Directors’ liability risk in Germany – Part 3
Procedural particularities when litigating D&O-liability cases
If the administrators of insolvent companies conclude that former management have made non-privileged payments, they would typically approach the directors with a letter, demanding the reimbursement of those payments. The former directors frequently have vastly different views on whether the relevant payments were privileged or not or whether the relevant company was actually insolvent at the time they were made. These disputes often cannot be settled amicably and are taken to the courts.
We now take a brief look at specific considerations in relation to D&O-liability related litigation.
- Origin of claims and limitation period: Formerly, claims for reimbursement of payments made in breach of Sec. 15b InsO were established separately for each payment at the time when it was made. Sec. 15b InsO now provides that the claim arises with the determination of a total creditor loss. This is typically the time of the opening of insolvency proceedings. From this point in time, the claims expire after five years and in the case of listed companies after ten years.
- Burden of proof and challenges for directors: Section 15b InsO presumes that non-privileged payments result in damages to creditors. The burden of proof to demonstrate otherwise, i.e., that creditors have suffered less or no damage, rests with the directors. If the court is convinced by the directors' evidence, this can be directly considered in the relevant proceedings, eliminating the need for the director to seek recourse with the insolvency administrator or creditors. However, providing such evidence presents significant challenges. The director must not only show that a payment was offset by an increase in assets but also that this increase remains within the company's estate. Without comprehensive or precise documentation of the compensating increase in assets, it can be difficult to effectively rebut the presumption of creditors' damages in court. To exonerate themselves, directors may inspect the company's accounts and, if necessary, apply to the insolvency court for access to relevant files. The most effective defence, however, is for directors to duly document the rationale behind specific payments at the time they are made.
- D&O insurance: recourse claims and notice of dispute: Due to the significant personal liability risks inherent in the role of a director, companies often procure specific directors and officers (D&O) insurance policies. If a director faces a reimbursement claim from an insolvency administrator and cannot successfully defend against this claim, they may seek recourse from the D&O insurer. Consequently, the D&O insurer may become a party to the court proceedings between the insolvency administrator and the director through a notice of dispute (Streitverkündung). Under German law, "Streitverkündung" involves formally notifying a third party about an ongoing legal dispute, enabling them to join the proceedings to prevent inconsistent judgments and safeguard their potential claims or liabilities. Should the D&O insurer join the dispute, any resulting judgment becomes legally binding for the insurer, thereby facilitating the enforcement of a subsequent recourse claim by the director. However, the insurer can raise its own objections, particularly if it believes the asserted claim is not covered by the insurance.
Relevance for cross-border cases
When cross-border corporate groups with German subsidiaries face financial distress, the stringent directors' liability regime under German law becomes a critical issue. This is especially relevant when German entities are involved in intragroup cash pooling, provide essential services or goods to other group companies, or hold strategically vital assets. These interdependencies necessitate the stability of German subsidiaries to prevent insolvency during group-level restructuring efforts, as their insolvency could potentially precipitate the collapse of the entire group.
Driven by concerns about the apprehensions of delayed insolvency filings or continued trading post-insolvency events, directors of German entities may feel compelled to consider filing for insolvency. It is crucial for group management, particularly those outside Germany, to understand the challenges faced by German-based directors in a restructuring scenario. Often, the financing of German entities depends on superordinate group entities, such as high-volume credit facilities provided by lenders at the sponsor or holding level. Restructuring activities at the parent company level may directly affect the German subsidiaries' ability to consider their own financing prospects as probable enough to uphold their going-concern prognosis, a vital element of the over-indebtedness insolvency test under Sec. 19 InsO.
Group management must be mindful of the importance of maintaining open communication channels with German directors to ensure coordinated and compliant decision-making processes. Best practices to provide German management with frequent reports and update calls on the progress of negotiations with relevant financing parties, including a thorough analysis of any relevant risk factors, such as foreseeable covenant breaches and shortfalls in group liquidity. By doing so, they can better support German subsidiaries in navigating the complexities of German insolvency law and contribute to the overall stability and success of group restructuring efforts.
Conclusion
Navigating the strict German directors’ liability regime requires a comprehensive grasp of the evolving legal and operational challenges that emerge once a company enters financial distress. By maintaining rigorous liquidity monitoring, documenting critical business decisions in real time and seeking timely professional guidance – particularly across borders where group interdependencies can introduce additional instability – directors (with the support of international management) can uphold the creditors’ interests while preserving long-term business viability. Through conscientious decision-making and transparent intra-group communication, directors solidify a foundation for more resilient restructurings and help ensure the survival of financially troubled companies under German insolvency law’s exacting standards.
