Transactions that don't benefit the company - when is the CEO liable?
Žygimantas Klizas, Senior Associate at AVOCAD
As one of the main bases for the creation of obligations, the conclusion of transactions is a normal part of a company's day-to-day business operations.
By entering into transactions, companies achieve their business objectives. In particular, business practice often leads to situations where, in order to develop their business, the management bodies of companies have to take risky decisions or enter into transactions that often do not work as well as planned and, consequently, cause material damage to the company or even lead to insolvency situations. Moreover, even in the face of business cycles, economic fluctuations and other factors beyond the company's direct control, a company cannot guarantee that every transaction it enters into will be economically advantageous.
In many cases, when negative consequences arise from the activities of a legal entity, the search for the guilty is often directed towards the decisions taken by the head of the company's management bodies or the members of the board of directors of the collegial management body, as well as the other actions taken by these individuals. In more than one case, this becomes part of the plan and a way to get the person in charge out from under the helm of the company.
The Civil Code of the Republic of Lithuania establishes the general duties of members of the management bodies of a legal person, otherwise known as fiduciary duties - to act honestly, reasonably, to be loyal, to observe confidentiality and to avoid conflicts of interest. It also stipulates that a member of the management body of a legal person who fails to perform or improperly performs the duties referred to in this Article or in the instruments of incorporation shall be liable to compensate the legal person in full for the damage caused, unless otherwise provided by law, the instruments of incorporation or the contract.
Civil liability requires a set of conditions set out in the law: unlawful acts of the manager (except for exceptions set out in the law), a causal link between the unlawful acts and the loss, fault on the part of the manager (except for the exceptions set out in the law or the contract), and damages. The burden of proving the totality of these conditions rests on the company or the shareholder of the company seeking civil liability, which is the shareholder's non-pecuniary right under the Law on Companies.
In disputes concerning the liability of members of the management bodies of public limited liability companies, it is recognised in case law that even if a particular business decision could lead to a loss, this does not mean that the decision was unlawful. As the Supreme Court of Lithuania has clarified in its case law, the mere fact that a transaction entered into by the company's manager turned out to be unprofitable and caused damage to the company or its creditors does not in itself provide grounds to consider the actions of the company's manager as unlawful, provided that the manager of the company has acted in good faith and with due care, has not breached any duties imposed on him by the law or the company's operating documents, and has not clearly exceeded the normal economic and commercial risk in the company's business.
The Supreme Court of Lithuania, in developing the practice of application of the liability of members of the management body of a legal person, also states that participation in business involves a risk that the decisions taken may be not only beneficial but also detrimental. If the members of the management bodies of a company were to be held personally liable for every decision that caused a loss, it would hamper their initiative and entrepreneurial spirit, limit their freedom of action in situations requiring quick and decisive decisions, and encourage shadow management of the companies. In order to protect members of a company's management bodies from damages claims, the business judgment rule applies, which presumes that they are acting in the bona fide best interests of the company they lead. This presumption is intended to protect the directors of a company from personal liability for business decisions made in good faith and in accordance with the standards of the duty of care. Therefore, it is not sufficient for the person seeking damages to prove the fact of the damage caused, but it is also necessary to prove a breach of the fiduciary duties of the members of the company's management bodies (loyalty, honesty, reasonableness, etc.), a manifest disregard of a reasonable commercial risk, a manifest negligence or an excess of powers.
It should be noted that it is the business judgment rule that ensures that the governing bodies of a legal person can take risky decisions that may lead to business development, bring about highly successful results of economic and commercial activities, and thus ensure the interests not only of the legal person but also of its shareholders. Moreover, this rule also protects the members of the management bodies of the legal person from strategic lawsuits, which are very often used in shareholder disputes as a means of exerting pressure on a shareholder who is also a member of the body of the legal person.
Thus, the question of compensation for damages is decided on a case-by-case basis, after assessing the totality of the circumstances, the reasons and motives for the respective decisions of the manager or the collegial management body, and other relevant circumstances which reveal whether the management body of the legal person has fulfilled or breached its fiduciary duties. It is precisely if it is established that a member of the management body of a legal person has breached his or her fiduciary duties by concluding a transaction that is manifestly unfavourable to the legal person and that has led to the occurrence of the damage that the manager of the legal person should be obliged to compensate for the damage caused by his or her actions.