When is the Managing Director of a GmbH Liable for Business Decisions?

The managing directors of German limited liability companies (Gesellschaft mit beschränkter Haftung – “GmbH”) are entitled to a certain indemnity (the “Business Judgment Rule”) when making business decisions. Moreover, managing directors who are sole shareholders are liable for business transactions violating the Business Judgment Rule only, if the violation does not create a risk to the existence or liquidity of the company or if the company’s share capital is withdrawn.

Background

The Higher Regional Court of Koblenz (Oberlandesgericht – “OLG”) had to decide the following case (judgment dated 23 December 2014, case 3 U 1544/13): The insolvency administrator of a GmbH claimed damages against the sole owner-manager (Gesellschafter-Geschäftsführer) for breach of duty. The managing directors had arranged for the insolvency administrator to maintain a business relationship with another company, the I-GmbH. The I-GmbH offered the managing directors delivery of motor vehicles with a price reduction of 30% from the gross list price. However, an advance payment of 30% to 50% of the gross list price had to be made upon entering into the agreement. The motor vehicles were to be delivered at a later date. No security for the advance payment existed nor had it been requested by the managing directors. Within a period of approximately two months, advance payments in the amount of around €160,000.00 had been made to I-GmbH.

Following the commencement of insolvency proceedings with respect to I-GmbH’s assets, the GmbH lost all advance payments, and the vehicles were no longer delivered. The insolvency administrator asserted claims for these damages after the GmbH itself had fallen into insolvency.

The Decision of the OLG Koblenz

The OLG Koblenz dismissed any liability of the managing directors. Managing directors are generally entitled to a certain indemnity when making business decisions in the usual course of business. If a transaction fails and causes damages to the company, liability is precluded under section 43 para. 2 of the German Limited Liability Companies Act (GmbH-Gesetz -  “GmbHG”), to the extent that the managing directors have soundly exercised their discretion. Whether the discretion was soundly exercised shall be determined from an ex ante perspective. If the information obtained from the managing directors as the basis for the decision proves to have been insufficient, the managing directors may be held liable. In the present case, the OLG Koblenz assumed that the transactions with the I-GmbH involved risks which, even at the time, were not within the scope of risks acceptable to a prudent businessperson. Thus, the managing directors were liable pursuant to section 43 para. 2 GmbHG. Despite this breach of duty, however, the owner-managers would not be liable because they had not withdrawn any assets from the GmbH which were indispensable to cover the share capital. Only those encroachments affecting or destroying the existence of the share capital could have justified holding the owner-managers liable. Mere management failure is not sufficient to establish liability, since the owner-managers would be harming only themselves.

Comment

The judgment comprehensibly outlines the liability of the managing directors of a GmbH. In particular, it illustrates that a relatively broad scope of action is granted to the managing directors of a GmbH. This scope of action is indispensable. The managing director of a GmbH has to be able to make business decisions, the effects of which are not always predictable. A managing director may always take a certain level of risk.

To protect themselves, managing directors should gather sufficient information before making risky decisions, and also document having done so. If a business decision should be reviewed with respect to the exercise of sound discretion, the ex ante perspective is decisive—and thus the question whether the managing directors had informed themselves sufficiently at the decisive time. In this case, the managing director bears the burden of proof.

However, there is a liability privilege for owner-managers. To the extent that the sole shareholders and the managing directors are identical and mutually withdraw assets, liability comes into consideration only in the case of encroachments jeopardizing the existence of the company or violations of the rules for maintaining capital. As long as the share capital is not jeopardized by the action, the owner-managers are not liable pursuant to section 43 para. 2 GmbHG. This can be based on the fact that they would have been able to distribute a corresponding amount to themselves as shareholders. As soon as third-party shareholders are involved, this privilege does not exist, and the managing directors shall be liable for all damages.