Czech Business Judgment Rule

What is the Business Judgment Rule and Why Does It Exist for You as a Managing Director

The reason for the existence of this rule is practical, as business cannot exist without risk. If managing directors bore personal liability for every failure regardless of the circumstances and effort exerted, no one would want to hold the office of managing director. This is precisely why the Business Corporations Act (ZOK) contains this rule to motivate you to take reasonable business risks necessary for the company's development.

In the Czech Republic, the business judgment rule is enshrined in Section 51 of the Business Corporations Act. Although it has been in effect for many years, its application is constantly evolving in response to the decision-making practice of the Supreme Court.

This is why the Prague-based ARROWS law firm intensively focuses on this issue and applies current case law to their clients' practice.

Origin of the Rule in the USA and Inspiration for Czech Law

To better understand the purpose of the rule, it is useful to know its origin. The rule originated in the USA, specifically in the case law of the State of Delaware, which is considered the hub of corporate law.

A significant milestone was the decision of the Supreme Court of Delaware in the case of Aronson v. Lewis (1984). This decision established a presumption that board members act on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company. In the USA, this rule functions as a strong procedural protection, where courts often dismiss lawsuits at the very outset unless the plaintiff proves otherwise.

The Czech regulation was inspired by this model but did not adopt it word for word. Under Czech legislation, the position of a managing director is somewhat more complex, especially regarding the burden of proof.

How the Business Judgment Rule Works in the Czech Republic

In the Czech Republic, the business judgment rule is regulated by Section 51(1) of the Business Corporations Act. It stipulates that a person acts with care and necessary knowledge if they could, in good faith, reasonably assume during business decision-making that they were acting on an informed basis and in the defensible interest of the business corporation.

Basic Conditions: What Must Be Met

For the business judgment rule to provide you with protection, you must cumulatively meet several conditions. The court will not retrospectively evaluate whether the decision was commercially "correct" or "profitable", but will examine the process by which you arrived at it. The key conditions are:

• Conscious decision (Volitional act): It must be an active decision of the body (action or conscious inaction). This does not apply to situations where a managing director fails to act out of negligence or merely mechanically fulfills a statutory duty without the possibility of discretion.

• Informed basis: This is a crucial condition in practice. You must make decisions based on information that is reasonably available at the given time and situation. You do not need to have all the information in the world, but you must use the information that another prudent manager would have obtained in a similar situation.

• Defensible interest of the company: Your sole criterion must be the benefit of the company. If the decision primarily pursues your interest, the interest of a related party, or a majority shareholder at the expense of the company, the rule will not protect you. You must be able to rationally explain why the decision was advantageous for the company.

• Good Faith: Your decision must have been made with honest intent and the belief that you are acting correctly. There must be no fraudulent intent, obvious indifference, or effort to harm the company.

• Absence of conflict of interest: Decision-making must be independent. If you have a personal interest in the outcome (conflict of interest), the business judgment rule generally does not apply unless you have gone through the statutory process of notification and approval of the conflict of interest by the company's bodies (Section 54 et seq. of the ZOK).

Burden of Proof: Why Documentation is Key

Here we encounter a fundamental difference from lay expectations. Under Czech legislation, in the event of a dispute over damages caused by a member of a statutory body, the burdened party regarding the duty of due managerial care is the defendant managing director (Section 52(2) of the ZOK).

This means that you must prove to the court that you acted with due managerial care and met the conditions of the business judgment rule. The company proves the occurrence of damage and the causal link, but you must rebut the presumption of negligence.

Therefore, the lawyers from the Prague-based ARROWS law firm strongly recommend that managing directors carefully document their decision-making process. Emails, meeting minutes, external analyses, and expert opinions represent your "insurance policies" for any potential future dispute.

Loyalty and Due Managerial Care – Two Pillars of Your Liability

The business judgment rule is inextricably linked to the duty to act with due managerial care (Section 159 of the Civil Code). This has two components:

1. Care (Duty of Care): The obligation to act on an informed basis, with the necessary knowledge and diligence. If you are not qualified for something, you have an obligation to secure professional assistance.

2. Loyalty (Duty of Loyalty): The obligation to prioritize the interests of the company over your own interests or the interests of third parties.

A breach of loyalty is fatal to the application of the business judgment rule. If a managing director pursues personal enrichment, they cannot invoke the protection of business risk, even if they formally submit stacks of analyses.

Practical Consequences of Breaching Due Managerial Care

If the court finds that you did not act with due managerial care and are not protected by the business judgment rule, the consequences may be as follows:

1. Duty to compensate for damage: You must compensate the company for the harm caused by your actions (Section 53 of the ZOK). If you do not compensate for the damage, you are liable to the company's creditors for its debts to the extent of the uncompensated damage.

2. Surrender of benefit: You must surrender all benefits obtained through the breach of duty.

3. Disqualification from office: If you have repeatedly or seriously breached your duties, the court may disqualify you from serving as a member of a statutory body of any business corporation for up to 3 years.

4. Action to supplement liabilities: In the event of the company's insolvency, the court may decide that you are obliged to pay the difference between the company's assets and debts if you contributed to the insolvency by breaching your duties.

Special Duty: Filing an Insolvency Petition

A managing director has a statutory duty to file an insolvency petition without undue delay after learning of the company's insolvency (Section 98 of the Insolvency Act). Breaching this duty establishes personal liability of the managing director for damage caused to creditors, which equals the difference in the satisfaction of their claims.

Risk Table: What Risks Await You and How ARROWS Helps You

How to Comprehensively Document Your Decision-Making Process – A Practical Guide

Given the shifting of the burden of proof to the managing director, documentation is your best defense. The recommended procedure according to the standards of due managerial care includes the following steps:

1. Written background documents: Before making a decision, gather relevant data (emails, market research, accounting outputs).

2. Meeting minutes: Even in a company with a single managing director, it is advisable to draw up a "managing director's decision" with a brief justification.

3. Executive Summary: For major projects, draft a document summarizing risks, benefits, and alternatives.

4. External opinions: For complex legal or tax issues, request an expert opinion, but you must provide correct input data and critically evaluate the opinion.

5. Archiving: Keep documents even after leaving office, at least for the duration of the limitation periods (objectively up to 10 years).

The lawyers from the Prague-based ARROWS law firm recommend that clients implement a "Compliance" system to ensure the automatic creation of this defensive documentation.

Special Situation: Instructions from a Controlling Entity in a Group

If your company is part of a group, you may be subject to instructions from the parent company that are disadvantageous to your subsidiary. Specific regulations under the ZOK apply here.

A managing director may be released from liability for damage resulting from following an instruction if they prove that the instruction was in the interest of the group and that any potential harm has been or will be compensated within a reasonable period.

However, it must be pointed out that a managing director must not follow an instruction if it would lead to the insolvency of the subsidiary. In such a case, liability for damage persists.

Table: Risks in Group Situations

How to Protect Yourself: Practical Advice for Managing Directors

1. Educate yourself and ask questions. Ignorance is no excuse, so if you do not understand an area, hire an expert.

2. Document everything. What is not on paper or in an email is as if it did not exist in court.

3. Liability insurance (D&O). Consider taking out directors and officers liability insurance, which covers the costs of legal representation and potential damages.

4. Address problems early. If the company is heading into trouble, do not wait for a miracle and consult the situation with experts.

The Prague-based ARROWS law firm has a team of specialists in corporate law and insolvency.

We are insured for professional negligence for amounts in the hundreds of millions of CZK, which provides our clients with a guarantee of stability and professionalism when resolving even the most demanding cases.

Do you need to assess a specific situation or set up preventive protection? Contact us at consultation@arws.cz.