Director’s liability for incoming payments
Risks for companies in crisis
Generally speaking, payments made by customers and debtors are always welcome. Unfortunately though, if a GmbH (German limited liability company) is in crisis, payments made into an account on the debits side may mean more than simply good news for the GmbH’s director; they could also result in personal liability risks for him or her. This post examines these risks in more detail.
1. Director’s liability for payments following illiquidity or over-indebtedness
Section 64 of the German Limited Liability Companies Act (GmbHG) specifies the personal liability of the director of a GmbH (German limited liability company) for payments following insolvency or over-indebtedness as follows:
“The directors shall be required to compensate the company for payments made after the company has become illiquid or after it is deemed to be over-indebted. This shall not apply to payments which, after this point in time, are compatible with the due diligence of a prudent businessman. (...)” [author's translation]
Insolvency administrators are particularly fond of invoking this basis for company claims against the director (also known as the director’s ‘internal liability’).
Behind the provisions of Section 64 GmbHG is the idea that if a company is on the brink of insolvency, its assets should be preserved for the purpose of satisfying all creditors uniformly and with the correct priority if bankruptcy should actually occur.
The director has a comprehensive duty to preserve the company’s assets. As such, he or she is required to be personally liable for any payments made to preferred creditors – such as well-disposed business partners – and reimburse the company for any such payments. Even the approval of shareholders, or instructions to the same effect by the shareholders to take payment via a particular account, does not protect the director from personal liability and potential claims.
2. Payment made into a debits-side account
If the company’s financial situation is strained, and the management and shareholders are already looking into whether there are grounds for insolvency, then available credit lines will often already be maxed out – with the company’s accounts in the red and overdraft facilities being used. Payments are more than welcome in such cases, yet they do in fact pose a special risk.
From a legal point of view, a bank overdraft is a loan from the bank to the company. If the account is in the red and a payment is received, this simultaneously reduces the bank’s claim for repayment against the company. Unlike other company creditors, the bank is in a particularly privileged position because its claim for repayment of its loan is met – at least in part – once payment is received.
In its judgement from 06.10.2009 (ref. IX ZR 191/05), the Ninth Civil Panel of the German Federal Court of Justice (BGH) was of the opinion that payments made to an account on the debits side count as extending unlawful benefits to creditors, and not only in cases where an overdraft facility has been agreed with the bank. If the bank merely tolerates the overdraft, meaning there is no explicit contractual agreement of which the director is aware, this was also deemed to count as extending unlawful benefits to creditors, thus triggering liability on the part of the director to compensate the company.
3. How can a director avoid such liability?
A director needn’t wait until crisis point to protect him- or herself from personal claims.
We recommend:
- The director should review the company’s liquidity on a daily basis.
- The company should always hold a ‘clean’ account into which payments can be paid during times of crisis, without banks simultaneously benefitting from this as creditors. This account should be held at a bank with which the company holds no other accounts. Only in this way is it possible to prevent the bank from making transfers between accounts.
- The director is obliged to notify the company’s creditors of the new bank details as soon as possible.