20. 4. 2020
PART ONE | DUE MANAGERIAL CARE
The emergency situation caused by the coronavirus is having fundamental impacts on business and many companies’ economic condition. Entrepreneurs need to quickly orient themselves in the current situation, which is still evolving, and at the same time to cope with new challenges that are yet to come. Members of corporate governing bodies have thus unexpectedly found themselves in the role of crisis managers facing high demands and expectations that they will guide their companies through the crisis without any significant harm.
This text is the first part of our summary for members of governing bodies. Our aim is to remind and present, in the light of today’s emergency situation, the basic principles of the functioning of governing bodies and their duties and risks arising from their position. However general the text may seem, we can and may only assess specific issues on the basis of these universal rules. In the next parts, we will present specific duties in the context of crisis management and important practical issues of this time (dividend payments and dividend advance payments, concern instructions and some other issues).
A very brief summary is highlighted in bold for very busy managers. We nevertheless recommend you read the whole text.
- The governing body is still obliged to act with due diligence, necessary knowledge and loyally with due managerial care;
- The governing body should seek all relevant information to make its decisions and should try to assess where it already needs an expert/specialist to fulfil its tasks;
- Under the business judgement rule, the governing body is responsible for the performance of its office, i.e. adhering to due procedures when making business decisions, and not for the outcome of this process.
Standard of due managerial care
Members of governing bodies are obliged to perform their office with necessary loyalty, which means that have to put the company’s interests before theirs and before the interests of third parties, including the company’s members, as well as with necessary knowledge and due care. The assessment of whether a member of the governing body fulfils this duty is objective and is conducted by means of a comparison with an average “manager acting with due care”.
Since a manager acting with due care is not expected to exercise due professional care, the member of a governing body does not have to be professional in all areas of the company’s operations. The body members need to have the basic knowledge necessary for management; however, they must be able to recognise where their abilities are not sufficient and where an expert must be engaged. The crisis management needed today may indeed be a new experience for many body members, and in some cases, it may be appropriate to contact company employees with necessary qualifications and experience or external consultants. Such assistance may also come in handy in the legal field because in times of a state of emergency we constantly learn about new government measures and laws, which are changing quite spontaneously and rapidly increasing in number. Similarly, procedures in relation to business partners and employees may also be exceptional at this time and may require greater knowledge of the applicable legal regulation or the analysis of existing contracts.
If the governing body decides to delegate some of its powers, it should bear the following important duties/responsibilities in mind:
- Responsibility for the selection – the governing body must take proper steps to select a third party, i.e. it must make the selection like another reasonably diligent person;
- Responsibility for the task definition, management and cooperation – the governing body must clearly define the task for, provide all necessary cooperation to, and manage the selected third party;
- Responsibility for checking the third party – the governing body must adequately check the third party’s performance not only in person but also using duly stipulated controls (see the Supreme Court’s judgement of 30 September 2019, ref. no. 27 Cdo 90/2019).
In the event that a member of the governing body has a certain qualification and ability, the member is obliged to use it when performing their office, even though body members are not required to exercise due professional care. In this event, the member will be assessed in the given area against increased demands whether they have acted with due managerial care.
The art of exercising due managerial care is also about making the right use of all available information and tools suitable for the company’s efficient operation. For example, the governing body should monitor economic outlooks relevant to the given industry and collect all the necessary data concerning the company for its further (we may say crisis) management, such as interim profit and loss data, estimated imminent damage, etc. If measures adopted under the state of emergency can provide companies with suitable relief or state support, the governing body should learn about such an option and make an informed assessment of whether it is appropriate for the company to use the instrument. Under the Supreme Court’s ruling, a member of the governing body must use reasonably available (factual and legal) information sources and on that basis carefully weigh the possible advantages and disadvantages (recognisable risks) of existing options to make a specific business decision (see the Supreme Court’s resolution of 18 September 2019, ref. no. 27 Cdo 844/2018). Each governing body should thus have a continuous overview about what is going on in the company and about relevant external facts that may influence its business decisions.
The Supreme Court also draws an important conclusion that compliance with this duty must be assessed ex ante. This means that, in order to assess whether a member of the governing body has made an informed decision and therefore proceeded with due care, we may only consider the information and facts that the body member knew or – upon exercising due care – could and should have known at the time of making the decision. The governing body cannot thus be held accountable for the fact that the situation later developed otherwise, from the ex ante point of view, unpredictably. In the context of the present time, we need to say that the unpredictability of the further development of the current situation is also a criterion to be taken into account when making specific decisions. In general, we may assume that the present time favours more conservative decisions than risky ones (with exceptions given in particular by the purpose of business). However, we cannot recommend that you take no action, since the failure to act may also be considered a breach of due managerial care.
Responsibility for the performance, not the outcome
It is clear that the members of governing bodies are facing increased demands today. Sanctions for their breach of due diligence care vary from the duty to compensate the company for the harm caused, through the surrender of the benefit obtained, liability for the company’s debts vis-à-vis its creditors, to the ban to serve as a member of any governing body for a certain period of time. The good news for body members is the existence of what is known as the business judgment rule. The law acknowledges that doing business carries a certain amount of risk and even diligent business decisions may bring about negative results. After all, the governing body’s duty is to maximise the company’s profit, which is practically impossible if it is too cautious and does not take any business risk. Therefore, the governing body is responsible for the performance of its office as such, i.e. for adhering to the due decision-making procedures, and not for the outcome of this process. Even if a business decision turns out to be negative, the member of the governing body can prove that they have not breached their duty to act with due managerial care. As the burden of proof lies with the governing body, we recommend that it should document its corporate management actions, for example by writing detailed minutes of the board of directors’ meetings.
We hope that our summary will help the members of governing bodies to navigate today’s difficult situation. Each member of a governing body should pay increased attention to due managerial care and the specific situation in their company. As every company is facing a bit different challenges, we unfortunately cannot provide specific advice in this newsletter apart from the fundamental and general principles outlined above. Nonetheless we will attempt to present specific situations to you in which our clients often seek our assistance.
In any case, our corporate practice group is fully ready to aid you at any time in any specific situation.