When a statutory agent fails to exercise due care: can you claim compensation?

Imagine building your company with care and commitment. You put your time, energy and financial resources into it. You are headed by a statutory body - the managing director, to whom you entrust the management and administration of your business. You expect them to act with the utmost responsibility and loyalty, with the care of a good steward. But what happens when this fiduciary bond fails? When the CEO's decisions turn out to be ill-advised, lead to tangible financial losses, and threaten the very existence of your company? The questions abound: how is this possible? Who is responsible? And most importantly, do we have any chance of recovering the lost funds? Can we claim compensation?

Author of the article: ARROWS (Mgr. Jan Pavlík, office@arws.cz, +420 245 007 740)

The answer is more complex, but in many cases it is: Yes, you have the right to defend yourself and claim damages. The law clearly defines the duty to act with due care, which applies to all members of statutory bodies, including managing directors of limited liability companies and members of boards of directors of public limited companies. Breach of this duty is not only an ethical failure, but constitutes a legal tort for which the executive may be held fully liable.

A deeper look at due diligence: more than a legal phrase

The concept of due diligence is a fundamental principle of commercial law. It is not merely a matter of formal compliance with the literal provisions of the law. It encompasses a wide range of duties and standards of conduct that every responsible statutory body should fulfil. Let us look at the key aspects of this care in more detail:

• Loyalty and the interest of the company first: A director has a duty to put the interests of the company ahead of his or her own, family's or other related parties' interests. Any conflict of interest should be transparently addressed and ideally avoided by the executive. An example of a breach of loyalty could be a situation where an executive enters into a contract with his or her own company on terms significantly disadvantageous to the company being managed.

• Professional competence and continuous learning: the executive is expected to have the necessary knowledge and skills to manage the company. If he or she does not have sufficient expertise in a given area, he or she should obtain professional advice (legal, economic, technical). Ignoring professional advice that would have prevented damage may be considered a breach of due care.

• Duty of information and due diligence: before taking major decisions, the managing director should obtain all relevant information, conduct a thorough risk analysis and consider various options for resolution. Failure to adequately vet a business partner before entering into a significant contract, which subsequently causes damage to the company, is a typical example of neglecting this duty.

• Transparency and accountability: The CEO should be able to properly justify and be held accountable for his actions and decisions. Non-transparent decision-making, concealment of important information from shareholders and denial of responsibility for damages are contrary to the principles of sound management.

• Preventing damage and managing risk: Part of being a good steward is actively seeking to prevent potential damage. This includes the implementation of internal controls, risk insurance and proactive monitoring of developments in the relevant industry. Ignoring obvious risks that have been brought to the attention of executives and failing to take adequate action can lead to liability for damages.

Specific situations and examples of breaches of due diligence

To better illustrate when a breach of due care may occur and what the consequences may be, let us look at some specific examples from practice:

• Unfavourable contracts: without a proper tender process, the managing director enters into a contract with an overpriced supplier for the company, thereby causing unnecessary costs to the company. Or, conversely, he sells key company assets below market price to a related party.

• Neglect of tax obligations: the CEO repeatedly fails to meet tax filing deadlines, leading to heavy penalties and interest on late payments that the company has to pay.

• Risky investment without analysis: The CEO invests a significant amount of company funds in a high-risk project without prior professional analysis and the project fails, causing the company to suffer a significant financial loss.

• Competitive behaviour: during his tenure, the CEO secretly starts a business in the same industry and poaches clients and employees from his existing company.

• Failure to act in a crisis situation: the CEO ignores clear signals of impending financial problems in the company and takes no action to avert them, thereby deepening losses and potentially leading to bankruptcy.

• Misuse of company funds: the executive uses a company credit card for personal purposes, has fictitious travel expenses reimbursed or pays himself unauthorized bonuses.

In each of these cases, it is crucial to prove a causal link between the executive's breach of duty and the damage suffered. This means that the damage would most likely not have occurred without the executive's wrongful conduct.

The damages recovery process: step by step to your rights

If you believe that the actions of your company's statutory body have caused damage as a result of a breach of due care, it is important to proceed systematically and with professional legal support. Here is a more detailed breakdown of the steps you should consider:

1. Internal investigation and gathering of evidence: In the first stage, it is essential to conduct an internal investigation and gather all available documents and information that suggest a breach of the duties of the managing director and the occurrence of damage. This includes contracts, invoices, internal directives, email communications, minutes of general meetings, accounting records and other relevant material.
2. Professional legal assessment: a key step is to consult with a law firm specializing in business law and directors' liability. Experienced lawyers will conduct a thorough analysis of the evidence gathered, assess the legal situation and evaluate your chances of successfully recovering compensation. They will advise you on the way forward and highlight potential risks.
3. Preliminary claim for damages: if the legal analysis confirms the existence of a claim for damages, this is usually followed by a written claim addressed to the statutory body (managing director). This notice should clearly specify the damage suffered, describe the infringement and set a deadline for the voluntary payment of the amount claimed. In some cases, a well drafted preliminary notice may lead to an out-of-court settlement.
4. Preparing and bringing an action: If there is no satisfactory response to the preliminary injunction from the statutory body, the next step is to prepare and bring an action before the competent court. The action must contain a precise statement of the facts, the legal classification of the infringement, the amount of damages claimed and the relevant evidence.
5. Court proceedings: court proceedings can be lengthy and demanding. It involves exchanging written submissions, taking evidence (e.g. witness interviews, expert reports) and final hearings. Quality legal representation is essential at this stage to successfully assert your rights.
6. Recovery of the claim: If the court decides in your favour and awards you damages, it is necessary to proceed with the actual recovery of the claim. This may involve enforcement proceedings if the debtor does not pay voluntarily.

Prevention is the key: how to minimise the risk of breach of due diligence

The best way to avoid complex and costly litigation for damages is active prevention. Here are some recommendations on how to minimize the risk of a breach of due diligence at your company:

• Clearly define powers and responsibilities: create clear internal guidelines and an organizational structure that define the powers and responsibilities of each member of the statutory body and other senior executives.

• Put controls in place: Implement effective internal control systems to ensure transparency in decision-making and management of corporate funds. Regular audits can detect potential problems early.

• Careful selection of statutory bodies: When selecting executive officers and board members, pay attention to their competence, experience and reputation. Check their references and past performance.

• Regular education and information: Ensure that statutory bodies are regularly informed of current legislation and standards of care. Offer them relevant training and seminars.

• Transparent communication: Encourage open and transparent communication between the statutory body, shareholders and other stakeholders. Early communication of important decisions and risks can prevent misunderstandings and disputes.

• Liability insurance: consider taking out statutory liability insurance (D&O insurance), which can cover legal defence costs and potential damages in the event of proven breaches of duty.
• Outside legal advice: regularly consult a lawyer specialising in commercial law to ensure that your practices comply with applicable legislation and standards of care.

Conclusion: Don't ignore the risks, defend your rights

A breach of due diligence by a statutory body can have serious financial and reputational consequences for your company. Don't ignore the warning signs and don't hesitate to act if you suspect wrongdoing. Thorough documentation, expert legal analysis and timely action are key to successful recovery of damages. And remember, proactive prevention is always better than after-the-fact problem solving.

Do you suspect that the statutory body of your company is acting in breach of due diligence? Contact our law firm for a no-obligation consultation. We will provide you with expert advice and help you protect your business.