It is common, particularly in finance and M&A transactions, that an adviser to a company also advises the shareholders and the management, as the interests of those parties seem to be generally aligned. The idea is that everything which is beneficial for the company is also beneficial for everyone else; both the shareholders and the management have a substantial interest in the commercial wellbeing of the company which they own or which employs them.
However, this view might be different when the company is in financial distress; in such case, the shareholders and management must decide to what extent they will subordinate their own interests to the company's interest in survival. In this situation it is vital for the management and shareholders to know whether they can rely on advice given by advisers to the company. It is equally important for the advisers to know whose interests they must take into account when providing advice, and who can hold them liable if any of the stakeholders suffers damage while relying on that advice. On June 14 2012 the Federal Supreme Court dealt with those questions in a judgment which provides insight to advisers and stakeholders on how to best protect their interests in a distressed situation.
The ruling dealt with a limited liability company which had a shareholder who was simultaneously its managing director, and a silent partner (a lawyer) who was also the managing director's husband.
The managing director had, on behalf of the company, instructed a tax adviser, who had been advising the company for some years, among other things in relation to its annual accounting obligations. A meeting between the managing director, the silent partner and the tax adviser took place in February 2006 in connection with the 2004 annual accounts. The topics discussed in the meeting included the company's economic situation and, in particular, the question of whether there was a potential obligation to file for insolvency. As a consequence of such discussions, the silent partner increased his investment in the company by injecting another €100,000 with a view to avoiding insolvency and allowing for the restructuring of the company.
However, four months after receipt of the 2005 annual accounts, in June 2006 the managing director filed an application for the commencement of insolvency proceedings. The application was based on the fact that the company was over-indebted and faced impending illiquidity. In the course of the insolvency proceedings, it was ascertained that the company was already over-indebted on December 31 2005. As the managing director had continued trading instead of complying with her statutory obligation to file for the commencement of insolvency proceedings within three weeks of the occurrence of either over-indebtedness or illiquidity, the court ordered her to indemnify the company personally for certain payments made after December 31 2005 and to compensate certain other parties, including the silent partner for the loss suffered as a consequence of his €100.000 fresh capital injection.
In turn, the managing director claimed compensation for damages from the tax adviser. In her view, the tax adviser had not properly advised her on the financial status of the company and her obligations to file for the commencement of insolvency proceedings, although this had been explicitly requested in the February 2006 meeting. With proper advice, the relevant payments would not have been made; nor would the silent partner have made the additional equity injection, since they would both have been aware that this contribution was insufficient to resolve the company's financial difficulties. The filing would then have been initiated much earlier and the managing director would not have suffered damages by having to indemnify other parties for losses suffered as a consequence of the delay.
The Federal Supreme Court ruled that in the case of an adviser acting on behalf of a company, third parties might also benefit from the protective effect of the agreement between the company and the adviser, and thus to a certain extent rely on this advice. This enables them to bring a damages claim against the adviser if the adviser does not take into account the third parties' interest when providing advice. According to the court, the managing director, in her capacity as managing director and shareholder, also benefited from the protective effect of the adviser contract. She could rely on the advice as it was clear from the outset that it would also form the basis of the managing director's decision on whether to file for insolvency. It was also the basis on which her husband formed the view that he should provide additional funding to the company in order to restructure it. The decision noted that in a restructuring context, it is very difficult to differentiate between advice rendered in the interests of the company and advice rendered in the sole interest of the managing directors and/or shareholders. Any advice will almost inevitably be used by all stakeholders to decide whether a restructuring is still viable or whether insolvency is inevitable. Any advice rendered in this context under an adviser agreement entered into with the company may generally be relied on by all stakeholders that are supposed to be provided with the advice. Such stakeholders can subsequently raise their own damages claims against the adviser if they suffer any damages due to the advice being incorrect or inappropriate.
The ruling was based on the idea that the company, its shareholders and managing directors are equally affected by incorrect advice concerning the financial situation, the insolvency risks of such company and the possibility and requirements needed to achieve a successful restructuring. The court decision means that where an adviser is aware that his or her advice is being made available to other stakeholders who are likely to base their decisions on that advice, the adviser must take into account the interests of those stakeholders – failure to do so may result in the adviser being held liable.
In practice, this could put the adviser in a difficult position, as different parties may need different advice.
Instructed by the company, the adviser must act in the company's best interests. The company's best interests normally involve continuing the business for as long as possible. Consequently, the adviser would have to advise the company to do everything possible to close liquidity gaps and to improve its liquidity situation by asking others to provide new financing, either as a loan or as equity. Advising the managing director to file for insolvency at an early stage would prejudice the company's interests.
In contrast, when considering the best interests of the managing director, the adviser would have to take a far more cautious approach and advise the managing director to file for insolvency sooner rather than later. Filing for insolvency at an early stage is crucial from the managing director's perspective, as if the situation is misjudged by the managing director and the adviser and the filing is not made within the mandatory filing period, he or she can be held liable for third-party damages incurred as a result of the delay in filing for insolvency. Additionally, he or she might become subject to criminal penalties.
From the shareholder's perspective, the best advice may be to avoid or limit contributions made by the shareholder and even prevent him or her from making any contributions at all if the complete set of restructuring measures which can be obtained from the various stakeholders seems to be insufficient to achieve a successful turnaround of the company's business.
This poses the question of how an adviser can protect himself or herself against potential liability for the advice which he or she gives on behalf of one party if the adviser is aware that this advice is also supposed to be made available to other parties whose interests are diametrically opposed. In such a case, the adviser's role appears to be almost impossible.
However, the court gave some guidance as to how the adviser can mitigate this risk. The court explicitly stated that it is not sufficient that the engagement be specifically limited to the company. It is also not sufficient that the other stakeholders can assess the legal situation by themselves. The court even stated that if the other party is sufficiently qualified to assess the situation himself or herself, this does not exclude the adviser's liability to that party. In the case at hand, the managing director's husband (the silent partner) was a qualified lawyer who should have been able to find out about the company's situation for himself and assess the risks and legal consequences of the situation. Nevertheless, the court decided that if the silent partner, as a lawyer, had decided to get independent advice on this issue, the adviser would be held to the same standards when providing advice as when rendering advice to any other person, and could then be held liable for any incorrect advice. The only case where an adviser can – in the view of the court – leave aside the interests of a party when rendering advice is the case where such a party has a separate adviser.
Against this background, the adviser and the various parties in a restructuring context should consider carefully whether their interests are still aligned or whether a stage has been reached where it becomes very difficult for one adviser to provide advice which serves everyone's best interests. At this point (at the latest), the adviser should insist on the appointment of a separate adviser for each stakeholder. Stakeholders should be receptive to the idea of seeking independent advice to protect their own specific interests. In many cases, the need and justification for taking separate advice outweigh the additional costs and the increased efforts which are required to coordinate the various advisers and their clients.
For further information on this topic please contact Stefan Sax or Oda Lehmkuhl at Clifford Chance LLP by telephone (+49 69 7199 01), fax (+ 49 69 7199 4000) or email (email@example.com or firstname.lastname@example.org).