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Directors' Liability

A Practical Guide to Directors Liability

Directors’ liabilities have a direct and undesirable effect: The company’s director will be held responsible of the company's debts to the company’s owners and to its creditors. He must therefore respond with his personal assets for the company's debts. And he is responsible jointly and severally, with his personal assets, together with the rest of the company's directors.

One of the keys determining director’s responsibility is whether fraud or guilt has been involved.

The following is a summary of the most recent case law on director’s liability in Spain. These cases of liability of directors affect individuals and legal entities.

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Directors’ liability for debts (367 Companies Act)

Here is an analysis of one of the director’s liability cases:

  1. Directors will incur in liability when being in a situation of compulsory judicial dissolution “ground of dissolution due to losses”. (Ground of dissolution due to losses when net assets value is under the 1⁄2 of the Share Capital Value). Under these circumstances, Directors must call for a General Meeting of Shareholders within two months. If they do not fulfill this obligation in due term, they will be liable. The Shareholders General Meeting must adopt, the resolution to dissolve or to file for bankruptcy of the company. Liability is only applicable to debts incurred after the decision to dissolve the company should have taken place (and didn´t). This liability is incompatible with Bankruptcy Liability. Are there any exceptions to this liability? The reasons that could justify the failure to comply with the legal duty to dissolve are very exceptional. It must be something that shows, under these exceptional conditions, that the directors no longer had the duty to dissolve the company.

Individual Liability Action against the Director (Articles 236 and 241 of the Corporations Act)

This is another of the Director’s liability cases:

  1. It is a liability of compensatory and guilty or aquiline nature. It is required to prove (a) direct damage and (b) liability. When we talk about “Direct Damage” we refer to any damage to the company’s assets, indirectly affecting partners’ assets. To exercise an individual action, a direct damage to the partner’s assets is required. However, there is some caselaw that also legitimizes indirect damage of partner’s assets in cases of emptying of a company.
  2. This is an “organic” responsibility: the misconduct must have been carried out by a Board of Directors’ member. The requirements for any compensatory action under 1902Cc: i) a Director’s active or passive behavior. ii) that such behavior is attributable to the Board of Directors. iii) Director’s behavior is unlawful because is contrary to law, bylaws or contrary to the diligence required to an honest businessman. iv) that the unlawful, negligent or faulty behavior is enough to produce damage. (v) that the inflicted damage is direct to the third contracting party, without the need to harm the company and (vi) a direct cause connecting the Director’s anti-legal conduct and the damage caused to the third party. The reversal burden of proof: “guilt shall be presumed, unless proof to the contrary, when the act is contrary to the law or the articles of association” (236.1.2 Capital Companies Act). It is essential to prove “the breach of the duty of care”, that is, a “negligent” act. This is compatible with any liability that may arise from the insolvency proceedings.

Situations under which individual responsibility may arise:

  1. (1) Personal and material damages, to the environment, to health, defective products, unfair competition or intellectual or industrial property infringements, (2) Failure to deliver the dividend agreed at the meeting, (3) Failure of the shareholder to call a meeting, (4) Failure to hold the meeting. (5) Non-compliance with the obligation to audit the accounts ( if mandatory), failure to formulate them, failure to register the shareholder in the register of registered shares. (6) refusal to provide information during the meeting, or supplying false information (always in these cases leading to direct damage). This group of cases also includes the denial of right of preferential acquisition and the undue redemption of shares. It also includes the failure to return to the partner the contribution made in an incomplete capital increase, etc.
  2. To present a false balance sheet for a bank granting credit. Director’s behavior provoking the breach of contract by the company of a contract with a third party. To engage a third party contracting with the company through a trust personal relationship with the Director.

Director’s Liability: Corporate Liability Action (238 to 240 Companies Act) (48 bis Insolvency Act)

As in the direct Director’s Liability Action, it is a compensatory and culpable or aquiline liability.

Legitimation is on Shareholders or Administrator, this last case if the company is under an insolvency procedure.

Director’s Liability: Liability derived from Insolvency (164 and 165 Insolvency Act)

The liability grounds are ruled as follows:

  1. Failure to keep accounting, or keeping double accounts, or having committed irregularities regarding the financial situation.
  2. Serious inaccuracy in the documentation filed for a declaration of insolvency
  3. Breach of the settlement reached with the creditors (if it is a debtor’s breach)
  4. Fraudulent bankruptcy/Assets Stripping. If the director has performed any act delaying or preventing the effectiveness of any initiated execution or foreseeable.
  5. Rights or assets fraudulently removed from debtor’s assets within the two previous years to the insolvency declaration.
  6. Any simulation of a fictitious asset situation previous to the court’s insolvency declaration.
  7. If the duty to request the declaration of insolvency is unfulfilled or delayed.
  8. Breach of duty to collaborate with the Bankruptcy Court.
  9. Breach of duty to approve annual accounts or failing to audit them when mandatory. Not filing the annual accounts in the Commercial Registry. And all these obligations apply to three years prior to the bankruptcy’s declaration.
  10. If the partners or directors had refused without reasonable cause to capitalize credits. Or if they had refused to issue securities or convertible instruments. And when those decisions have prevented a company’s debt refinancing agreement.

Conclusion:

The directors can be held responsible for any social obligation. And they will be liable in both public and limited liability corporations.

If this article has been of interest, we also suggest you to read the following article published on our website:

Company Dissolution: Directors’ Duties and Liabilities

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