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Director and parent company liability

Liability

Under what circumstances can a director or parent company be held liable for a company’s insolvency?

Director's liability Generally, a managing director is personally liable for breaching their duties under the Act on Limited Liability Companies. Such liability also extends to a director's deputies. However, the so-called ‘business judgement rule’ allows for the exculpation of directors. This rule will be applied if a director, when taking a certain action, could reasonably be assumed to have acted in the best interest of the company on the basis of adequate information. The same applies to directors of German stock corporations.

In addition to the above, directors are held liable for:

  • any (negligent) reduction of assets if the filing for insolvency is delayed; and
  • all payments made by the company after it becomes insolvent.

If a company has several managing directors, the responsibilities may be distributed among them. In this case, each director will be held responsible only for their area of responsibility. As a result, each director will have their own function in respect of which they will act on their own initiative, but also be held fully liable. Each director will have comprehensive monitoring and information duties with regard to the other directors' functions and will be held liable if they fail to meet these duties.

The liability of a managing director may also be limited by a shareholders' resolution approving such director's past actions. This resolution documents that business and corporate management have been deemed appropriate.

Parent company's liability As a rule, a parent company is not held liable for its subsidiaries' insolvency if the company has effectively paid up the stake in full. This does not apply if the subsidiary has paid the initial share capital contribution back to the parent company. Parent companies will be held liable if they have caused the subsidiary's insolvency by an intervention that leads to its winding up. Eventually, parent companies will be held liable in the event of their subsidiaries' insolvency if they have provided securities to third parties on behalf of the subsidiaries (especially through suretyship, cumulative assumption of debt and guarantee agreement).

Defences

What defences are available to a liable director or parent company?

Many insurers offer a pecuniary damage liability insurance to cover the internal and external liability risks, which is called directors and officers (D&O) insurance, like the ‘Anglo-Saxon model’ on which it is based. In most cases, this insurance is taken out by companies rather than members of corporate bodies themselves. In recent years, D&O insurance has become a standard insurance product and is taken out by almost all listed companies in Germany. But even in German limited liability companies, D&O insurance is playing an ever-increasing role.

Alongside D&O insurance policies, the exemption of directors from liability beyond insurance policies is becoming increasingly important. However, its legal basis and limits have not yet been fully clarified in Germany. In this context, there has been discussion of limiting the scope of liability of directors and of holding them liable only for grossly negligent breaches of duties rather than any negligent breach of duties. The possibility of a temporal limitation of a directors' liability (claims regularly become time-barred only after five years) is also being considered. Whether it is possible to limit the amount of directors' liability is also being discussed.

Due diligence

What due diligence should be conducted to limit liability?

Company directors must continually monitor their company’s solvency. In the case of a company's inability to pay or overindebtedness, directors generally have to file a petition for insolvency.

Generally, a parent company is not held liable for their subsidiaries' insolvency. The parent company therefore is generally not obliged to monitor its subsidiaries' insolvency.