Liability of an Executive of a Limited Liability Company

Are you a director? Your liability is greater than you think

This is not a theoretical risk. The economic environment is unstable, and many companies are operating on the edge of their financial capabilities. In 2024 alone, 686 corporate bankruptcies were declared in the Czech Republic, representing a year-on-year increase of 4–5%. The most affected sectors are traditionally trade, construction, and the manufacturing industry. These figures do not show a massive wave of collapses, but rather a creeping increase that analysts are calling the "calm before the storm." Companies lack the financial reserves they once had, and their resilience to crises is lower.

In such an environment, the margin for error shrinks dramatically. A managerial decision that would have been just an unpleasant but manageable complication a few years ago can now send a fragile company into insolvency. And it is at such moments that the attention of creditors, insolvency administrators, and state authorities turns to the directors. They scrutinize every decision, looking for misconduct that would allow them to satisfy their claims from the director's personal assets.

The lawyers at ARROWS monitor economic trends and their impact on our clients' legal risks. That is why we emphasize preventive legal advice that helps companies build resilience in uncertain times and protects their management from personal repercussions.

What exactly does the "duty of due managerial care" mean in practice?

The term "duty of due managerial care" sounds abstract, but the law gives it very specific content. According to Section 159 of the Civil Code, every member of an elected body is obliged to perform their function with three key qualities: the necessary loyalty, the required knowledge, and diligence. Mastering these three pillars is the foundation of your protection.

The three pillars of the duty of due managerial care

1. Necessary loyalty: This means one thing only – the company's interests always take absolute precedence over your own interests, those of your relatives, or any third parties. Any decision motivated by personal gain at the company's expense is a gross breach of this duty.

2. Required knowledge: You don't have to be an expert in everything – law, taxes, accounting, and production technology. However, it is your duty to have a sufficient overview to recognize when your knowledge ends and when it is necessary to call in an expert.
Ignoring a complex problem or making a decision "blindly" without consulting an expert is in itself a breach of the duty of due managerial care. Engaging a lawyer or tax advisor is not a sign of ignorance, but rather the fulfillment of the legal duty to act on an informed basis.

3. Diligence: The law requires you to act as another "reasonably diligent person" in the same position would act in a similar situation. This means acting responsibly, conscientiously, and prudently, considering risks, and not leaving things to chance.

The Business Judgment Rule: Your key defensive shield

Business is inherently risky. The law accounts for this and does not hold a director liable for every failure. This is precisely why the institute known as the Business Judgment Rule was introduced into the Business Corporations Act. This rule, contained in Section 51 of the Business Corporations Act, acts as your "safe harbor."

It states that if, in your business decision-making, you acted:

• in good faith,

• on an informed basis (based on reasonably available information),

• and in the defensible interest of the company (your decision had a rational business basis),

then you are not liable for any potential damage, even if your decision later proves to be wrong. The court does not assess the outcome, but the quality of your decision-making process.

This modern approach completely changes the nature of your defense. Your most important task is not to prove that you were right, but that you made the decision in the right way. This elevates careful documentation – minutes of meetings, analyses, supporting documents, expert opinions – from a mere administrative burden to a key element of your personal legal protection.

The most common mistakes that can cost you your personal assets

Theory is one thing, practice is another. A breach of the duty of due managerial care does not only occur with major strategic errors, but often with seemingly routine operational mistakes. Here are the most common examples that, in practice, lead to the personal liability of directors:

• Conflict of interest: The most typical example is concluding a contract with a company that you or a member of your family owns, on terms that are disadvantageous to the company for which you are a director.

• Insufficient due diligence: You approve the purchase of expensive assets, the acquisition of another company, or entry into a significant partnership without having a thorough financial and legal risk analysis prepared.

• Passivity and "formal" directorship: Many directors, especially in companies with multiple partners, gradually withdraw from active management and remain in their position only "on paper." This, however, is a huge risk. The law does not distinguish between an active and a passive director – you are jointly and severally liable for all decisions. Ignoring warning signs or failing to convene a General Meeting when the situation requires it is a clear breach of duty.

• Neglect of administrative and tax duties: You fail to ensure the timely filing of tax returns, proper bookkeeping, or compliance with other legal obligations. The resulting fines, penalties, and additional tax assessments are direct damages for which you can be held liable.

Threatening insolvency: When you must act and what are the consequences of delay?

The greatest test for any director is when the company finds itself in financial difficulties. It is at this moment that your duties multiply, and any hesitation can have fatal consequences for your personal assets. 

The law defines a state of threatening insolvency, which is a situation where it can be reasonably assumed, considering all circumstances, that the company will not be able to duly and timely meet a substantial part of its monetary obligations.

As soon as this state occurs, you, as a director, have clear obligations:

1. Act immediately: You must take all necessary and reasonably foreseeable measures to avert insolvency. This may include negotiating with creditors, seeking new financing, selling non-essential assets, or preparing a restructuring plan.

2. Convene a General Meeting: You are obliged to convene a General Meeting without undue delay, inform the shareholders of the situation, and propose a solution to them (e.g., dissolving the company with liquidation or adopting another measure).

The key point is that the law protects activity, not passivity. The law explicitly protects directors who were appointed as "crisis managers" with the aim of averting insolvency and who acted with due managerial care. Conversely, if you resign in the face of a crisis or remain inactive in the hope that "it will somehow resolve itself," the courts will view this as a gross breach of your duties. Carefully documented attempts to save the company are your best defense, even if they are ultimately unsuccessful.

The duty to file an insolvency petition

If insolvency cannot be averted and the company becomes insolvent (has multiple creditors, obligations more than 30 days past due, and is unable to meet them) or is over-indebted, you have an unconditional duty to file an insolvency petition for the company.

You must do so "without undue delay" after you learned of the insolvency or, with due diligence, should and could have learned of it. Case law interprets this term as a very short period, in the order of days, not weeks or months.

If you breach this duty, you are liable to creditors for the damage caused by your delay. This damage is typically calculated as the difference between the amount a creditor would have received if the petition had been filed on time and what they actually receive in the later insolvency proceedings. The longer you delay, the more damage you can cause – and the higher the compensation creditors can demand from you.

The lawyers at ARROWS specialize in insolvency law and restructuring. We are able to quickly analyze your company's situation, propose concrete steps to avert insolvency, and, if it is unavoidable, ensure the preparation and filing of an insolvency petition to protect the directors from personal liability for delay. We represent clients in negotiations with creditors and in insolvency proceedings.

Liability for debts: When can creditors and the Tax Authority come knocking?

Even if the company avoids insolvency, it does not mean the director is safe. There are two main ways creditors can seek payment of the company's debts directly from your assets.

Liability towards private creditors

According to Section 159(3) of the Civil Code, a director incurs subsidiary liability towards the company's creditors if three conditions are met:

1. The director caused damage to the company by breaching their duties.

2. They did not compensate the company for this damage.

3. The creditor cannot obtain payment from the company (e.g., because it has no assets).

In such a case, the creditor can sue you directly and demand payment of the debt up to the amount of the damage you caused to the company and did not compensate. This process is lengthy for creditors because they must prove all these facts in court proceedings. Nevertheless, it represents a serious risk.

Liability for tax debts: Beware of the Tax Authority!

Much more dangerous is the liability for tax arrears. Here, the tax administrator (Tax Authority) has an exceptionally powerful tool at its disposal. Recent case law from the Supreme Administrative Court has confirmed that the Tax Authority does not have to wait for the outcome of a civil court case.

The procedure is as follows: If a company has a tax arrear that it cannot pay, and the Tax Authority concludes that this situation arose because the director breached the duty of due managerial care and caused damage to the company, it can issue a so-called guarantor's notice directly to the director.

This notice has the nature of an enforceable title. This means that the Tax Authority assesses your fault as a preliminary question and can immediately initiate enforcement proceedings against your personal assets. Furthermore, the burden of proof is on your side – you must prove that you acted with due managerial care.

However, it is important to understand what constitutes "damage" in this context. The courts have concluded that the damage is not the tax debt itself. The damage is the director's prior action that unlawfully drained funds from the company's assets that could have otherwise been used to pay taxes (e.g., siphoning off money, paying fictitious invoices, selling assets at a loss). The Tax Authority must therefore prove not only the existence of the tax debt but also this initial harmful interference with the company's assets.

Representation before courts and administrative authorities is one of our key specializations. We have extensive experience in defending clients against creditors' claims and against guarantor's notices from tax authorities. Our legal opinions and proactive advice help prevent situations that lead to such liability.

International business, international liability

If your company operates in international markets, your liability becomes even more complex. Each country has its own legal framework for the liability of statutory bodies, its own rules for insolvency, and its own tax regulations. A decision that is fully compliant with Czech law and protected by the Business Judgment Rule may be considered a breach of duty in Germany, Poland, or Slovakia.

Managing an international company with a purely domestic legal perspective is a hidden but enormous risk. You may unknowingly commit misconduct in one jurisdiction while trying to comply with the rules in another. This requires not only knowledge of local laws but also the ability to coordinate legal strategy across borders.

Thanks to the ARROWS International network, built over ten years, we deal with the issue of statutory body liability with an international element on a daily basis. For our clients, we ensure that their decision-making is in compliance not only with Czech law but also with the legislation in the countries where they operate. This provides unified and comprehensive legal protection that eliminates risks arising from ignorance of foreign regulations.

ARROWS: Your partner for safe and successful company management

The role of a director carries significant responsibility, but with the right partner by your side, it can be managed safely and effectively. The key is prevention, being informed, and the ability to react quickly when problems arise. At ARROWS, we understand not just the letter of the law, but also business. We know the pressure you face, and our goal is to provide you with legal certainty so you can focus on growing your company.

Our experience, backed by long-term cooperation with a portfolio of more than 150 joint-stock companies, 250 limited liability companies, and 51 municipalities and regions, allows us to provide services at the highest level. We pride ourselves on speed, quality, and a proactive approach.

We provide our clients with comprehensive legal services covering all aspects of a director's liability:

• Drafting internal policies and compliance programs.

• Preparing and reviewing key contracts and other documentation.

• Preparing legally required documents for General Meetings.

• Legal consultations and opinions that protect you from fines and risks.

• Representation before courts and administrative authorities in the Czech Republic and abroad.

• Obtaining necessary licenses and permits.

• Expert training for management and leadership, including certification.

Moreover, we understand that law and business are two sides of the same coin. We are happy to connect our clients when we see interesting business or investment opportunities, and we are always keen to hear inspiring entrepreneurial ideas ourselves.

Don't risk your personal assets and reputation. Contact us today and schedule a consultation. Our experts at ARROWS are ready to analyze your situation and propose a solution that will ensure your peace of mind and the safe management of your company.