Liability of Managing Director Despite Formal Approval of Past Actions?

A GmbH (limited liability company under German law) may claim damages from a managing director despite the formal approval of such director's past actions if the facts and circumstances on which the liability is based could not be recognised by the shareholders when the managing director submitted the accounts before the approval was granted.

Brandenburg Higher Regional Court, judgment of 24 January 2024 – 7 U 2/23

A managing director is personally liable to the company if the director negligently or wilfully violates their responsibilities, resulting in damage to the company. The criterion for determining a breach of duty always is what a prudent businessman would do. Liability is excluded once the past actions of the managing director have been formally approved by a shareholder resolution. If actions have been formally approved, the company can no longer make any claims against the managing director to the extent such approval has been granted (known as the preclusion effect). The scope of the managing director's liability is therefore determined by the scope of the approval.

In terms of time, formal approval is granted for actions in the period set forth in the approval resolution and for which the managing director has submitted accounts. This generally covers transactions of the past fiscal year if no further details are provided. Such formal approval, however, does not release the managing director from such director's existing present and future obligations towards the company. Notably, these obligations also exist if there is the danger of new disadvantages resulting from a past event covered by the approval.

In terms of content, the formal approval covers all facts that the shareholders were aware of from the reports by the managing director or from the documents submitted or that the shareholders could have recognised on careful examination. The key criterion for recognisability is whether the managing director's reports or the documents provide specific evidence for doubts or questions that the shareholders could have clarified by recalculating, making enquiries or exercising their right to information. Recognisability can be ruled out, however, if the managing director has not given the shareholders sufficient opportunity to exercise their rights of inspection, information and disclosure, be it on purpose or not. If the managing director prevents the shareholders from making enquiries, conceals facts or disguises them, the managing director does not need protection. For the formal approval of the managing director's past actions is obtained by using fraudulent measures. Such fraudulent approval does generally not lead to any exclusion of the managing director's liability.

The Brandenburg Higher Regional Court recently dealt with questions relating to liability and formal approval.

Background (simplified)

In the case on which the decision was based, the shareholder / managing director of a German GmbH had made various payments to himself over the years in addition to his salary and bonus in order to increase his salary as managing director. The shareholders' meeting approved the annual financial statements for all years and formally approved the managing director's actions, except those of the last two years of his term of office. Whether the payments were identifiable in the balance sheets of the annual financial statements remained a matter of dispute between the parties.

The shareholders' meeting decided to claim repayment from the (former) shareholder / managing director after his dismissal and immediate termination of his contract. He argued that the salary agreed in his employment contract had been unreasonably low and therefore void. As a result of the additional payments, he had received a total salary that corresponded to the value of his services. Therefore, the company had not suffered any damage. Furthermore, his liability was excluded due to the formal approval of his actions. The same applied to the last two years of his position as managing director due to the acceptance and/or approval of the annual financial statements, in each of which the payments were recognisable.

The Brandenburg Higher Regional Court partially ruled in favour of the shareholder / managing director:
The unauthorised initiation of the payments must be considered a breach of duty by the shareholder / managing director because the salary of a managing director is the sole decision of the shareholders' meeting. The shareholder / managing director is not entitled to adjust his remuneration unilaterally, even if his salary is objectively considered to be unreasonably low.

However, the company is no longer entitled to repayment for the years for which the shareholder / managing director's actions have been formally approved. This is because the approval covers all business transactions that were recognisable to the shareholders upon careful examination of the documents submitted to them. This was the case: the unauthorised payments were identifiable in the balance sheets and the shareholder / managing director's actions were approved regardless of this.

On the other hand, the approval of the annual financial statements does not lead to a 'formal approval of actions' and thus to an exclusion of the shareholder's / managing director's liability for the last two years of his term as managing director. These payments were visible in the balance sheets of the approved annual financial statements for the last two years. However, in the case at hand the approval of the annual financial statements does not have an exonerating effect in such a way that the unauthorised payments had been approved by all shareholders and cannot be reclaimed. This is because by approving the annual financial statements with regard to third-party liabilities, the shareholders are merely making a declaration as to which expenses have actually been incurred. The annual financial statements generally do not contain any information as to whether the amount of the third-party liabilities was appropriate and whether the company may have claims for repayment due to any overpayment.

It is true that, in the relationship between the shareholders and the company and among the shareholders themselves, the approval of the annual financial statements generally means to declare the balance sheet binding, i.e. the shareholders recognise its correctness. The disputed unauthorised raising of the managing director's salary, however, is a third-party liability that does not originate from the internal relationship between the company and the shareholders. In the case of third-party liabilities, it cannot automatically be assumed that the amount of the third-party liability shown in the balance sheet has been reviewed by the shareholders and considered to be appropriate. Such authorisation effect through the approval of the annual financial statements with regard to third-party liabilities is only possible in exceptional cases, for example if the parties agree on it or if all parties involved are aware that there is disagreement with regard to certain liabilities. In the absence of any discussion, however, only the making of payments is approved, but not a corresponding ‘discharge’ of the shareholder from a repayment of overpayments made.

Comments and Practical Advice

Neither the approval of the annual financial statements nor the formal approval of the actions of the managing directors of a GmbH are mere formalities to be made without thought. In both cases, questions, doubts and discrepancies should be clarified and resolved in advance − where necessary with the help of experts.

This is because the formal approval of the managing director's actions generally excludes the assertion of any claims by the company against the managing director to the extent such approval has been granted. In terms of content, the exclusion of liability relates to all business transactions that could have been recognised by the shareholders upon careful examination of the reports by the managing director or from the documents submitted. This means that not only the circumstances that were known to the shareholders when the resolution was passed are covered, but also all circumstances that the shareholders could have detected through recalculation or enquiry. If the shareholders refrain from further clarification despite clear evidence and in case of doubt, this regularly leads to the preclusion of any claims by the company against the managing director. In case of doubt, the shareholders should therefore actively enquire or try to clarify the facts in another way.

The same applies to the approval of the annual financial statements. This is because the company's internal receivables and liabilities are bindingly confirmed when the annual financial statements are approved. This means that claims may normally not be asserted at some later date. As explained above, this also applies to third-party liabilities in exceptional cases. Caution is therefore required in order not to lose any (repayment) claims of the company against the managing director. If there are any open questions, the resolution on the adoption of the annual financial statements and the formal approval of the managing directors' past actions should be postponed.

Dr Barbara Mayer
Lisa Werle