Director liable when 'emptying' a corporation?
If a company fails to fulfill any of its obligations or commits a wrongful act, the basic principle is that only the company is liable for the resulting damage. Under special circumstances, the director of the company may also be liable for the resulting damage.
This was the case in a judgment of the Rotterdam District Court, in which a director frustrated a third party's recourse by withdrawing money from the company and, in his capacity as a shareholder, made a decision to pay dividends.
This blog will cover a brief situational summary of the judgment, followed by a discussion of the Court's opinion.* In addition, the role of shareholders and/or directors in dividend distributions will be discussed, covering the balance sheet test and the distribution test. These tests are important to avoid potential personal liability risks.
*For the readability of this blog, the terminology from the verdict is followed.
Brief situation description
After the death of Person B's parents, Person B becomes sole shareholder of the company Hermax Holding B.V. (hereinafter, "Hermax"). Person B performs a dual role, as she is appointed (sole) director of Hermax in October 2019. Shortly thereafter, Person B in her capacity of sole shareholder takes the AGM resolution to pay dividends, to which she subsequently approves as a director (after performing the distribution test). The dividend distribution results in Hermax being unable to meet its monthly payment obligation in favor of Person A. This is a payment obligation of Hermax to Person A, which continues until the death of Person A. The money received by Person A from Hermax is intended as a pension.
Judgment of the Court
The following special circumstances come into play in this case. First of all, Hermax does not conduct any business: no activities take place within the company. The only obligation of Hermax is the monthly (pension) payment to Person A. This is also apparent from the purpose of Hermax, which is to manage the assets in order to provide Person A with a pension until death.
Person B, as a director of Hermax, should have ensured that Hermax would be able to pay the monthly benefit to Person A for many years to come. Since Person B failed to do so, Person B as director is acting seriously culpable and unlawful to Person A. As a result, the District Court rules that Person B is liable for the damages incurred by Person A. In estimating the damages, it considers what the situation would have been without the dividend payment. With nothing more being paid to Person A, the amount of Person A's damages is equal to the monthly (pension) payment that should have accrued to Person A.
Dividend distribution
To give a little more background on what is involved in paying dividends, let's take a foray into a general explanation of dividend payments. In a BV, the general meeting is authorized to appropriate the profits determined by the adoption of the financial statements and to determine (dividend) distributions, unless the articles of association have limited or assigned these powers to another body.
Before the general meeting or the authorized body can pay dividends to shareholders, the balance sheet test must first be verified. The general meeting may proceed to pay dividends only if the equity exceeds the reserves that must be maintained by law or by the articles of association. The general meeting must perform the balance sheet test and proceed to declare the distribution. If it does not do so or does not do so properly, the shareholder to whom the distribution accrued risks having to repay it to the company. On the other hand, a correctly performed balance sheet test and adopted resolution of determination does not (yet) mean that the company can proceed with the distribution without prejudice.
In fact, a resolution of the general meeting of shareholders seeking a distribution has no effect until the board approves it. The board, in turn, must assess whether the company has sufficient freely distributable capital (also called the distribution test ). What matters is whether the board knows or should reasonably know whether the company can meet its due payment obligations after the distribution at the time of the actual distribution. If this is not the case, then the distribution test is not met.
When performing the distribution test, the adopted financial statements of the company are taken as the starting point, with key figures such as liquidity, solvency and profitability being taken as distribution measures. If the financial statements have not yet been adopted or are otherwise unavailable, the company's financial data available at that time will suffice. In such cases, it is left to the company on the basis of which document(s) the distribution is assessed. What is important is that the documents show whether the company is able to pay its due debts.
Normally, in the distribution test, it is sufficient for the board to look forward one year from the time of distribution. Under special circumstances, this principle can be deviated from, as in the case of this ruling by the Rotterdam District Court.
The benefit test performed by Person B is not sufficient
Instead of one year, Person B maintained a three-year period in the distribution test from the time of dividend payment. Person B thus extended the period, yet the Court found this (extended) period insufficient.
This is because it was uncertain how long the monthly payment obligation to Person A would continue. This is because the payment obligation exists until the time of the death of Person A. The fact that Person A had reached the age of 76 at the time of the dividend payment does not mean that Person B was entitled to assume that the monthly payment obligation would continue for only three years. Person B has not alleged anything that would show that Person A would die after three years.
Conclusion
Before a company proceeds with a (dividend) distribution, the general meeting must perform a balance sheet test and proceed to determine the distribution. It is then the board's turn, and it must conduct a thorough distribution test. If it later turns out that the company can no longer meet its obligations as a result of the profit distribution, the director can, under circumstances, be held liable for the resulting damage. A director should avoid this at all times. The director in the ruling under consideration is the one who got off lightly: until the death of the third party, the director is personally liable for the monthly pension payment.
Let our specialists know if you have any doubts about the legality of an (intended) profit distribution and the associated liability risks for directors and shareholders within your company. They can also draft the necessary resolutions for a dividend distribution.
