Governance in times of crisis

Sustainability and ESG still remain the most relevant topics these days. But is the focus on governance enough in times of crisis? Would leaders be better advised to concentrate on compliance instead? And is self-governance perhaps the better compliance management?

Management needs to initiate appropriate measures to recognize any developments of a damaging character relevant to their company. Such means include establishing a monitoring system as stipulated in the German Stock Corporation Act. However, in times of crisis, this mandatory obligation to monitor and supervise becomes more important and failure to do so could ultimately result in D&O liability.

D&O liability is twofold in Germany – different obligations exist at the management and the supervisory board levels. Cases were rarely brought before the courts but in the last decade this has changed due to the highly publicized ­instances of corruption, bribery, and antitrust involving DAX-listed companies (see Magotsch/Otto, Germany: Take ­Action Now, Sustainability And Human Resources, 29 June 2022).

Various obligations at management board level

German insolvency rules differentiate between imminent illiquidity, current illiquidity, and over-indebtedness.

While imminent illiquidity means that a company would be unable to pay its debts due during a forecast period of up to 24 months, current illiquidity obliges management to file for insolvency within three weeks at the latest. Over-indebtedness extends this grace period by up to six weeks from seeing a balance sheet where debts are no longer covered by assets (without a liquidity forecast ­period of up to 12 months being positive).

During the earlier phase of imminent illiquidity, the ma­nagement board is bound by various obligations, such as to monitor the crisis, initiate restructuring measures, meet information obligations, and call a stockholders’ meeting.

At the later stage of current illiquidity or over-indebtedness, the obligations become more stringent and include filing for insolvency proceedings, maintaining the assets, and freezing payments.

While directors might be held personally liable for a failure to meet obligations, such as filing for insolvency proceedings, violations of other obligations and duties may first lead to claims for damages and penalties brought against the company. The question of whether such dama­ges or penalties should be passed on to the responsible directors can only come up later. In the famous steel cartel case of 2017 that included ThyssenKrupp, the German Federal Labor Court denied ThyssenKrupp’s attempt to pass on its €100 million in damages to one of their former managers. The case was transferred to the civil courts to answer antitrust issues. On 27 July 2023, the Higher Regional Court of Düsseldorf also ruled in one of the still-pending steel cartel cases against a company that had tried to pass on investigation and legal fees of approximately €1 million to one of its former directors. The court argued that passing on antitrust penalties to managers would undermine the key aspects of issuing penalties, ­because this would allow companies to release themselves from penalties and ultimately may mean indemnification is paid by D&O insurance companies. This will not be the end of the saga, since the court has admitted an appeal against this case to the Highest Federal Civil Court.

Well-defined obligations at supervisory board level

Coming back to our initial question: are compliance mana­gement methods of prescribing regulations, monitoring behavior, and punishing violations successful tools in times of crisis? Or could strengthening self-governance in organizations be the more promising way forward, parti­cularly in times of crisis? Unlike other jurisdictions, Germany’s two-tier executive structure and the clear role of the supervisory board already provide incentives for compliance, monitoring behavior, and punishing violations. Perhaps this is sufficient to successfully regulate ­human behavior.

In addition to the management board, stock corporations must also have a supervisory board, which may also include employee representatives. Whilst such a supervisory board is strictly separate from the management board, one of its key powers is the right to appoint and dismiss members of the management board. Do not forget that mandatory supervisory boards with employee representation are also a must for German limited liability companies (GmbH) with a minimum number of employees.

Depending on the number of employees of the company, the supervisory board consists of representatives elected by the stockholders and employee representatives elected by the staff (in most cases members of the works council and trade union), provided the company is subject to German co-determination laws. The supervisory board’s key obligation to monitor and supervise the management consists of ensuring management board members comply with (German) law and regulations on the one hand, and that management has set up appropriate structures of gover­nance to observe the law and thereby secure the ­existence and assets of the company on the other hand. The supervisory board may delegate individual monitoring tasks to specific committees.

In 2018, the German Federal Supreme Court confirmed a legacy decision of 1997 involving ARAG, tightening and increasing the liability of supervisory board members.

In this landmark decision, the Supreme Court stressed the position of the supervisory board and highlighted the increased risk for supervisory board members of being held liable for damages caused by the management board if they fail to bring damage claims before the courts and ­ensure potential remedies on behalf of the company. In the case at hand, the management board had violated its fiduciary duties vis-a-vis the company. Potential damage claims by the company against the management board had since become time-barred due to the failure of the supervisory board to bring such claims against the management in due time. The court confirmed that the supervisory board’s duty was to bring legal action against the management and to pursue damage claims against them.

Failing to do so makes the supervisory board liable for such damages even if the claims against the management had become time-barred. Thus, supervisory board members remain at risk of being held liable many years after the original wrongdoing. Bear in mind that a claim for damages against the members of the supervisory board can only be made once the statute of limitation for a claim for damages against members of the management board has kicked in.

In summary

It is recommendable to review and check existing com­pliance management schemes and to correct and amend them, if necessary, keeping in mind potentially outdated D&O insurance policies for both tiers of executives.
Supervisory board members are advised to carefully analyze and evaluate whether they should bring legal actions against the management in good time prior to deadlines prescribed in the statutes of limitations.