Every managing director of every company is required to act with the due care of a prudent business person. This is the foundational duty from which practically everything else follows.
The concept of the duty of due care essentially covers two main obligations.
The first is the duty of loyalty. This means the necessity to prioritize the interests of the company over one's own interests or the interests of others. The second is the duty to act with due diligence and on an informed basis.
In practice, this means that a managing director must carefully consider every business decision, weigh the arguments for and against, and make decisions based on available information.
Membership in a company's governing body brings with it a number of duties – convening the general meeting, proper bookkeeping, the duty to provide information to shareholders, and more.
If someone is elected or appointed to such a body, or otherwise called upon to serve, they must perform their duties upon the company's incorporation or otherwise, they must perform their function with loyalty, the necessary knowledge, and diligence.
If an executive breaches this duty and causes damage to the company as a result, the company may demand two things from them. Compensation for the damage and, at the same time, any benefit they obtained from performing their role, such as their remuneration.
A breach of the duty of due care can be illustrated by obvious examples such as:
There are many variations in practice. These may include disadvantageous sales or purchases of assets, excessive remuneration, suspicious transactions with no economic rationale, and other forms of what is collectively referred to as asset stripping.
However, it is also important to keep in mind that a breach of the duty of due care often includes less obvious and seemingly harmless situations, typically:
The consequences of breaching the duty of due care can take various forms; the most significant are outlined below.
If an executive has breached the duty of due care, the company may demand the return of any profitobtained in connection with such conduct.
If such conduct also resulted in damage to the company, it may demand compensation from the executive.
The second level concerns creditors. If an executive has indebted the company through their decisions (for example, by entering into a contract in violation of the duty of due care that leaves the company with a debt) and the company lacks the funds to pay it, the creditor has the right to demand payment directly from the executive based on their liability, to the extent that the damage has not been compensated to the company.
The third level is punitive. If a member of a business corporation's statutory body, such as an executive of an LLC, repeatedly or seriously breaches their duties, a court may disqualify them from serving as a member of a statutory body of any business corporation. This can last for up to three years.
If they continue to perform their duties despite the established ban, they face an extension of this disqualification for up to ten years. This effectively excludes such a person from holding a statutory position entirely, and it is important to remember that this fact is now recorded in the register of disqualified persons.
The fourth level applies in cases where a managing director has contributed to the insolvency of a business corporation through a breach of their duties; in such a case, the court may immediately order the return of any benefits (remuneration) the director received as a result of performing their duties, for a period of up to two years prior to the commencement of insolvency proceedings.
In the event that bankruptcy has been declared for the company, there is even a risk that the director will be required to contribute to the bankruptcy estate an amount up to the difference between the total debts and the value of the company's assets.
The fifth level is criminal liability. A breach of the duty of due care can also take the form of a criminal offense, such as breach of duty in the administration of another's property, even if committed through gross negligence (in other words, intentional fault on the part of the director is not necessarily required). A director may also commit the criminal offense of causing insolvency of the company, where again, gross negligence is sufficient.
The Criminal Code also recognizes a number of other criminal offensesthat a member of a governing body can commit. And often very easily. This is therefore not a distant, theoretical threat.
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In disputes involving executive directors, the burden of proof is generally reversed. This means it is not the company that must prove the director acted improperly. On the contrary, the director must prove that they did not breach their duty of due care. In practice, this is often quite difficult, yet litigation in this area is relatively common.
On the other hand, there is the so-called business judgment rule, which allows a director to be absolved of liability even in cases where their decision actually resulted in a loss. However, the condition is that the director must have acted in good faith, believing that their decisions were made on an informed basis and in the best interest of the company.
Simply put: business inherently involves a certain degree of risk, and a director must sometimes make risky decisions – often from the very moment of incorporating the company. They will not be held liable for any resulting loss, however, provided they gave the decision sufficient thought, obtained the necessary information, and acted in the company's best interest.
"The business judgment rule is not an automatic safety net. The court examines whether the director truly acted on an informed basis in the given situation. It is therefore worth keeping written records of key decisions, including email or other correspondence. Without them, it is difficult to defend against a reversed burden of proof,” says attorney Oldřich Starůstka.
A typical situation where the liability of a managing director is fully addressed occurs after a change in leadership. The former management leaves the company, or is dismissed, and the new management discovers the state in which the company was handed over to them. If any of the partners or the new management suspects that misconduct has occurred, a legal audit often follows—that is, an assessment of whether everything that took place within the company was in compliance with the law.
Such an audit sometimes reveals that the former management engaged in conduct that caused damage to the company.
Before taking concrete steps, however, it pays to honestly answer a few questions. Did a loss actually occur? What is the amount? Who is specifically responsible for it? Is the claim already time-barred? And is it more appropriate to file a civil lawsuit, a criminal complaint, or both at once?
"In some cases, compensation for damages can be sought not only from the managing director who acted directly. In some instances, it is possible to recover damages from members of the supervisory body—typically the supervisory board, if one has been established in the company. Damage does not have to be caused only by the person acting on behalf of the company. Those tasked with overseeing them also bear responsibility. Neglecting oversight establishes independent liability for damages," adds attorney Oldřich Starůstka.
The best defense against a lawsuit regarding managing director liability is not a conviction of one's own integrity. It is documentation. For key business decisions, it makes sense to keep records, including the materials upon which the managing director based their decision, as well as all related communication. When a dispute arises, they then have a solid foundation to withstand it and prove that they properly fulfilled their duties.
If you are taking on the role of a managing director and want to clarify where the boundaries of liability lie, it pays to dedicate time to the topic before a problem arises. And if a problem has already arisen, get in touch. Whether you are a managing director under pressure or a new managing director dealing with what your predecessor left behind, we will assess the situation and propose a course of action.
Just fill out form or write to us at info@endors.cz
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Oldřich is an attorney specializing primarily in complex transactional advisory, corporate law, and setting up structures for wealth management. In his practice, he has also gained experience in Real Estate and SME lending issues.
