The ruling of the Supreme Court of Lithuania of 25 November 2016 established a system of criteria to decide in which situation the manager of the company and/or its shareholders may be ordered to pay to its creditors a compensation for damages caused by transactions that are harmful to the company.

In the respective case the bankruptcy administrator, who defended the creditors of the failing company, applied to the court; he challenged the agreement on purchase and sale of premises and requested the court to order the shareholders and the manager of the failing company to pay damages jointly and severally. According to the claimant, the company acquired the premises from the parents of the shareholders at a price much higher than the market price. In this way a transaction which was clearly unprofitable to the company was concluded and damage was caused to the company.

The court of first instance dismissed the claim but the court of appeal upheld it and ordered the shareholders and the manager of the company to pay damages jointly and severely. In the view of the court, the decision to acquire property at a price much higher than the market price having no sufficient ground for that has infringed interests of the creditors and it may not be considered as normal economic and commercial risk-taking. In the case the court established that in principle damage had been caused through actions related to the conclusion and non-implementation of the leasing agreement on acquisition of the premises in question, which caused the company to lose the acquired property and, moreover, to remain owing money to the leasing company and in this way reduced its assets, increased its obligations to its creditors and reduced its possibility to settle accounts with other creditors.

The Supreme Court of Lithuania revoked the decision of the court of appeal and referred the case back to it finding that the value of a transaction higher than the market value alone may not be considered as a sufficient ground for establishing uselessness and unprofitability of the transaction.

The criteria for deciding in which situation the manager and/or shareholders of the company may be ordered to pay to its creditors compensation for damages caused by transactions harmful to the company

Firstly, the court of cassation noted that liabilities of the company’s shareholders and manager are independent; therefore, their joint and several liability to a legal person or the legal person’s creditors is possible only in exceptional circumstances.

Secondly, the shareholder of the company does not have statutory obligations to the company, except the obligation to pay the authorized capital. The shareholder may vote in meetings of shareholders in its own interests; only the prohibition to abuse limited liability applies to it. The interests of the shareholder may not always coincide with the interests of the company itself; therefore, the shareholder has no obligations based on the relationship of trust to the company. The shareholder has no duty to take into account interests of all interest groups and has no statutory obligation to avoid a conflict of interests. Thus, liability of the shareholder is subsidiary and possible in rare circumstances.

The principles related to functioning of the manager of the company require the managing bodies of the company to act solely in the interests of the company, i.e. to ensure stable, effective and competitive activities of the company as a market player. Therefore, even the consent of the meeting of shareholders to the transactions in question does not exempt the manager of the company from civil liability for the damage caused to the company by these actions.

On the other hand, when the company operates normally, the manager has no obligations based on relationships of trust to creditors. Therefore, only when the situation of the company worsens, the obligation of the manager arises to take into account interests of the creditors too when taking decisions related to activities of the company. Liability of the manager arises only where the company is unable to satisfy on its own the creditors’ requirements. In such cases liability of the manager of the company as well as of its shareholders is of a subsidiary nature.

This means that it is not enough for the person seeking compensation for damages to prove that damage has been caused; it is also necessary to prove that the duties of the manager of the company (loyalty, fairness, reasonableness, etc.) have been breached, a reasonable economic and commercial risk has been exceeded, there has been clear negligence or that the manager has exceeded the powers vested in him.

Thirdly, when assessing whether the manager may be ordered to compensate for damages it is necessary to establish whether the company (at the moment of completing the transaction) has already been insolvent and unable to implement the agreement, and to prove that the manager completed such transactions while being aware that through completion of the transactions, which are considered to have caused the damage, would result in a damage to the company; or to prove that the decision to enter into the transaction, which caused damage, had been taken obviously negligently (without collecting enough information, by assessing it carelessly, etc.), so that a reasonable and prudent manager in analogous conditions would have not entered into the transaction; or to prove that at the moment of completion of the transaction the manager, as compared to the usual business practice of the company, took unreasonably high risk of losses to the company.

Fourthly, all requirements of the creditors approved in the bankruptcy proceedings may be recognized as damage only in exceptional circumstances where the claimant proves that if it was not for the delay of the manager, the accounts with the creditors would have been settled in full.

This court decision embodies the consistent position of the court of cassation of recent years – that in each specific case when deciding upon the issue of damage to the company and/or its creditors it is necessary to seek balance between the rights and obligations of different interest groups of the company.

For more information see the ruling of the SCL of 25 November 2016 in case No 3K-3-485-421/2016