What ESG means for board members in times of operative and financial challenges

Management and supervisory boards in Germany need to be vigilant during a company’s crisis.

“What is the best government? That which teaches us to govern ourselves.” - Johann Wolfgang von Goethe

Sustainability and ESG become even more important while enterprises are facing a crisis. But is the focus on governance enough when economic challenges arise? Should leaders rather concentrate on compliance? Is self-governance perhaps the better compliance management system?

The management board must initiate appropriate means and measures to recognize any damaging developments that might threaten the survival of the company. This comprises the development and establishment of a monitoring system. The legal basis for compliance measures is soundly embedded in German law. However, in times of crisis, monitoring and supervising duties become more important and failure to comply likely results in D&O liability.

Bear in mind, that D&O liability is twofold in Germany: different obligations exist for management and the supervisory board members. Cases were for quite some time rarely brought before courts but in the last decade this has changed and often resulted in publicly discussed corruption, bribery, and antitrust cases, even involving DAX-listed companies (Magotsch/Otto, Germany: Take Action Now, Sustainability And Human Resources, 29 June 2022, mondaq.com)

Various obligations for management boards

German insolvency rules differentiate between:

  • imminent illiquidity
  • current illiquidity
  • over-indebtedness

While imminent illiquidity means that the 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 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 an imminent illiquidity the management board is bound by various obligations:

  • Monitor the crisis
  • Initiate restructuring measures
  • Information obligations
  • Call a shareholder meeting

Obligations get stricter once the status changes to current illiquidity or over-indebtedness

  • File for insolvency proceedings
  • Maintain the estate
  • Freeze payments

While directors might be held personally liable for a failure to meet obligations such as filing for insolvency proceedings, violations of obligations and duties may first lead to claims for damages and penalties brought against the company. Only subsequently will the question be raised of whether such damages or penalties should be passed on to the (acting) responsible directors.

In a famous case involving ThyssenKrupp, the German Federal Labor Court rejected ThyssenKrupp’s attempt to pass on its € 100 million damages to one of their former directors. The claim was transferred to the civil courts to answer antitrust issues.

On Thursday, July 27th, 2023, the Higher Regional Court in Düsseldorf ruled in one of the still pending steel cartel cases against a company, which had tried to pass on investigation and legal fees accounting to approx. € 1 million against one of its former directors.

The court argued that passing on antitrust penalties to managers will undermine the basic idea of issuing penalties, because companies could then get rid of the penalties and may even achieve indemnification from D&O insurance companies. However, this will not be the end of the story since the court has admitted the revision to the German Federal Civil Court.

Well defined obligations for supervisory boards

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 self-governance be the more promising way forward, particularly for companies facing operative and financial challenges?

Unlike other jurisdictions, Germany’s two-tier management 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 have a supervisory board where employee representatives may also be positioned. This supervisory board is strictly separate from the management board of a company. One of its key authorities is the right to appoint and withdraw members of the management board.

Supervisory boards with employee representation are also a must for limited liability companies with more than 500 employees.

Depending on the number of employees of the company, the supervisory board consists of representatives elected by the shareholders 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 management as stipulated in the German Stock Corporation Act consists of ensuring managers comply with German law and regulations and setting up appropriate structures of governance to observe the law and thereby secure the existence and wealth of the company.

In 2018, the German Federal Supreme Court confirmed a legacy decision (ARAG/Garmenbeck, 1997), tightening and increasing the liability of supervisory board members. In this landmark decision, the German 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 were meanwhile statute-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 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 management were meanwhile statute-barred. Thus, supervisory board members remain at risk of being held liable for many years after the original wrongdoing.

Bear in mind, a damage claim against the members of the supervisory board can only be made once the statute of limitation for a damage claim against members of the management board has kicked in.

In summary

We recommend reviewing and checking existing compliance management schemes and correcting and amending them, if necessary, keeping in mind the 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 management well in time prior to deadlines prescribed in the statutes of limitations.

This article was previously published on www.mondaq.com

Über Rimon Falkenfort

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