Taking counsel: Personal liability of directors to creditors

  • 2008-04-09
  • Laurynas Didziulis [Jurevicius Balciunas & Bartkus]
The World Bank report "Principles for Effective Insolvency and Creditor Rights Systems" (revised edition, 2005) states that creditor protection is one of the key elements in a modern credit-based economy. The efficiency of protection of creditors' rights reflects the efficiency of a country's legal system and of the overall legal framework. One of the most effective and widely discussed legal remedies can be personal liability of a director/executive.

A company is a member and/or director-independent unit with separate assets and independently liable under its own obligations, so the concept of personal liability of a director might seem quite unusual. The decision to hold directors liable might deter talented businessmen from starting up companies or lead to a reduction in the number of important projects. On the other hand, the fact of a director taking up personal liability is often the only way to protect the rights of creditors against possible fraudulent and speculative activity.
The assumption of liability is effective in two cases: first, it provides the possibility to satisfy specific requirements for the benefit of creditors; second, it functions as a deterrent against fraudulent and irrational acts.

Global trends tend to be quite ambiguous. There is, as an example, one the most influential cases in company law: the recent decision of the Delaware Supreme Court in the case North American Catholic Educational Programming Foundation v. Gheewalla, which marked an unexpected retreat from the managers' personal liability against creditors. Still, global trends demonstrate the preference for managers' personal liability to be applied. In the European Union, for instance, a single model of personal liability is being drafted (wrongful trading).

Taking into consideration the advantages and disadvantages of the personal liability factor and the trends of legal regulation, the most acceptable decision for the courts would be as follows: that liability should be invoked, but only in exclusive cases.
Courts in Lithuania have tended to act in this way. In a ruling on May 25, 2006, the Supreme Court made clear that the civil liability of a company director (individual or collective) might be called on when an executive authority acts against the interests of a company and/or third parties, and when an executive violates the restrictions having predefined certain grants for the protection of rights of the third parties. The court established that if an activity of a company's executive members is considered a criminal offense under the judgement of the court and has respectively caused the company not to fulfill obligations it has taken, the members of the executive body are liable to third parties 's to the extent of their personal assets.

The court's position is essential in several aspects. Firstly, managerial liability to creditors has been established in Lithuania. Secondly, it is clear that the Supreme Court of Lithuania adopted a model of limited responsibility (in this case a restriction is applied to criminal offenses); however, the court might extend the range of liability to other major cases (i.e. not only in the case of formally adjudged criminal offense) in the future.
On the other hand, the ruling leaves one hoping that the court will not settle on too liberal a liability regime. In this case, doors should be just slightly opened but not left wide open. This must be done under a strict and careful analysis of the causal relation between the damage incurred by a creditor and the company director's unlawful actions.

Laurynas Didziulis is a lawyer at Jurevicius Balciunas & Bartkus, a member of Baltic Legal Solutions, a pan-Baltic integrated legal network of law firms including Glikman & Partnerid in Estonia and Kronbergs & Cukste in Latvia, dedicated to providing a quality "one-stop shop" approach to clients' needs in the Baltics.