Personal liability is one of the main deterrents to finding competent managers. High liability exposure can discourage individuals from accepting an appointment as a manager, director or supervisory board member, and may lead to risk aversion that can ultimately be detrimental to the shareholders’ interests. Balancing the need for good corporate governance with the need to give management room for development is thus crucial. The newly introduced “Business Judgment Rule” aims to achieve this by providing a safe harbour from personal liability for management and supervisory boards if they follow certain key principles.
Framework and key principles
With effect from 1 January 2016, the Austrian Stock Corporation Act (Aktiengesetz) and the Austrian Act on Limited Liability Companies (GmbH-Gesetz) were amended to intro-duce a so-called “Business Judgment Rule” into law. The new rule applies to managing directors, management board members and supervisory board members.
The key elements are that the rule protects only business decisions; and in addition the following criteria must be met: i) board members must act free from conflicts of interest; ii) decisions must be based on all (material) information reasonably available; and iii) board members must have (in good faith) believed that the decision was in the best in-terest of the company.
The limitation to business decisions means that the BJR will only protect board members and managers in areas where they legitimately have discretion to decide between alter-native options. This is not the case if the law or the articles of the company require spe-cific conduct. For instance, whether to seek approval of the supervisory board or the shareholders for an important matter or whether to file for the opening of insolvency pro-ceedings is not a question left to the discretion of management.
Putting words into deeds: Beware the burden of proof
The burden of proof that the criteria for benefitting from the BJR were met is on the manager or board member. The only time when a plaintiff would first have to provide an “initial suspicion” would be when it comes to determining whether board members acted free from conflicts of interest. It would otherwise be virtually impossible for the manager to exclude all potential conflicts of interest.
In practice, this means that (standardised) documentation, transparency and profession-alism (of processes) will become increasingly important in the preparation of business decisions.
Austrian case law, as a principle, provides that management and supervisory boards enjoy broad discretion and risk personal liability only when materially overreaching their room for manoeuvre, ie when taking “manifestly incorrect” or “disproportionate and indefensible” (business) decisions.
The benefit of hindsight
However, one of the main risk factors is the problem of “hindsight bias”. In other words, once a deal has turned bad, several years after the fact it will be tempting to accuse the manager in charge at the time of not having acted diligently or of having overlooked something, or of simply second-guessing their actions.
Managers and board members should also be aware that liability claims are often raised only after the termination of their mandates. What this typically means for the individual manager is that they no longer have access to evidence and documentation. They may also have been prevented from taking copies of records with them in terms of the terms of their employment agreements.
Lessons to be learned
There are several practical steps that can help protect a manager or board member:
- sound preparation is key: be unbiased, keep an open mind, ask critical questions and insist on a cost/benefit analysis based on realistic parameters;
- certain things are just a step too far: if the potential exposure arising from an idea is so high that it could put the company out of business if it fails, no matter the likelihood of that risk materialising, it will be an uphill battle to argue that this was “in the best interest of the company”, and in hindsight this may become almost impossible;
- standardised documentation: if certain steps have always been taken in the preparation of a decision during your tenure, a court will find it credible if you argue that there just must be a certain valuation, expert opinion or risk analysis – even if you don’t have it because you left the company;
- as far as supervisory boards are concerned, especially in complex or far-reaching matters, it will not be sufficient to rely on summaries or overviews prepared by management; instead, the supervisory board must conduct its own assessment of the matter. This may entail obtaining independent (expert) advice.
Analysis of the US Sarbanes-Oxley Act of 2002 showed that a rigid liability regime discourages individuals from taking management positions and leads to risk aversion. Recommendations resulting from this analysis went so far as suggesting that managers should not be liable for slight negligence and proposing a liability cap for cases of gross negligence. We are not there yet, but the introduction of the BJR and its “safe harbour” from personal liability is an important step in the right direction.
“No risk, no reward” is part of being an entrepreneur. Too much risk is not good for companies, but neither are managers who sit on their hands because they are too afraid to take decisions.