ESG – In Times Of Crisis Should “G”overnance Be Replaced By “C”ompliance? Aufsichtsräte Be Aware!

“What is the best government? That which teaches us to govern ourselves.” – Johann Wolfgang von Goethe

Sustainability and ESG still remain THE topics these days. But is the focus on “Governance” enough in times of crisis? Are leaders rather better advised to concentrate on “Compliance”? And is self-governance perhaps the better compliance management?

The Management Board (der Vorstand) must initiate appropriate means and measures to recognize any damaging developments that might threaten the survival of the company. This includes the establishment of a monitoring system (§ 91 Abs. 2 AktG (German Stock Corporation Act)). Thus, the legal basis for compliance measures is soundly embedded in the German Stock Corporation Act. No news on this front. However, in times of crisis, this mandatory obligation to monitor and supervise becomes more important and failure to do so could ultimately result in D&O liability (Organhaftung).

Bear in mind, that D&O liability is twofold in Germany: different obligations exist at the Management and the Supervisory Board levels. Cases were rarely brought before courts but in the last decade this has changed due to the highly publicized instances of corruption, bribery, and antitrust involving DAX-listed companies (see also: Magotsch/Otto on Monday 29 June 2022; “Germany: Take Action Now, Sustainability And Human Resources“).

Various obligations at the Management Board Level (Geschäftsleitung)

German insolvency rules differentiate between

• imminent illiquidity (drohende Zahlungsunfähigkeit) pursuant to § 18 InsO (German Insolvency Code);

• current illiquidity (Zahlungsunfähigkeit) pursuant to § 17 InsO; and

• over-indebtedness (Überschuldung) pursuant to § 19 InsO.

While imminent illiquidity means that the company would be unable to pay its debts due during a forecast period of up to 24 months, current illiquidity obliges management to file for insolvency within three weeks at the latest. Over-indebtedness extends this grace period up to six weeks from seeing a balance sheet where debts are no longer covered by assets (without a liquidity forecast period of up to 12 months being positive).

During the earlier phase under § 18 InsO, the Management Board is bound by various obligations:

• Monitor the crisis (Krisenbeobachtungspflicht) § 91 Abs. 3 AktG / § 1 Abs. 1 StaRUG (Restructuring Framework for Businesses)

• Initiate restructuring measures (Sanierungspflicht) § 93 Abs. 2 AktG / § 1 Abs. 1 StaRUG

• Information obligations (Informationspflicht) § 90 Abs. 1 und 2 AktG / § 1 Abs. 1 StaRUG

• Call a shareholders meeting (Pflicht zur Einberufung der HV) § 92 Abs. 2 AktG.

At the later stage under §§ 17, 19 InsO, the obligations become more stringent:

• File for insolvency proceedings (Insolvenzantragspflicht) § 15a Abs. 1 InsO

• Maintain the estate (Masseerhaltungspflicht) § 92 Abs. 2; 93 Abs. 3 AktG

• Freeze payments (Zahlungsverbot) § 92 Abs. 2 AktG

• Damage compensation (Schadensersatzpflicht) § 93 Abs. 2 AktG.

While Directors might be held personally liable for a failure to meet obligations such as filing for insolvency proceedings, violations of obligations and duties may first lead to claims for damages and penalties brought against the company. Only subsequently will the question be raised of whether such damages or penalties should be passed on to the (acting) responsible directors. In the famous Schienenkartell-case, the German Federal Labor Court (Bundesarbeitsgericht/ BAG, 29 June 2017/ 8 AZR 189/15) denied ThyssenKrupp`s attempt to pass on its € 100 million damages to one of their former directors. The claim was transferred to the civil courts to answer antitrust issues pursuant § 87 GWB, the German Competition Act. Only last Thursday, 27 July 2023, the Higher Regional Court (Oberlandesgericht/ OLG Düsseldorf, VI-6 U 1/22) ruled in one of the still pending steel cartel cases against a company, which had tried to pass on investigation and legal fees in the amount of approx. € 1 million against one of its former directors. The OLG argued that passing on antitrust penalties to managers will undermine the key aspects of issuing penalties, because thereby companies can “free” themselves from penalties and ultimately may achieve indemnification from D&O insurances companies. This will not be the end of the saga, since the OLG has admitted the revision to the Highest Federal Civil Court (Bundesgerichtshof/ BGH).

Well defined obligations at the Supervisory Board level (Aufsichtsrat)

Coming back to our initial question: are compliance management methods of prescribing regulations, monitoring behavior, and punishing violations successful tools in times of crisis? Or could strengthening self-governance in organizations be the more promising way forward, particularly in times of crisis? Unlike other jurisdictions, Germany`s two-tier management structure and the clear role of the Supervisory Board already provide incentives for compliance, monitor behavior, and punish violations. Perhaps this is sufficient to successfully regulate human behavior.

In addition to the Management Board (i.e., Vorstand at AG), stock corporations must also have a so-called Aufsichtsrat, a Supervisory Board where employee representatives may also be positioned. This Supervisory Board is strictly separate from the Management Board of a company. One of its key authorities is the right to appoint and withdraw members of the Management Board. Do not forget, mandatory supervisory boards with employee representation are also a must for limited liability companies (GmbH) with a minimum number of employees.

Depending on the number of employees of the company, the Supervisory Board consists of representatives elected by the shareholders and employee representatives elected by the staff (in most cases members of the Works Council and Trade Union), provided the company is subject to German co-determination laws. The Supervisory Board’s key obligation to monitor and supervise the executives as stipulated in § 111 Abs. 1 AktG consists in ensuring the executives comply with (German) law and regulations and have set up appropriate structures of governance to observe the law and thereby secure the existence and wealth of the company. The Supervisory Board may delegate individual monitoring tasks to specific committees as per § 107 Abs. 3 AktG and rules set within the DCGK, the German Corporate Governance Code.

In 2018, the German Federal Supreme Court (Bundesgerichtshof/ BGH, 18 Sept. 2018/ Az: II ZR 152/17) confirmed a legacy decision (ARAG/Garmenbeck) of 1997, tightening and increasing the liability of Supervisory Board Members (Aufsichtsräte“). (see also Magotsch in JD Supra legalnews of 27 November 2018; “Aufsichtsräte be aware“)

In this landmark decision, the Supreme Court stressed the position of the Supervisory Board and highlighted the increased risk for Supervisory Board members of being held liable for damages caused by the Management Board if they fail to bring damage claims before the courts and ensure potential remedies on behalf of the company. In the case at hand, the Management Board had violated its fiduciary duties vis-a-vis the company. Potential damage claims by the company against the Management Board were meanwhile statute-barred due to the failure of the Supervisory Board to bring such claims against the management in due time. The court confirmed that the Supervisory Board’s duty was to bring legal action against management and to pursue damage claims against them.

Failing to do so makes the Supervisory Board liable for such damages even if the claims against management were meanwhile statute barred. Thus, Supervisory Board Members remain at risk of being held liable for many years after the original wrongdoing. Bear in mind, a damage claim against the Members of the Supervisory Board can only be made once the statute of limitation for a damage claim against Members of the Management Board has kicked in.

In summary

We recommend reviewing and checking existing compliance management schemes and correcting and amending them, if necessary, keeping in mind the potentially outdated D&O insurance policies for both tiers of executives.

Supervisory Board Members are advised to carefully analyze and evaluate whether they should bring legal actions against management well in time prior to deadlines prescribed in the statutes of limitations.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.