Directors’ Liability in Czech Republic

1.     Introduction

The liability of directors is in the Czech Republic regulated since January 1, 2014 by the new legislation; Act No. 513/1991 Coll., the Commercial Code, Act No. 40/1964 Coll., the Civil Code and other laws were replaced, beside others, by Act No. 89/2012 Coll., the Civil Code (hereinafter referred to as “the Civil Code”) and Act. No 90/2012 Coll., on commercial companies and cooperatives (hereinafter referred to as „the Act on commercial corporations“). The acceptance of this new legislation is considered as the biggest legal recodification in the history of independent Czech Republic. Apart from citizens of Czech Republic these changes will also naturally affect foreign persons running a business in Czech Republic.

The liability of directors in the Czech Republic is understood as a liability of the Executive Directors in a Limited Liability Company and as a liability of the members of the Board of Directors in a Joint Stock Company.

According to the new legislation the directors are in the position of representatives of the Company[1] and they are liable for their management decisions. In general this liability arises from the duty to act with due managerial care determined by the Civil Code and the Act on commercial corporations. Whatever covenants restricting the liability to damages caused in the performance of the position of a director are absolutely invalid.[2]

2.     The duty to act with due managerial care

In accordance with the Section 159 paragraph 1 of the Civil Code a director acts with due managerial care if he performs his position “…with the necessary loyalty and necessary knowledge and care…” The Act on commercial corporations supplements that “Carefully and with the necessary knowledge is one who can, in business decisions in good faith reasonably assume that it is an informed and defensible business interests of corporations, it does not apply if such decision has been made with the necessary loyalty”[3]. Section 52 paragraph 1 of the Act on commercial corporations sets down objective approach in respect of assessing whether a certain person acted with due managerial care.[4] If a director acted with due managerial care it will be assessed with regard to how would in a similar situation act other reasonably careful person, not with regard to what is typical rate of care for the specific director. The directors must in all circumstances, regardless of their level of expertise spend care typical for reasonably careful person, whereas it is also inferred that if the position is held by a person with professional knowledge, it is required to use this knowledge for the purpose to act with due managerial care.

3.     Business judgment rule

The new legislation adopts the business judgment rule in the Section 51 paragraph 1 of the Act on commercial corporations. According to this provision if a director has a good will, is informed and acts in defensible interest of the Company, he acts with necessary knowledge and care. Then even if the accepted decision is harmful for the company, the director who made a judgment is not liable for breach of his duty to act with necessary knowledge and care.

The duty to act with due managerial care consists in accordance with Section 159 paragraph 1 of the Civil Code of two components, the loyalty and the duty to act with necessary knowledge and care. The business judgment rule is applicable only for the assessing whether a director acted with necessary knowledge and care.

The Act on commercial corporations puts emphasis on the decision-making process, not on the result of the decision. The directors are awarded with a privilege to make mistakes in the business judgment, and so they do not need to be afraid of the liability for the decisions, which caused damage to the company, if it is proved that they acted with due managerial care.

4.     The consequences of a breach of the duty to act with due managerial care

A director who breached his duty to act with due managerial care is liable for this breach and consequences for this breach arise for him.

One of the basic principles of private law and of the performance of the position of a director is the liability to damages caused by breach of the duty to act with due managerial care. In the Czech legal system a director is liable to damages in accordance with Section 2910 of the Civil Code. “Wrongdoer, who violates by his own fault obligation imposed by law and thus affects the absolute right of the injured party will replace the injured what caused by it.”[5] Wrongdoer is liable only for deliberate breach of his duty. So if it is proved that a director did not fail in his duty to act with due managerial care, it is not possible to impose on him a liability to damages, which the company has suffered. However the burden of proof is not carried by a company which seeks damages, but it is carried by a director who is accused of breach of his duty to act with due managerial care. A director has to prove that he did not fault a breach of his duty for purposes of liberation from liability to damages.

In terms of Section 53 paragraph 3 of Act on commercial corporations may a company settle damages by an agreement concluded with an obligated person, who breached the duty of due managerial care (hereinafter referred to as “the Settlement Agreement”). The Settlement Agreement must be approved by the supreme body of a company accepted at least by two-thirds majority vote of all company members. The regulation of the Settlement Agreement is new and only future practice, in particular court decisions, will show what are the limits and opportunities for content of the Settlement Agreement between a company and a director.

Except from the liability to damages, a director who breached the duty of due managerial care shall hand over to a company a benefit which he gained in connection with such his behavior. If it is not possible to hand over a gained benefit, an obligated person shall replace a gained benefit to a company in money. A company may seek a disloyal director to hand over a gained benefit even if a company suffered no damages. This provision regulates cases when a director as representative of a company concludes a business transaction in which he is personally interested and in this respect he does not act with his duty of due managerial care, because he breaches his duty of loyalty.

The insolvency court may decide that a director of the company in the bankruptcy cannot perform the function of a member of statutory authority of any business corporation or to be in a similar position (hereinafter referred to as “exclusion”), if released that his performance of his function with regard to all circumstances of the case led to the bankruptcy of the company.[6] If the company is not in bankruptcy the court can also exclude a director if he in the last three years repeatedly and seriously violated the duty of due managerial care.[7]

5.      Direct liability of the directors

As mentioned above the directors are liable for their management decisions and they shall compensate a company injured damages caused by them. The Civil Code remembers a situation when a director does not replace caused damages and determines direct liability of the directors for the company debts in front of the company´s creditors. If a director did not replace to a company damages caused by breach of his duty in the performance of his position, although he was obligated to replace the damage, he is liable to a company´s creditor for her debt in the scope that he did not replace the damages, if the creditor cannot enforce a performance from a company.[8]

6.     The liability of directors in the case of bankruptcy of a company

On application by the insolvency administrator or company´s creditors the court may decide that a director or a former director is responsible for the fulfillment of its obligations, if it was decided that the company is in bankruptcy, and a director or a former director of the company knew or should have known that the company is in impending bankruptcy, and contrary to the duty of due managerial care did not do for the purpose of averting it all necessary and reasonably predictable.[9] This provision is not applicable on the directors who have been provably appointed to the position in order to avert bankruptcy or other adverse economic situation and they performed their position with due managerial care.[10]

If in the insolvency proceedings initiated on a proposal from a person other than the debtor, the court decided that the company is in bankruptcy, the directors shall expended if they are called upon to do so by an insolvency administrator, the benefits derived from an agreement on the performance of the function as well as any other benefit, which he received from the company, and this for two years back before legal power of the decision on bankruptcy. The directors shall expended the benefits only if they knew or should have known that the company is in impending bankruptcy and in contrary with the duty of due managerial care did not do for the purpose of averting it all necessary and reasonably predictable.[11] If it is not possible to hand over the benefits, the directors shall replace it to the company in money.[12] The terms of section 62 of the Civil Code are as well applicable on the former directors of the companies.

Due to new legislation, currently there is no new case law in respect of the liability of directors according to the new legislation, despite that it is partly possible to use judicial decisions in regard to former legislation of the liability of directors, because the Civil Code is based on some of them.

The expected time for obtaining an enforceable judgment in a legal action before the Court against the directors and the costs of the court proceedings depends on every individual case. However, generally we estimate the length of the court proceeding approximately to 1, 5 – 2 years. If the law suit was filed, the expected fees and costs consist from court fees and attorney´s fee. In the Czech Republic the attorneys usually provide their services in the court proceedings regarding the liability of directors in accordance with their hourly rate.