Article

Early warning tools to detect financial crises and avoid director liability

The Corporate Stabilization and Restructuring Act (dubbed “StaRUG”) came into force on 1 January 2021. It codified, for the first time, management’s obligation to introduce a system for early detection of distress and crisis management across all legal corporations.

The new StaRUG provides a legal framework for the reorganization of distressed companies outside of insolvency proceedings. Corporate debtors may now implement necessary reorganization measures by introducing a restructuring plan affecting selected creditors only to ultimately avoid insolvency proceedings. The new StaRUG transposes the EU Restructuring Directive (EU) 2019/1023 into German law, which requires all EU member states to establish a pre-insolvency restructuring framework to avert probable insolvency.
Another key feature of the StaRUG-regime is the early detection of corporate crisis markers so that the companies may take advantage of the now available restructuring opportunities. To that end, Sec. 1 (1) first sentence StaRUG obligates corporate management to continuously monitor any development that may put the continued existence of the company at risk. Management is under a statutory obligation to take action and introduce appropriate countermeasures to address such risk and report to the supervisory bodies – the company’s supervisory board or its shareholders in a shareholders' meeting – should they identify risk of that nature. Pursuant to Section 1 (2) StaRUG, this statutory obligation also applies explicitly to entities without their own legal personality as defined by the German Insolvency Code, for example limited partnerships such as the German GmbH & Co. KG.

Major innovation of the StaRUG

At its core, the obligation for early crisis detection and crisis management is not new. It was already part of management’s general obligation to manage corporate risk, stemming from management’s general (equitable) duty owed towards their company, as established by German case law. Indeed, Section 91 (2) of the German Stock Corporation Act (AktG) contains a special provision requiring the management board of a stock corporation to monitor and address risks.

The duty for the management as is now established in Section 1 StaRUG can be summarized in four core duties, namely to:

  1. monitor developments which may put the continued existence their company at risk (early crisis detection);
  2. take appropriate action and introduce countermeasures when risks are identified (crisis management);
  3. report to supervisory bodies; and
  4. involve other bodies, if necessary or prescribed by law.

Irrespective of the introduction of these statutory obligations, however, there are as of yet no precise specifications or guidelines from German case law or bodies such as the Institute of Public Auditors in Germany e.V. as to what management of a company should specifically do and/or introduce to discharge of their obligations. This naturally brings with it uncertainty and risk.

Impending liability of the management

The law does not contain any liability explicitly linked to management’s failure to monitor and address risk in breach of their statutory obligation pursuant to Section 1 StaRUG. Rather, Section 43 StaRUG outlines a central standard for management’s conduct which establishes a (mere) liability of management towards their company if breached for such damages caused by not conducting a necessary restructuring with the diligence of a prudent and conscientious business manager.

However, it is currently hotly debated in the profession and academia whether management’s failure to introduce a necessary restructuring and utilize the tools now available under the StaRUG-regime irrespective of the occurrence and/or detection of a significant corporate crisis may lead to personal liability of the corporate’s management. For instance, it is debated whether in a future insolvency procedure, an insolvency administrator could examine and assert such breaches of duty by management, the argument being that would management have acted earlier and made use of the restructuring tools available under StaRUG, the current insolvency proceedings could have been avoided.

It is therefore essential for management, whether board of directors or managing director, to implement a suitable early warning system so as to detect and address a corporate crisis and, at the same time, avoid their own risk of personal liability. Different standards may be applied, depending on the size of the company. For example, family-run SMEs have different obligations compared to big global corporations with branches abroad. In the case of the latter, there are often interdependencies which can cause the entire group to totter in a crisis. Industry-specific peculiarities must also be taken into account.

Conclusion

Early crisis detection and management has always been a core obligation of corporate management. However, with the new statutory provision in Section 1 StaRUG, the legislator is now increasing the pressure on business managers to implement suitable systems for their company rather than merely pretending to do so and/or using defective systems. Even though the legislator has not established a direct legal link between the statutory duty to identify and address corporate crises at an early stage with the liability provisions of the StaRUG, it can be safely assumed that going forward, the German courts will hold business managers personally liable if they breach this duty. Corporate management can only avoid this risk by continuously documenting their actions and measures introduced to identify and address a crisis early. The industry-specific challenges and different standards to be applied depending on the size of a company do not make it any easier for business managers to implement the necessary framework for such early crisis detection.

Webcast "Legal Update #12/2022"

Our experts Frank Tschentscher, Stefan Weniger und René Scheffler will give more insights on „Early Crisis Detection to avoid Liability Risks and Restructuring Delays“ in our Webcast, dated 28 September. Register now! 

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