12 October 2017

Liability in company law: actions and defense

Actions and their interrelation

In the case of damage caused by the directors and managers to the company, its shareholders or its creditors, the question arises as to which actions are at the disposal of the aggrieved party and what is the interrelationship of these actions. Can the various actions be brought at once or only in a specific order? The defendants often argue that given the (alleged) subsidiarity of the action taken, the claimant should bring another action against one or more third parties first.

According to the case law of the Swiss Supreme Court an action against shareholders' resolutions is not available if it is based on facts which may serve as the basis of a liability action against the directors and managers of the company. The courts are not willing to judge the same facts more than once. It is hence likely that the Swiss Supreme Court will apply the same approach with respect to the action for annulment.

With respect to the interrelation of the liability action to:

  • the action for restitution of dividends, bonuses etc. which have unduly and in bad faith been paid to shareholders, directors and their close associates,
  • the actio Pauliana, which aims at the restitution of payments and other actions which were executed shortly before the opening of bankruptcy proceedings and which resulted in a discrimination of creditors, and
  • the action for dissolution of the company,

numerous details are to be considered. The capacity to sue, the standing to be sued, the relevant damage, the consequences and further aspects may differ between these actions. Thus, for example, restitution of dividends, bonuses etc. may be claimed for repayment only to the company. The actio Pauliana may be taken after the opening of bankruptcy proceedings only for the benefit of the claiming receivership or the creditors. The liability action may be taken even before the opening of bankruptcy proceedings, but in this case not by creditors of the company. The action for dissolution does not result in any (direct) financial benefits.

As a consequence, the goals must be analyzed and the appropriate strategies diligently developed. Tactical aspects and the solvency of the defendant (and a potential D&O insurance or other liability insurance) should also be considered when assessing the various actions.

Defense strategies
Business Judgment Rule
The director or manager who faces a liability action may take recourse to a variety of defense strategies. With increasing frequency the so called business judgment rule is deployed. Business decisions which were taken in a diligent decision-making process, based on proper information and without of any conflict of interest may be subject to limited review only. The Swiss courts indeed apply great restraint when reviewing business decisions. It is only the tenability of the relevant business decision which is subject to review, not whether it is defective. Business decisions are assessed ex ante and not based on any later insight. Besides the interests of the company, the overall context (including, but not limited to, the financial basis) and the opportunities pursued shall also be considered.

The interests of the relevant group of companies may also be taken into account, but the knowledge of the bodies of a company with respect to details of another group company may increase the liability. With respect to the actio Pauliana, such knowledge of group companies is even presumed by law (shifting of the burden of proof).

In practice, the deployment of the business judgment rule is no guarantee for a successful defense against liability actions. The formal requirements for deployment of the business judgment rule are considerable. It is hence important that the decision-making process be not only performed diligently but also be documented. In the case of any formal conflict of interest thorough documentation and arm's length conditions are essential.

Discussions and investigations regarding the profile of risks and opportunities ascribed to the business decision shall also be recorded.

Delegation of duties and board committees
The delegating of duties to the management board and to board committees may also limit the responsibility of the individual director.

However, a delegation of duties to the management board is permissible only with respect to those duties whose delegation is not prohibited by law. The delegation must be anchored in the articles of association and requires the adoption of organizational rules. The delegates must be selected, instructed and supervised with diligence.

Board committees are less appropriate means to limit the liability, since the decision-making power remains with the board of directors in its entirety. However, if breaches of duty committed by individual members of the board were undetectable despite careful and diligent questioning, the other members are not liable.

Approval by the aggrieved party
In practice, the approval by the aggrieved party may also result in a limitation of liability. However, this is true only if, and to the extent, the approval is based on a comprehensive knowledge of the relevant facts. While the approval of the fully informed sole shareholder may be eligible, an approval by way of a consultative shareholders' resolution passed by the majority of votes will hardly ever be eligible to reduce the liability of the directors and managers.

Third party action vs third party notice
In the context of the actions described above and in view of the worst-case scenario, the claimant and the defendant frequently have to consider whether they should immediately take an action against a third party before the same court which is competent to deliver a ruling in the initial proceedings. In particular, this scenario becomes relevant in the case of potential recourse claims of the auditor or the defendant director against the (other) directors of the board.

With the third party action all claims by the various parties are submitted for judicial assessment in a single procedure before the same court. Thereby the procedure becomes a multi-party trial. The situation may hence become complicated and time-consuming. Moreover, the party taking action against a third party may appear to argue contradictorily, thereby weaken its own position.

As it relates to the third party action, a specific amount of money must be claimed, which can be a difficult task as long as no ruling on the principle action has been delivered. In cases where the principle action is dismissed, the third party action will not be declared irrelevant but will also be dismissed. This will again entail costs.

In practice, the third party notice turned out to be more advantageous in most of the cases. The notified third party may intervene in favor of the notifying principal party without turning the proceedings into a multi-party trial. If the notified third party does not intervene it runs the risk that it will not be heard in any recourse proceedings when maintaining that claimant has not diligently argued in the principle proceedings.

Nevertheless, the question as to whether the third party action is more advantageous than the third party notice or vice versa may only be assessed in the light of all relevant information pertaining to the particular case.

Our litigation team, insolvency team and corporate team are at your disposal to answer any questions you might have on this topic.

Author: Thomas Krizaj

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