Those who start a start-up often do so in good spirits. It is inherent in this that risks are taken and capital is raised and liabilities are incurred without being able to be repaid immediately. However, if the opportunities do not turn out well and debts go unpaid, the start-up can fall over, possibly resulting in bankruptcy.
Date: May 01, 2024
Modified May 07, 2024
Written by: Jelle Alkema and Erik Jansen
Reading time: +/- 4 minutes
In late 2020, we wrote about directors' liability in start-ups and scale-ups. Since then, developments have not stood still. With this article, Erik Jansen and Jelle Alkema provide an update on this topic and conclude with concrete advice for directors of start-ups on how to avoid a directors' liability claim.
Director liability is often around the corner in bankruptcies. Creditors remain unpaid and want to hold the board of the Start-Up-BV liable for this. When this succeeds, the director is liable in private for the debts incurred by the BV.
In other blogs, we previously elaborated on the various interpretations of directors' liability and what role it plays in and around bankruptcy. In this blog, I limit myself to directors' liability under the so-called Beklamel standard.
As we wrote earlier, the Beklamel standard is violated when the board enters into an agreement on behalf of the Start-Up BV while it knows or should know that the Start-Up BV will not be able to fulfill its obligations under that agreement and, in doing so, provides no recourse for the damages that the creditor will suffer as a result of that default.
As a director of a Start-Up BV, you have extra leeway when it comes to director's liability. The fact that the BV was in bad financial shape when it entered into certain obligations is less of a criticism of the board. It is part of being a start-up.
In the case of Smart Bussiness 4 Bussiness, written about in the previous blog, the court expressly considered that "the situation was actually inherent in the nature of a start-up.
Later - in 2022 - the District Court of Northern Netherlands (Rb. Noord Nederland March 9, 2022, ECLI:NL:RBNNE:2022:880) considered exactly the same thing in a case in which an investor had invested €100,000 in a start-up. The start-up was engaged in the development of an "innovative mill aimed at generating energy.
The court considered that "it is true for investors to put money into a company where they run an above-average risk that their investment will come to nothing" and that "inherent in [start-ups] is the need to invest in the development phase before there are any potential returns.
The judge then repeated the consideration quoted above from the Smart Bussiness 4 Bussiness case and considered that "by definition, a startup [has] a period where there is debt but not yet operating cash flow.
The standard used in the ruling for directors' liability in a start-up is that it must have been clear when the obligations were entered into that the start-up had no future prospects.
The director must therefore estimate future operations and future income generated by the company. What the financial position of the Start-Up BV is at the time the obligation is entered into may play a role in this, but it is not decisive. The director's expectations of the future financial position of the Start-Up BV are particularly important.
The creditor seeking to hold the director liable must prove that the director made the wrong judgment in entering into the new obligation. This is difficult, as the creditor often does not have the proper documentation to do so.
While this is normally already a difficult task for the creditor, it is even more pressing in the case of start-ups. As mentioned earlier, it is very common for start-ups to be in a bad financial position at the time of entering into new obligations. After all, as a director, you assume growth and progress. This is respected in case law - as evidenced by the above rulings.
This makes it even more difficult for the creditor to prove that the director knew or should have known that he would have no recourse for the obligations he assumed and that his start-up therefore had no future prospects. After all, the director of the Start-Up-BV is granted a certain degree of optimism.
However, the director can still be held liable. In a case handled by the District Court of Limburg (Rb. Limburg 05-07-2023, ECLI:NL:RBLIM:2023:4202), that court considered that a director may be expected to make an adequate estimate of the necessary resources and to ensure that they are present. Also the Court of Appeal of 's-Hertogenbosch (Court of Appeal of 's-Hertogenbosch, December 6, 2022, ECLI:NL:GHSHE:2022:4179), in a case involving a relaunch, considered that starting a company without proper financing may entail directors' liability. The issue then turns on whether it was known at the start of operations that there would be a "substantial liquidity shortage and thus a substantial financing requirement" from the outset.
In the case of start-ups, it is important that, if those funds are not available, alternative provisions are arranged for this. If a director fails to do so, he runs the risk of being held liable in bankruptcy.
Although the Limburg court ruling discussed above involved a different form of directors' liability than the Beklamel standard, it does highlight the risk faced by directors of start-ups. The ruling shows that start-ups business owners must prepare a cost-benefit analysis and may need to raise liquidity. The court reiterates in the ruling that it is common for losses to be incurred by start-ups business owners, but these losses should be able to be absorbed. Liability therefore still lurks.
An important factor here is that, as a director, you have information that the creditor does not have. If the director of a Start-Up-BV enters into obligations where he creates the appearance of being in a strong financial position, after which he then fails to fulfill his obligations, the Beklamel standard is more likely to be violated.
This risk of director liability can be reduced by being transparent about the Start-Up-BV's financial situation.
If a creditor or financier knows about the financial position and chooses to do business with the Start-Up-BV anyway, they are accepting the risk, as it were, that the Start-Up-BV may not be able to fulfill its obligations. If this then happens unexpectedly, you will be less easily held liable afterwards.
To exclude directors' liability in this way, the creditor must know as much about the financial position as you do. If the creditor does not get the chance to accept the risk of default, for example because he has no knowledge of the Start-Up-BV's financial position or because of an incorrect representation of that financial position, there is a risk of violation of the Beklamel standard.
Partial knowledge of the Start-Up-BV's finances by the creditor may also play a role. There is a view in the literature that in that case own fault comes into play. For example, Mr. R.H. Bask and Mr. M.D. Schuilwerve write about this in their FIP article, "The Beklamel standard in failed start-ups: towards a balanced risk allocation.
"Own fault" means that the director's liability is mitigated because the creditor himself is at fault for the occurrence of the damage. In the case of partial knowledge of the Start-Up-BV's financial position, this means that the creditor also bears partial self-blame for the occurrence of the damage, since he partially accepted the risk of the damage occurring.
Make regular liquidity projections and discuss them with the bookkeeper or accountant. If those realistic projections show that the obligations under the new agreement can be met, that is good for your defense against a Beklamel liability. Map out what losses you will incur and how you will absorb or offset those losses.
When making new commitments, disclose the financial position of the Start-Up-BV. As long as you are honest with your contract partner, the choice is his to accept the risk you have indicated. If your contract partner is convinced by your ambition and agrees, you will have less liability to fear if things do not turn out as hoped.
Are you in doubt about your position as a director or do you need advice or guidance while starting a business? If so, please feel free to contact one of our specialists.