Gerald Stevens (Trialys) : Liability of managers and directors of Luxembourg com

Gerald Stevens (Trialys) : Liability of managers and directors of Luxembourg companies

Regardless of their nationality or residence, directors or managers of companies in the Grand Duchy must strictly comply with the provisions of the law on commercial companies and the company's articles of association. Gerald Stevens, Partner at Trialys discusses the obligations governing their mandates.

Including holding companies, related to the investment fund industry or otherwise, and the constantly increasing tally of commercial companies, the estimated number of existing Luxembourg companies totals nearly 100,000. This results in elevated demand for corporate officers on a relatively small-scale market. In addition, for various reasons, many directors or managers of Luxembourg companies are not citizens or residents of the country. Nevertheless, regardless of their nationality or residence, they remain subject to Luxembourg law regarding the execution of their duties and the scope of their responsibilities. On principle, directors and managers acting in their capacity as representative of a company are not personally liable for obligations incurred on behalf of the company they represent. In certain circumstances, however, they may be required to indemnify the company or even take on personal liability toward third parties. This article outlines the liability of directors and managers of Luxembourg companies, illustrated with examples arising from the latest case law. The term director is used here to refer to both the 'gérant' of an S.à r.l. (Société à responsabilité limitée) and the 'administrateur' of an S.A. (Société anonyme).

Mismanagement

Directors are, according to general principles of civil law, liable towards the company in case of negligent acts and mismanagement in the performance of their duties, resulting in a loss for the company. Since they are only subject to an obligation of means, assessment of the wrongful nature of their action or inaction, is made in accordance with the criteria of a prudent head of a family. Only when an action taken by a director is manifestly contrary to what would reasonably be expected of a normally prudent and diligent director in equivalent circumstances, i.e. in case of mismanagement, shall the director be required to compensate the company for any resulting loss. On the other hand, directors should be protected from liability if, in the exercise of their duties, they acted in good faith, having obtained all necessary information and made decisions that they reasonably considered to be in the corporate interest of the company, having considered any possible alternatives. The notion of corporate interest may not be defined by the law, but according to the most widely accepted (and restrictive) definition by doctrine and case law, it matches the interests of the company's shareholders.

Examples of mismanagement:

Excessively low or high sale price or value of assets transferred to third-party companies
Non-payment of taxes (including VAT or payroll deductions) or social security contributions
Failure to collect debts owed to the company
Production of false or deliberately inaccurate accounts or financial statements
Incurring unjustified or extravagant expenses
Granting loans for private purposes and/or without collateral purposes that place the company in financial difficulty
Failure to attend board meetings or to carry out part or all of the director’s management duties over a period of months or years

Breaches of the law of August 10, 1915 or of the articles of association

The actions of the directors must strictly comply with the provisions of the law on commercial companies and the company's articles of association. Any breach may be sanctioned by the joint and several liability of all directors for any damage suffered, not only by the company itself but also by third parties. In contrast to a judge’s determination of mismanagement (based on their subjective judgement), determining a breach of the law or of the articles of association is carried out according to objective criteria. This makes the penalty all the more severe.

Examples of breaches:

Commitments outside the bounds of the company's corporate purpose
Failure to convene a general meeting at least once a year or ignoring a request from shareholders to do so
Failure to summon a shareholders' meeting in the event of the company
Breach of legal requirements regarding conflicts of interest, distribution of dividends or repurchase of the company’s own shares
Failure to comply with the rules of representation set out in the articles of association

« Numerous court decisions have been handed down in favour of the tax authorities »

Tortious liability

The existence of specific types of directors' liability does not exclude other types of liability drawn from general principles of law and more particularly that of tortious liability provided for under article 1382 of the Civil Code.

Directors may be held liable under this provision for damages suffered by shareholders or third parties if they have acted in a manner inconsistent with the conduct of a reasonably prudent and diligent director (including the violation of any applicable law) provided the wrongdoing is not related to their role or duties as directors. In other words, such negligence cannot be related to the exercise of their activities within the company (a so-called "distinct fault") and the claimant's loss must be distinct from any suffered by the company itself. In practice, this liability is therefore rarely upheld by the courts.

Sanctions and liability in the event of bankruptcy

Any commercial company that is unable to make due payments and to access credit is obliged to file for bankruptcy. Failure to do so within one month of the cessation of payments constitutes a criminal offence (criminal bankruptcy) punishable by a prison sentence of between one month and two years, regardless of any additional sanctions of professional prohibition or removal of authorisation.

An action to reimburse liabilities also makes it possible to obtain an order against any person who has operated, in fact or by virtue of a mandate, a company declared bankrupt, to bear all or part of its liabilities. This liability usually arises where bankruptcy is the direct result of wilful and gross negligence on the part of the manager in question. This action can be initiated only by the bankruptcy receiver.

Examples of sanctions and liabilities:

Abrupt interruption of the company's activities and sale of its assets to competitors without declaring bankruptcy
Indiscriminate pursuit of commercial activity in the absence of cash resources
Preferential payments to non-secured creditors at the expense of tax and social security authorities
Unjustified and undocumented cash expenditure jeopardising the solvency of the company.

« The actions of the directors must comply strictly with the provisions of the law on commercial companies and the company's articles of association. »

Special responsibility in tax matters

In accordance with Luxembourg’s general tax legislation, company representatives are personally liable for all obligations resulting from the company's default under itstax liabilities where the default is the result of their negligence.

Numerous court rulings have been handed down in favour of the tax authorities, especially in cases where the company was collecting taxes (VAT or payroll withholding tax) and was unable to remit these sums to the treasury. Defences put forward by directors, such as that the company's finance or accounting department has been taken over by managers or persons other than themselves, that they are not a beneficial owner of the company or that they were no longer in office at the time of the administration's legal action, are normally dismissed by the courts.

Criminal sanctions
Breaches of the law of August 10, 1915

The law on commercial companies sets out criminal sanctions to which directors may be liable in the event of breach of obligations stipulated by the law in order to ensure the proper functioning of its governance bodies and the provision of information to shareholders or third parties. These criminal sanctions apply in addition to the civil liability rules discussed above.

Other criminal offences

Certain penalties set out in the Penal Code also apply. These include fines and prison sentences for the misappropriation of company assets, applicable to managers who have misused company’s assets or have not returned all, or part of the professional tools made available to them at the end of their employment or period of office. The fact that the misappropriation of assets may have been conducted with the consent of the shareholders or that the director may have received a discharge does not constitute a valid defence.

Finally, directors may be personally sanctioned, including under criminal law, if their conduct has led the company to commit criminal offences (for example, the operation of a commercial enterprise without authorisation). The Penal Code explicitly states that the criminal liability of legal entities may coexist with the criminal liability of its directors.

This range of sanctions and responsibilities should not be a cause for anxiety. Determination by the courts of a director's liability presupposes reckless behaviour on their part or, at the least, imprudent behaviour that is inconsistent with acceptance of the position. It cannot be overemphasised that a directorship should never be accepted out of courtesy, friendship or altruism, nor in the hope or belief that other directors or employees of the company will ensure the proper conduct of its affairs. The minimum expected of as person in this position is ongoing vigilance not to let the company's governance bodies remain inactive for too long and ensuring that the company complies with its legal obligations, including the approval and filing of its annual accounts. Drawing up annual accounts and submitting them to the shareholders for approval is not just a formal exercise and requires at least basic understanding of their underlying reality. Only under these conditions can a director behave in a manner consistent with the duties entrusted to them.