Authors

Dr. Rebekka Krause

Salary partner

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Dr. Dirk Lorenz

Partner

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Dr. Jonas Woitzyk, LL.M. (Auckland)

Salary partner

Read More
Authors

Dr. Rebekka Krause

Salary partner

Read More

Dr. Dirk Lorenz

Partner

Read More

Dr. Jonas Woitzyk, LL.M. (Auckland)

Salary partner

Read More

25 November 2021

Corporate Compliance @ Tech Deals – 4 of 4 Insights

Corporate Compliance @ Tech Deals – The Phantom of the Legal Judgement Rule

  • Briefing

Making the wrong decision can give rise to liability. Where board members or managing directors take the wrong business decisions, which can usually only be assessed in retrospect, they are in principle personally liable to their company for damages. In the course of any litigation, they must prove that they did not act culpably (Section 93 (2) sentence 2 German Stock Corporation Act (AktG)). However, since every business activity and decision inevitably involves a certain weighing up of risks, a protected margin of discretion must remain in favour of board members or managing directors, where liability for damages is excluded even in the case of wrong decisions. Otherwise, any willingness on the part of the management to take risks in the further development of a (tech) company would be stifled from the outset. This is because the threat of liability for damages where a business decision subsequently fails would constantly hang over the company management.

 

When is management entitled to a protected margin of discretion?

For a subsection of decisions made by a company’s management, this protected margin of discretion has been codified in section 93 (1) sentence 2 AktG under the so-called Business Judgement Rule. According to this rule, there is no breach of duty if a board member or managing director, when making an entrepreneurial decision, could reasonably assume to be acting in the best interests of the company on the basis of adequate information. The Business Judgement Rule therefore protects the company management in the case of entrepreneurial discretionary decisions.

However, the Business Judgement Rule does not offer any protection in the case of legal uncertainties, which the company management must take into account in its discretionary decision. Therefore, the question of whether there is a “legal judgement rule” in addition to the Business Judgement Rule repeatedly arises in discussions concerning the duty of care of board members and managing directors. A legal judgement rule would result in additional protected discretion for the board members or managing directors insofar as they make a decision against the background of an uncertain legal situation, where, for example, a ruling from the highest-ranking court on the issue in question does not yet exist. Board members or managing directors could then rely on the legal opinion that is favourable to their company without running the risk of later being held liable following a different ruling by the Federal Court of Justice. Especially for tech companies, whose business model has not yet been verified by decisions of the Federal Court of Justice, this often existential question arises.

Factual requirements of the protected margin of discretion

Insofar as the existence of a legal judgement rule is affirmed, its prerequisites are based on those of the Business Judgement Rule codified in section 93 (1) sentence 2 AktG. The Business Judgement Rule itself grants board members and managing directors a protected margin of discretion if the following four prerequisites are met:

  1. Entrepreneurial decision: This is the case when a management decision, due to its future orientation, is characterised by forecasts and non-adjustable assessments. In practice, these are often commercial decisions that are significant for the company. Examples are M&A transactions or investment decisions.
  2. Basis of adequate information: In an M&A deal in the tech sector, the question of the scope or depth of due diligence arises in particular. For the buyer, the problem regularly arises as to which costs for the investigation of the target company can be deemed reasonable in proportion to the benefit thereby gained. Especially with regard to compliance aspects, a risk-based approach will be pursued: The higher the risk, the more detailed the examination should be.
  3. Acting in the company’s best interests: The board or management only act in the best interests of the company if they base their decision on a careful assessment of the risks and believe in the correctness of their decision. It is particularly important to document the pros and cons in the decision-making process in order to be prepared in advance if it later transpires that the investment decision was not worthwhile, for example.
  4. Freedom from special interests and extraneous influences: This unwritten constituent element requires in particular that decisions are made free from conflicts of interest. If, for example, a board member might be biased by also sitting on the advisory board of the target company, it must be ensured and clearly documented that such member does not influence board decisions, for example by not participating in the deliberations and voting.

The duty of legality as the limit of the protected margin of discretion

The scope of the Business Judgement Rule is “limited” by the management’s duty of legality. Its members therefore have absolutely no discretion as to whether they comply with the applicable laws and legal provisions when making a decision. So-called “useful” violations of the law, which bring the company an economic advantage, are also not permissible, such as antitrust violations. The scope of application of the Business Judgement Rule is completely out of bounds for illegal decisions.

However, this duty of legality is not breached in the case of a violation of simple contractual obligations of the company. Contracts are not included in the legal provisions covered by the duty of legality. Members of the board of directors or managing directors can, for example, decide not to fulfil a contract and assume the risk of a claim for damages if it brings an economic advantage for the company.

The legal judgement rule as a breach of the duty of legality?

Is it now possible to break through the obligation of legality even further if the legal situation is uncertain? This is affirmed to some extent in legal literature. The Business Judgement Rule should be applied mutatis mutandis as a legal judgement rule to decisions in the case of an uncertain legal situation, because it would offer a practicable way of dealing with legal risks for the management. The above-mentioned prerequisites of the Business Judgement Rule as stipulated in section 93 (1), sentence 2 of the AktG should be applied in a modified form to cases of decision-making in an uncertain legal situation.

However, the Federal Court of Justice rejects this in its ISION decision (dated 20. September 2011, II ZR 234/09). Instead, the Court resolves the cases of decisions in an uncertain legal situation solely according to the principles of mistake of law in the context of the question of guilt. Thus, a board member cannot plead that he has misjudged the legal situation. “A board member, like any debtor, must be liable for a mistake of law if he has acted culpably”, states the Federal Court of Justice.

According to the Federal Court of Justice, strict standards are to be applied to the existence of a mistake of law without fault. The board member must carefully examine the legal situation, obtain legal advice if necessary and observe the case law of the highest courts. However, the board member does not have to accept fault on the part of the lawyers he or she consulted.

In order to meet the strict requirements of the Federal Court of Justice in the ISION ruling regarding the examination of the legal situation incumbent on the board of directors, the board of directors, if it does not itself have the necessary expertise, must (i) obtain advice from an independent professional who is qualified for the question to be clarified, (ii) giving a comprehensive description of the circumstances of the company and disclosing the necessary documents to the adviser  and (iii) subject the legal advice provided to a careful plausibility check. The legal opinion must be given in writing. Insofar as the expertise is available in the in-house legal department of the company, its examination may suffice. 

Lessons learned

The legal judgement rule remains a phantom. Even if the rejection of the rule by the findings of the Federal Court of Justice can be criticised with good arguments, it is decisive for legal practice. If the legal situation is uncertain, the liability privilege of the Business Judgement Rule does not apply mutatis mutandis. Rather, a board member or managing director can only exonerate himself through a non-culpable mistake of law. To do so, he must seek legal advice and observe the criteria of the ISION decision. An independent expert must be selected and the expert must be fully briefed. The written legal advice must then be checked for plausibility. If doubts remain, it may be advisable to obtain a second legal opinion.

In this series

Corporate crime & compliance

Corporate Compliance @ Tech Deals in Germany - The Compliance Guarantee

Briefing

by Multiple authors

Corporate crime & compliance

Corporate Compliance @ Tech Deals – Germany is the world champion for keeping registers

Briefing

by Multiple authors

Corporate crime & compliance

Corporate Compliance @ Tech Deals – The Phantom of the Legal Judgement Rule

Briefing

by Multiple authors

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