Liability in a private limited company
Entrepreneurship involves taking risks, but a director must never go so far as to mismanage the company and thereby cause damage to the company (internal director liability) or to third parties (external director liability). Directors can be held personally liable for poor policy, apparent improper management and mismanagement. What exactly is the situation regarding liability in a private limited company?
Director liability: a real risk
Director liability is not limited to listed companies, but is a real risk for all entrepreneurs, large and small. A private limited company is a legal entity. This means that directors and supervisory directors are in principle not liable for damage. However, there is one important exception. In the event of a breach of contract (improper management) or failure to register a private limited company in the Commercial Register, directors in a private limited company are liable.
What is improper management?
A director is obliged to perform his or her duties properly or in accordance with proper management. With regard to internal liability in a private limited company, but also in an association or foundation, improper management is an important factor in the liability of directors or supervisory directors. Improper management is also known as mismanagement or improper performance of duties by a director of a company.
Liability of directors and supervisory directors
There are various situations in which liability in a private limited company lies with directors or supervisory directors. Examples of liability of directors and liability of supervisory directors are internal director liability, the liability of the director towards the legal entity, and external director liability, the liability of the director towards third parties.
Internal director liability
A director who does not perform his or her duties properly or fails in the day-to-day management of a company may be held liable for damages by a legal entity. This is only possible in the case of serious misconduct, such as neglecting the administration, causing a private limited company to run into problems.
Internal liability in a private limited company arises in the following cases:
• Acting in contravention of the rules that protect the legal entity
• Withdrawing funds from the legal entity without permission or reason
• Putting personal interests above business interests (conflict of interest)
• Neglecting administrative or accounting obligations
• Contributing private assets to the business assets in a non-traceable manner
• Taking unnecessary (financial) risks without clear reason
• Irresponsible financial management
• Failure to fulfil obligations entered into by the director on behalf of the company
• Taking far-reaching decisions with major consequences without proper preparation
• Failure to comply with the insurance obligation
• Intentionally allowing the legal entity to perform a criminal or damaging act
• Granting (risky) loans to third parties, knowing that they cannot meet these obligations
• Violation of the non-competition clause
• Unjust personal enrichment
• The director acts contrary to the interests or outside the objectives of the legal entity
External director liability
External director liability arises when a director or private limited company acts negligently towards third parties. Examples of external director liability and liability in a private limited company include entering into obligations while a director knows that the company cannot meet these obligations. In the case of external director liability, a director or supervisory director may be held liable for unlawful acts.
External director liability applies in the following cases:
• Entering into obligations or agreements when the director knows that the legal entity cannot pay these potential debts
• In the event of unwillingness to pay
• Causing damage to a counterparty by failing to comply with existing agreements
• Improper management is a major cause of the bankruptcy of the legal entity
• Failure to comply with tax obligations
Who is liable?
If a director – or one of the co-directors – can be blamed for the above, then, on the basis of Article 2:9 of the Civil Code, there could be director liability due to improper performance of duties. Only those who can be seriously blamed are liable. Whether there has been improper management is determined in accordance with reasonableness and fairness according to standards of decency, as currently interpreted by the courts. Directors’ liability is therefore not a static concept.
Individual responsibility
Each director is individually responsible for their share in the management and therefore in the policy of the company. If a claim for liability on the grounds of improper performance of duties under Article 2:9 of the Civil Code is unsuccessful in court, creditors can hold a director liable by other means through an action for unlawful acts (Article 6:162 of the Civil Code).
Article 6:162 of the Dutch Civil Code stipulates that anyone who commits a tortious act against another person, which can be attributed to him, is obliged to compensate the other person for the damage suffered as a result. Both large and small entrepreneurs can be held liable for a private limited company through these two channels, whereby the possibility of also holding directors personally liable should not be underestimated.
Shareholder liability
In principle, a passive shareholder is not legally liable, but there may be exceptions. When shareholders effectively act as directors or policymakers, they can be held liable in the same way as other directors and supervisory directors. In principle, shareholders are only responsible for their own investment. However, liability in a private limited company may be invoked if a payment is made to a shareholder in the event of bankruptcy and this payment has resulted in the company no longer being able to meet its obligations.
A shareholder can also be held liable if the share capital held has not been paid up in full. The liability then applies to the value of the unpaid share capital. In other words, the shareholder can then be required to pay up the shares.
When can a director be held personally liable for the policy of the private limited company?
As a director of a private limited company, you are in principle not personally liable for the company’s debts. However, this changes in the event of serious culpable acts or omissions. You can then be held personally liable if it is clear that no reasonable director would have acted in the same way under the same circumstances. Examples include continuing loss-making business activities with no prospect of recovery, unfairly disadvantaging creditors, or failing to comply with tax or administrative obligations. Liability may also arise in the event of selective payments or entering into obligations that you knew (or should have known) that the company could not fulfil.
Therefore, always assess major decisions against the financial capacity of the company, record this carefully in the minutes and seek legal advice. This will prevent strategic choices from unintentionally affecting your private assets.
Supervision of legal entities: association or foundation
In 2021, the Legal Entities Management and Supervision Act came into force. This Act brings the rules for managing foundations and associations more into line with the legislation on liability in a private limited company. It also introduces new rules for directors’ liability. The aim of the Act is to improve the quality of management and supervision of associations and foundations.
Advice on liability in a private limited company
It is not only directors of large listed companies who are held liable in a private limited company. Claims are also becoming more common and occurring earlier within SMEs and non-profit organisations, associations or foundations. Would you like more information about directors’ liability? Please feel free to contact one of our corporate law solicitors. The solicitors at Fruytier Lawyers in Business can advise you on risk-mitigating measures and are always up to date with the latest developments in the field of liability for directors and supervisory directors.
Authors: Employment law solicitors Mignon de Vries and Myrddin van Westendorp