The Coronavirus pandemic has its hold on the economy, impacting companies of all sizes. In the process, managing directors and boards of directors are tasked with taking management decisions during this crisis, which means that they are confronted with the difficult challenge of navigating companies through turbulent waters. The progression and economic impacts of the pandemic are hard to predict. Forecasts are changing continually. Decisions are forced to be taken on a precarious factual footing. Business decisions could in retrospect prove to be adverse to the company.
For managing directors and boards of directors, this is associated with a concrete liability risk (in addition to reputational harm and – in extreme cases – potential repercussions in criminal law). However, particularly in crisis situations like the Coronavirus pandemic, this liability risk must not paralyse those with power to take decisions. The liability risk for managing directors and boards of directors is reduced by the business judgement rule (cf. section 93 para. 1 of the German Stock Corporation Act [AktG] and section 43 para. 1 of the law on Limited Liability Companies [GmbHG]), which under certain conditions provides a margin of discretion within which managing directors and boards of directors have no liability with respect to their companies. This is of particular importance in times of crisis.
II. The Business Judgement Rule
The business judgement rule exempts managing directors and boards of directors from liability for a relevant decision if they take a business decision (1.) based on adequate information (2.) to the benefit of the company (3.) whilst observing the level of care of a diligent managing director (4.). All matters deserve particular attention in view of the Coronavirus pandemic.
- Business Decision
Fundamentally, a business decision is any decision by a managing director or board of directors that pertains to conducting the business of the company and characterised by the fact that the decision-maker can in law and in fact choose among several alternative courses of action. Here, an active decision of inaction (different to mere lack of action) is an available decision alternative.
As a rule, business decisions inherently have a prognostic nature. At the time of the decision, the decision-maker often does not know for certain which alternative is best for the company. He must choose the best alternative within his estimation.
Also, in times of the Coronavirus pandemic, companies – as in times of crisis generally – face a multitude of business decisions. Relevant decisions, among other things, are reducing or switching production, obtaining loans, reducing investments, converting to short-time work, utilising state aid, adjusting contracts or terminating M&A transactions, but also conducting a virtual meeting of shareholders or postponing the meeting of shareholders by virtue of the law adopted in March to mitigate the impacts of the COVID-19 pandemic in civil, insolvency and criminal procedural law (“Coronavirus Act“). On the subject of meeting of shareholders during the Coronavirus pandemic we also refer to the « contribution by our colleagues, Dr Jörn-Christian Schulze and Nima Hanifi-Atashgah ».
However, it is only a business decision if the decision-maker is in principal free in his decision-taking. Hence, circumscribed powers, consequently those decisions which are prescribed by law or statute, are generally excluded from the business judgement rule. In view of the pandemic, occupational safety and insolvency law provisions must be considered first and foremost. With regard to the possibility that the obligation to file for insolvency is suspended in the Coronavirus Act, we refer to the « contribution by our colleague, Johannes Landry ».
- Establishment of an adequate basis of information
An exemption from liability through the business judgement rule is only possible if the management has prepared diligently for the decision. The establishment of an adequate basis of information is essential to the application of the business judgement rule. A diligent decision from among several alternatives is only possible given an adequate basis of information. Above all, the business value of the decision must be ascertained, but also the costs thereof as well as the legal and actual risks, long-term opportunities and trends associated with the decision, and impacts on the market position as well as the reputation of the company. The information must be gathered for all alternatives under consideration in order to make an assessment on this basis.
Of course, in the course of the Coronavirus pandemic, it is problematic that the establishment of an adequate basis of information can be protracted. There is a general obligation to use all available sources of information. However, the adequacy of the basis of information depends on the specific situation. This means that a cost-benefit analysis is permitted with respect to an additional provision of information. The urgency and importance of the decision for the company are significant factors of this analysis. If a decision is urgent because the company is otherwise threatened with serious harm and additional information gathering likely will not provide any new insights, it is in line with the diligence of a conscientious managing director to maintain the information gathering so that a risk to the company is no longer posed. However, in no case does the cost-benefit analysis exempt management completely from information gathering. Thus, a conscientious managing director must ask himself the question whether he has established a sufficient basis of information in the particular situation in order to take a decision for the benefit of the company.
An additional problem of the pandemic is that, for its part, the basis of information often consists of forecasts. Findings are also not yet established in many cases because sources conflict or their reliability appears questionable. Therefore, in many cases it is not possible to reliably conduct a conclusive assessment of the impacts of the crisis.
However, the fact that the underlying information is heavily comprised of forecasts does not preclude the application of the business judgement rule. If no other information is available, decisions may be based on forecasts. In the final analysis, it depends whether it is reasonable to assume that one is acting on an adequate basis.
- Decisions to the benefit of the company
Only a decision to the benefit of the company can lead to an exemption from liability by way of the business judgement rule. Thus, the decision-maker may align the decision solely to the interests of the company. The decision must, in an ex-ante approach, strengthen and serve the company. As an absolute limit, no measures may be taken which harm the company or pose a threat to its survival. At the same time, alignment with the wellbeing of the company also means that irrelevant considerations, such as the special or private interests of the decision-maker, cannot inform the decision.
It should be noted that the decision in retrospect will not be reviewed based on information that is later available (ex post). Rather, what will be considered is whether, at the time of the decision, based on the information generally available at that time, the decision-maker could rely on an adequate basis of information upon which to act for the benefit of the company (ex ante). Practically speaking, however, there is the risk that one could always subsequently have greater knowledge. It is therefore important to comprehensively document the information used, the alternatives, and the deliberation process.
- Observing the level of care of a diligent managing director
Due to this urgency and forecast-heaviness, in most cases there is not just one single correct decision. The margin of discretion typically opens up various opportunities, in particular allowing for the decision of whether to take a more risky or more cautious approach. It is essential, but also sufficient, that the decision is taken with the level of care of a diligent managing director. The decision-maker must weigh the pros and cons of the alternatives. However, the path with the lowest risk need not be chosen. In the final analysis, the decision may not be completely unacceptable. In addition, the decision-maker must act in good faith to take the right decision for the benefit of the company.
III. Practical Examples
- Measures to Ensure Liquidity
Measures to ensure liquidity have gained particular relevance as a result of the economic impacts of the pandemic. The liquid assets of a company and margins for manoeuvre could shrink due to halting demand owing to the crisis. This can ultimately lead to the insolvency of the company. Measures to ensure liquidity that are worth considering for example include the forbearance of debts (inter alia rental liabilities, accounts payable or loan liabilities), taking out new loans, short-time work or applying for state assistance.
Whether measures to ensure liquidity are taken, in particular whether external help is used, is a decision that is categorically subject to the business judgement rule. The decision-maker has several options available to him, the effect of which generally speaking cannot be predicted in every detail. The limits of the business judgement rule are exceeded, however, if the liquidity shortage of the company is so obvious that the decision-maker is obligated to act in a certain manner due to legal requirements (such as the obligation to file for insolvency) or special statutory regulations or shareholder resolutions. Then this is a circumscribed decision which does not fall under the scope of the business judgement rule. Likewise, the decision-maker is not protected by the business judgement rule if the decision compromises the existence of the company or harms it. A threat to the company is to be understood as an absolute limit. If the financial margins of the company are narrow, it can for example be imperative, for the benefit of the company, to carry out measures to ensure liquidity such as obtaining loans.
As with any business decision, an adequate basis of information must be established in the first place. Above all, information regarding the liquidity position of the company and its future performances, the influence of the measure being considered on the future liquidity position of the company, economic growth within its scope of activity, repayment terms, and costs and impacts on the reputation of the company are relevant in this respect.
These are predictive decisions. There is no one single correct decision. What is important is transparent consideration aligned with the wellbeing of the company. The fact that the duration of the restrictions due to the pandemic as well as the duration and scope of the related economic impacts are not yet foreseeable at present is a strong argument that such measures can fall under the business judgement rule if the company otherwise does not run into financial difficulty.
- Reluctance to Invest
The unforeseeable developments of the pandemic also call business investments into question. Investment decisions are fundamentally business decisions which fall under the scope of the business judgement rule.
Essential information that must be gathered are savings from refraining from investments as well as a possible need to convert financial resources into a financial buffer, but at the same time the long-term negative consequences of refraining from investments, as well.
Advantages and disadvantages of the investment decision during this crisis must be contrasted. The fact that withholding financial resources is lower risk does not mean that only this decision may be taken. The business judgement rule allows for risk. There is a limit here, too, if the company is harmed or its existence is threatened by the decision. Thus, the investment decision is not covered by the business judgement rule if the company will surely be financially overburdened by the decision.
- Non-Acceptance or Termination of an M&A Transaction
The pandemic can likewise affect planned or current M&A transactions. Paramount here is the question concerning the termination of a transaction. Similarly, the scenario must be considered that an opportunity for a transaction arises precisely due to the pandemic.
If the management of board of directors wishes to terminate a transaction due to the pandemic, the first step of the agenda depends on whether the company appears to be the buyer or seller. The basis of information differs depending on the vantage point.
On the seller side, the main focus is the possibility of higher sales revenues from a later sale, but also the costs of continued ownership of the company as well as any losses in the value of the company to be sold. On the buyer side, what takes centre stage are the impacts of the crisis on the operation of the company to be acquired as well as the future development of the company purchase price. In addition, damage to reputation and claims for damages when terminating the transaction must be considered on both sides.
The decision must be aligned with the wellbeing of the company. If, as a result of the acquisition, the buyer surely takes on too much and thereby threatens the existence of his own company, this is a strong argument that the decision not to proceed or continue with the transaction is covered by the business judgement rule.
Conversely, if a company decides in favour of a business acquisition, with a view to the uncertainties tied to the pandemic, the decision-maker ought to advocate for sufficient safeguards in the negotiated purchase agreement (such as special rights of rescission) against the potential impacts of the pandemic and also sufficiently document this. This applies in particular in the case that the safeguards are not or are only partially enforced. If no safeguards are regulated in the purchase agreement, this can mean that proceeding with the transaction is fundamentally not in accordance with the wellbeing of the company and the level of care of a diligent managing director. Consequently, there is a liability risk for the decision-maker when conducting the transaction. In case of doubt, the lack of safeguards can therefore even be a deal breaker for the decision-maker.
The decision for or against conducting a transaction is not a decision set in stone once taken. Rather, it corresponds to the level of care of a diligent managing director to continuously review the decision and to revise it if necessary. This, in the case of deciding for a transaction, it must be considered whether, in view of new insights concerning the pandemic, it is indeed still advisable for the company to terminate the transaction. This decision may be covered by the business judgement rule even if the original decision for conducting the transaction was likewise covered by the business judgement rule or the transaction is already at an advanced stage. The same applies in the converse case. If one has decided against proceedings with a transaction due to the pandemic, it must be examined on a continuous basis whether the transaction ought to be resumed subsequent to future changes in the situation to the benefit of the company.
- Postponement of the meeting of shareholders vs. conducting a virtual meeting of shareholders
Art. 2 section 1 para. 1 of the Coronavirus Act allows the board of directors, under certain conditions, to decide that a virtual meeting of shareholders will be conducted, even if no corresponding statutory provision exists. On the other hand, there is the possibility of postponing the meeting of shareholders until a later date.
Thus, in this case, the fundamental business decision lies in the question of whether a virtual meeting of shareholders at the present time or an in-person meeting of shareholders at a much later date is more appropriate.
Above all, the basis of information includes the forecast of whether an in-person meeting of shareholders can probably still be conducted in the current calendar year and to which restrictions (such as room size requirements and distancing, provisions for admission) it may be subject. On the other hand, it must be considered whether a virtual meeting of shareholders is currently necessary as a matter of fact because compelling decisions must be taken.
Against this backdrop, the unforeseeable length of the pandemic and the restrictions accompanying it, the view may be taken that an in-person meeting of shareholders without restrictions in the current calendar year is unlikely, in particular where large, listed companies are involved. A decision for a virtual meeting of shareholders is encouraged if there is a need for compelling decisions by the meeting of shareholders, such as resolutions concerning necessary amendments to the articles of incorporation or capital measures. Thus, the decision pertaining to a virtual meeting of shareholders also depends on the selected agenda items.
For example, the mere decision concerning a distribution of profits is not sufficient to justify a virtual meeting of shareholders in the near-term. Namely, Art. 2 section 1 para. 4 of the Coronavirus Act gives the board of directors the right to decide on instalment payments on the net profits to shareholders. It should be noted that the decision regarding an instalment payment such as this is in turn a decision which falls under the business judgement rule.
IV. Conclusion and Recommended Action
The answer to the question of whether a decision falls under the business judgement rule in the first place depends on the particular case. Particularly in the current situation many business decisions must be taken. The establishment of an adequate basis of information is certainly essential for the business judgement rule. Precisely due to the fact that the decisions during the Coronavirus pandemic rely heavily on forecasts, decision-makers continue to have a margin of discretion if the decisions are not unacceptable per se as they will certainly harm the company based on the information available when the decision is taken. In this respect, we live in exciting times from a business perspective, as creativity of the decision-maker is sought.
In any event, the decision-maker ought to sufficiently document his decision-making. Managing directors and boards of directors carry the burden of proof that the requirements of the business judgement rule have been met. If they are unable to demonstrate this, they will not benefit from the exemption from liability regardless of whether the requirements of the business judgement rule were objectively present. As the decision will not be reviewed until well after the actual decision is taken, sufficient documentation of the facts, the underlying basis of information, and the entire decision-making process with all its considerations is, in practice, of tremendous importance for an exemption from liability.
Your contact persons: