Internal director liability at start-ups: cutting-edge entrepreneurship

Managing a start-up is all about vision, courage and speed. These qualities stimulate innovation, but can make directors vulnerable from a legal perspective, especially if the company goes bankrupt. In that case, the receiver, acting on behalf of the company, may hold directors liable for improper performance of their duties on the basis of Article 2:9 of the Dutch Civil Code.

Legal standard: improper performance of duties and serious blame

Article 2:9 of the Dutch Civil Code obliges every director to perform his duties properly. If a director performs his duties improperly and can be seriously blamed for this, he is liable to the company.

The company can then bring a claim against the director. In bankruptcy situations, the trustee acts on behalf of the company.

The standard for serious culpable conduct by directors is set out in the Supreme Court judgment in the case of Staleman/Van de Ven. It follows from this that the question of whether a director can be seriously blamed depends on all the circumstances of the case. The following circumstances, among others, may be relevant:

– the nature of the business;

– the risks associated with that company;

– the division of tasks within the board;

– the information that the director had or should have had at the time of the decisions or conduct for which he is being blamed; and/or

– the insight and care that may be expected from a calculating and meticulous director.

For start-ups, this assessment may differ from that for established companies. In this initial phase, there is often uncertainty, high investment costs and a business model that is still under development. After all, start-ups often go to market with a “Minimum Viable Product”. This is the simplest working version of a product with just enough core functionalities to quickly launch to real users, gather feedback and guide further development.

Case law shows that judges recognise that taking risks is part of this phase of the company’s development, but that does not mean that directors have carte blanche. They must always maintain sufficient insight into the financial situation and intervene in good time when things threaten to go wrong.

In practice, courts also seem to offer leeway for the positive approach often taken by start-up entrepreneurs. In principle, this means that, for example, the lack of full financing or overestimating market opportunities does not in itself lead to serious criticism, as long as the management acts on the basis of realistic expectations and keeps the financial position transparent.

Real-life example

A recent case before the District Court of Overijssel illustrates how judges can deal with internal director liability in start-ups[1].

After the bankruptcy of a young technology company, the receiver held the directors personally liable, primarily on the basis of Article 2:248 of the Dutch Civil Code (manifestly improper management in the event of bankruptcy) and, in the alternative, on the basis of Article 2:9 of the Dutch Civil Code (improper performance of duties). According to the receiver, they had managed the company recklessly, contrary to the business plan and without regard for the interests of creditors.

However, the court ruled that there was no manifestly improper management or improper performance of duties. The company had started in line with the business plan and the directors had carefully weighed their choices. The judge emphasised that the fact that a start-up takes risks or faces a failed financing round does not necessarily mean that the directors have performed their duties improperly. In addition, the judge took into account that the investors were aware of the risk of failure and had consciously accepted this risk.

Important was the judge’s ruling that the directors:

– maintained sufficient insight into the financial situation;

– were able to substantiate their decisions; and

– did not act contrary to reasonableness and fairness towards creditors.

Conclusion: leeway, but no carte blanche

It can be inferred from case law that judges recognise that doing business in a start-up context often means that risks have to be taken. This context allows for some situation-dependent leeway in determining whether there has been manifestly improper management or improper performance of duties. The basic principle remains that directors must act in a well-considered, transparent and responsible manner.

Directors can therefore be expected to:

– keep the financial administration in order;

– intervene in a timely manner in the event of liquidity problems;

– communicate openly with investors and creditors; and

– properly document their decision-making.

Questions?

Do you have any questions about this article? Our solicitors are ready to advise you! Contact one of our solicitors by email or telephone, or fill in the contact form for a no-obligation initial consultation. We are happy to help.