Director liability for failure to make timely provision

The moment you, as a director of a company, must seriously consider a (legal) claim for compensation for damages (a "claim"), you must make a provision. Making such a provision limits your ability to pay dividends. If you do not make a provision and thus fail to take such a claim into account when distributing dividends and consequently suffer damages, you have improperly performed your duties as a director and may be held liable. In the event of bankruptcy, this may result in the trustee being held liable for the deficit in the bankruptcy.

Case law on failure to make timely provision and pay dividends

In a telling case on this matter, the Arnhem-Leeuwarden Court of Appeal handed down its judgment on March 24, 2020. The case involved a company located in an industrial harbor. In 1983, soil testing was done in the harbor, which showed that the sludge was quite clean. In 1992, the sludge was found to be seriously contaminated. The company was subsequently held liable by the State for the (costs of the) remediation. In proceedings, the company was ordered to pay nearly € 1.3 million to the State in 2005. The company lodged an appeal against this judgment, but during the proceedings an expert report was published holding the company responsible for the contamination. In 2011, the company is finally held liable to pay nearly € 1.2 mln to the State, and on Jan. 31, 2012, the company is declared bankrupt on its own filing. The present case involves the various payments made by the company in spite of the State's claim during the period from 2003 to 2010. In 2008 and 2009, for example, two dividend distributions totaling more than € 1.2 million were decided upon. The directors did not make any provision for the State's claim, even after the publication of the expert report in 2009.

The trustee (among others) holds the directors of the company liable for improper performance of duties. According to the court, the directors did not act as a reasonably thinking director would have acted under the same circumstances. At least from the time of the expert report in 2009, the directors should have taken serious account of the fact that the State's claim had to be paid and should have taken measures. The court reproached the directors for not making provision for the State's claim and for withholding their cooperation in the dividend resolutions of the general meeting of shareholders.

Commissioner also liable

The court ruled that the auditor was also liable by not intervening. After all, the supervisory duty of a supervisory director entails that the supervisory director must be informed and must independently obtain information about the state of the company. A supervisory director must intervene if the company takes irresponsible financial risks with a dividend distribution. If he does not intervene, he may be (jointly) liable.

For practice

If your company has to take serious account of a claim, you should make a provision so that it is taken into account when dividends are paid. If you don't, and if you think that it won't go that far, then such a claim can come back like a boomerang and also affect you as a director (privately).

The attorneys on my team specialize in directors' liability issues so please feel free to contact me with any questions.