Directors' Duties in a Crisis

Directors' duties in a crisis: the essentials

Directors' duties in a crisis change in three stages under German law. First, every managing director and board member must monitor developments that could threaten the company's existence and react to them (§ 1 StaRUG).

Second, when the company becomes illiquid or over-indebted, the directors must file for insolvency without culpable delay, at the latest three weeks after illiquidity and six weeks after over-indebtedness (§ 15a(1) InsO). Third, from the moment insolvency occurs, they may no longer make payments for the company except those compatible with the care of a prudent and conscientious manager, and are personally liable to reimburse prohibited payments (§ 15b InsO). Breaches can lead to criminal prosecution, personal liability for damages, tax and social security liability, and disqualification.

These duties apply to the managing directors of a GmbH, the management board of an AG, the directors of an SE and the managers of a GmbH & Co. KG's general partner. They cannot be delegated away or excluded by shareholder instructions: payments made in breach of § 15b InsO must be reimbursed even if the shareholders instructed the directors to make them, insofar as reimbursement is needed to satisfy creditors. Supervisory board members have parallel monitoring duties and can themselves be liable if they fail to press management to file.

This page explains the tests, the deadlines, the rules on payments, the documentation that protects directors, the role of D&O insurance, and the special risks around taxes and social security contributions. It is written for managing directors, board members, CFOs and the advisers who support them. For the procedures available to the company, see StaRUG restructuring and insolvency proceedings.

Directors' duties of early warning and monitoring

The members of the management body of a legal entity must continuously monitor developments that could endanger its continued existence; if they identify such developments, they must take appropriate countermeasures and report to the supervisory bodies without delay (§ 1(1) StaRUG). For stock corporations, § 91(2) AktG additionally requires a system for the early detection of developments threatening the company's existence. In practice this means an integrated planning system appropriate to the size of the business: a liquidity plan for the coming weeks and months, a financial forecast covering at least 24 months, covenant monitoring, and reporting to the supervisory board or shareholders.

Specific warning signs trigger additional duties. If half of the share capital is lost, the managing directors of a GmbH must convene a shareholders' meeting without delay (§ 49(3) GmbHG), and the management board of an AG must convene a general meeting and inform it (§ 92(1) AktG). Covenant breaches, the loss of credit insurance limits, overdue payments to tax authorities or social security agencies, and supplier demands for advance payment are typical signs that the company is moving towards insolvency and that the directors must assess the legal position formally.

The insolvency tests behind directors' duties

Directors' duties in a crisis turn on two tests. Illiquidity (§ 17(2) InsO) means that the company is unable to meet its payment obligations as they fall due; it is generally presumed where payments have stopped. Case law of the Federal Court of Justice distinguishes illiquidity from a mere temporary payment stoppage by comparing liquid funds and available credit with debts due, and looking at the size of any gap and whether it can be closed within a short period; a significant gap that cannot be closed soon generally indicates illiquidity. A liquidity status and a liquidity plan are the standard tools for this assessment.

Over-indebtedness (§ 19(2) InsO) exists where the company's assets no longer cover its liabilities, unless continuation of the business over the next twelve months is predominantly likely. The test therefore has two stages: a going-concern forecast and, if that is negative, a balance sheet at liquidation values. Shareholder loans with a qualified subordination agreement are not counted as liabilities, which is why shareholders are often asked to sign such agreements in a crisis.

Hidden reserves, for example in real estate, can be taken into account at realistic values in the liquidation balance sheet. A well-founded positive forecast, based on a credible business and financing plan, prevents over-indebtedness even where the balance sheet shows a deficit, which makes the documentation of the forecast central to protecting directors.

The filing deadline under § 15a InsO

When the company is illiquid or over-indebted, the members of the management body must file for insolvency without culpable delay. The three-week and six-week periods in § 15a(1) InsO are maximum periods, not grace periods: they may be used only if there is a realistic prospect of eliminating the insolvency within the period, for example through a binding financing commitment or a restructuring agreement. If it becomes clear that the insolvency cannot be cured, the directors must file immediately. Where a GmbH has no managing director, every shareholder is obliged to file, and in an AG every supervisory board member (§ 15a(3) InsO).

Failing to file, filing late or filing incorrectly is a criminal offence punishable by imprisonment of up to three years or a fine, and by up to one year or a fine if committed negligently (§ 15a(4), (5) InsO). Directors who delay filing are also liable in damages to creditors who extended credit to the company during the delay. While a StaRUG case is pending, the filing duty is suspended, but the directors must notify the restructuring court of any illiquidity or over-indebtedness without culpable delay (§ 42(1) StaRUG).

Payments after insolvency: § 15b InsO

From the moment the company is illiquid or over-indebted, directors may no longer make payments for it, except payments compatible with the care of a prudent and conscientious manager (§ 15b(1) InsO). Payments in the ordinary course of business, especially those needed to maintain operations, are deemed compatible with due care during the filing period, but only as long as the directors pursue measures to eliminate the insolvency or prepare a filing with due care (§ 15b(2) InsO).

After the filing deadline has passed without a filing, payments are generally not compatible with due care (§ 15b(3) InsO). Payments made between the filing and the opening of proceedings with the consent of a preliminary administrator are also deemed compatible with due care.

Directors who make prohibited payments must reimburse them to the company; if the creditors suffered a smaller loss, the liability is limited to that loss (§ 15b(4) InsO). Waivers and settlements by the company are generally invalid. Claims become time-barred after five years, or ten years if the company was listed at the time of the breach. In practice, insolvency administrators routinely examine payments after the onset of insolvency and assert § 15b claims against directors, often as the first step towards a settlement with the D&O insurer.

Taxes and social security contributions

Directors face a particular dilemma regarding taxes and employees' social security contributions. Withholding employees' social security contributions from the collecting agency is a criminal offence (§ 266a StGB), and directors are personally liable for taxes that are not paid as a result of their intentional or grossly negligent breach of duty (§§ 34, 69 of the Fiscal Code, AO).

The legislator has addressed the conflict with § 15b InsO: within the filing period, the non-payment of taxes is not a breach of tax duties if the directors pursue a timely filing or restructuring measures with due care (§ 15b(8) InsO). After the deadline, the rules on tax payments apply in full. Directors should therefore treat wage tax and social security contributions as a priority and seek advice on the sequence of payments, particularly at the end of each month when contributions fall due.

Group companies

In groups, directors' duties attach to each legal entity separately. The managing directors of a subsidiary must assess the insolvency of their own company, even if the parent has promised support. A parent's letter of comfort or cash pool participation helps only if it gives the subsidiary an enforceable claim to liquidity; a soft letter of comfort does not prevent illiquidity. Cash pooling is a particular risk: if the subsidiary's claims against the pool leader are no longer recoverable, its liquidity and its balance sheet are affected at once. Directors of group companies should obtain binding commitments, monitor the parent's own financial position and, where necessary, terminate participation in the cash pool.

Supervisory board members

Supervisory board members are not obliged to file for insolvency unless the company has no management board, but they must monitor management's handling of the crisis, press for a timely filing and ensure that management does not make prohibited payments. Supervisory board members who fail to intervene can be liable to the company under § 116 AktG in conjunction with § 15b InsO. Their directors' duties in a crisis therefore include asking for liquidity reports, challenging forecasts and documenting their own deliberations.

D&O insurance and documentation

Directors' and officers' liability insurance is the main financial protection for directors in a crisis, but it has limits. Policies are written on a claims-made basis, so cover depends on the policy in force when the claim is made. Insurers may dispute whether § 15b InsO reimbursement claims are covered as damages, invoke exclusions for knowing breaches of duty, or try to avoid the policy for non-disclosure at renewal. Directors should check the policy wording on § 15b claims, extended reporting periods after insolvency, the allocation of the limit among several insured persons, and the advancement of defence costs.

Documentation is equally important. The business judgment rule protects entrepreneurial decisions taken on the basis of adequate information, but it does not protect breaches of statutory duties such as the filing duty. Directors should keep a crisis file with liquidity plans, forecasts, advisers' reports, minutes of board and shareholder meetings, correspondence with lenders and the reasons for each key decision. Where directors rely on expert advice, they must ensure that the adviser is qualified and fully informed and must check the advice for plausibility. See our page on corporate governance for board duties in general.

• Update the liquidity status and 24-month forecast at least monthly, weekly in an acute crisis.
• Record the insolvency assessment and its basis in board minutes.
• Prioritise payments of wage tax and employees' social security contributions.
• Check D&O cover for § 15b claims and notify circumstances in time.
• Involve restructuring advisers early, before the filing period runs out.

Liability after insolvency and the role of shareholders

After an insolvency filing, the administrator investigates the directors' conduct. Typical claims include reimbursement of prohibited payments under § 15b InsO, damages for breach of the general duty of care (§ 43 GmbHG, § 93 AktG), liability for payments to shareholders that breached capital maintenance or caused the company's insolvency, and damages for late filing. Creditors may bring their own claims for late filing. Public prosecutors routinely receive insolvency files and investigate late filing, fraudulent bankruptcy offences and the non-payment of social security contributions.

Shareholders also have duties in a crisis. A GmbH shareholder can be obliged to file where the company has no managing director, may face liability for withdrawing assets needed to pay creditors, and sees its loans subordinated and its repayments challenged. Shareholders who instruct directors to delay filing or to make prohibited payments can be liable as accessories. Directors' duties in a crisis therefore require coordination with shareholders, but the final responsibility for filing remains with the directors. Our page on distressed M&A covers the position of buyers and investors.

How TRW & Co helps

We advise managing directors, board members and supervisory board members on directors' duties in a crisis. We assess illiquidity and over-indebtedness with financial advisers, help set up and document going-concern forecasts and crisis early-warning systems, advise on payments, taxes and social security contributions during the filing period, and support the decision between restructuring and filing. We review D&O policies and notify circumstances, and we defend directors against claims by insolvency administrators and in criminal investigations. To discuss your situation in confidence, please contact us as early as possible.