) the particularities of co-determination in the various jurisdictions, as co-determination is the result of cultural and socio-political developments shaping a specific equilibrium of interests.

Nevertheless, as this article will show, the obligation to set up an SB in a GmbH should not be ignored, as both, the management and the shareholders might be on the hook in case of non-compliance.

The role of the supervisory board

The core function of the SB – apart from appointing and recalling the management board (Vorstand) of an AG – is to control, supervise, and counsel the management. This role should not be underestimated. It is particularly important in challenging economic times when the midand long-term strategic role of the SB is supplemented by its involvement in short-term management. An experienced, insightful, and versatile SB is an important match for and addition to the operational role of the management. Such an SB is an asset to the company and benefits both management and shareholders.

Legal consequences of not establishing a supervisory board

Still, since a SB is not mandatory in a GmbH, it can happen in practice (especially in closely-held companies) that no SB is established. What are the potential legal consequences, apart from the obvious downside that management lacks its most important “sparring partner”?

First, there is the risk of potential liability of the managing directors towards the company. One could argue that such exposure is theoretical – no relevant case law exists. While that may be the case in good times, the tide could quickly turn once the economic sea gets rough. In the event of insolvency, the insolvency administrator will certainly look at every available option to recover funds for the estate, and if failure to set up a supervisory board played a part, he may test that option too.

Secondly, looking at historical parliamentary materials, it is clear that the rules on the SB in the GmbH were introduced not only to increase protection of shareholders but also to improve the company’s creditors’ position. It could thus be argued that the rules requiring a GmbH to have an SB are generally applicable protection laws with third-party effect. If that view were upheld, there may be grounds for a direct claim by creditors against the company and its shareholders in case of non-compliance.

Thirdly, for companies belonging to a larger group, there may be capital markets implications. Even if a GmbH itself cannot list on a stock exchange under Austrian law, the GmbH may have issued bonds, or its parent may be listed or have issued securities trading on a regulated market. The news that a transaction in a subsidiary went wrong is bad enough to disclose by itself. If, however, one is forced to admit that the appropriate control mechanisms (including a SB) were not in place, your compliance record may well be in tatters.

Lastly, for companies whose annual consolidated financial statements are subject to a (voluntary or mandatory) audit, there may be another important rule to note. Under Sec 269 of the Austrian Enterprise Act (Unternehmensgesetzbuch; UGB), as part of the annual audit, it is the auditor’s duty to verify general compliance by the company with “applicable laws and related provisions of the articles”. Pursuant to Sec 274 UGB, the auditor must report whether and to what extent the audited accounts “are in compliance with applicable laws and regulations”.

Now, admittedly, the auditor’s role is focused on a review of the books and records of the company, the preparation of the financial statements, and their compliance with (under the UGB) Austrian GAAP. But recently auditors more frequently request legal opinions as to compliance with the obligation to set up an SB. Moreover, as the going gets tougher and auditors of insolvent firms increasingly find themselves in the spotlight, is that a bet that prudent management and shareholders really want to take?

Depending on the interpretation of the law, there may be grounds for a direct claim by creditors against the company and its shareholders.