Increased duties of a public company’s supervisory board in crisis

This article highlights selected aspects of the judgement and recalls the heightened monitoring, reporting, and disclosure obligations of the supervisory board during a corporation in times of crisis.

During a crisis, the supervisory board’s monitoring duties intensify. The supervisory board should exercise closer control over day-to-day management and ensure that the management board fulfills its obligations, such as the timely submission of the annual financial statements. Therefore, it is advisable to shorten the intervals between supervisory board meetings. Otherwise, the shareholders may question the discharge of the management board and the supervisory board for the past financial year. The Company may even be entitled to claims for damages against the individual board members.

By granting discharge, the annual general meeting approves the actions of the Management and the supervisory board for the past financial year. This is primarily a symbolic sign of trust. Unlike in limited liability company law, such a resolution does not prevent the Company from asserting claims for compensation against the board members (section 120 subsection 2 sentence 2 German Stock Corporation Act (“AktG”)). Nevertheless, the discharge remains a crucial indicator of shareholder confidence in the board members and is of considerable importance for the assessment of a corporation’s corporate governance. For members of the supervisory board in particular, it can sometimes be decisive for re-election. Moreover, the rejection of the discharge is perceived by the public and is generally viewed negatively.

As the case decided by the Regional Court I of Munich demonstrates, failure by the supervisory board to intensify its monitoring of the management board can lead to further errors in convening and conducting the annual general meeting. If such errors result in serious violations of law or the articles of association, the discharge resolutions adopted by the annual general meeting may be contestable.

The case

In the specific case, several minority shareholders had filed an action for annulment against the resolutions passed by the annual general meeting to discharge the supervisory board and the management board, and the election of the supervisory board. The Company in question had been in financial difficulties. However, in its report to the annual general meeting (cf. section 171 subsection 2 AktG), the supervisory board had not provided any information on the frequency of its meetings. Even when shareholders raised questions in the annual general meeting regarding the number of meetings and the participants, no information was provided. In this instance, the supervisory board’s incorrect reporting even led to the re-election of two supervisory board members being declared null and void. According to the court, it may be significant for shareholders’ decisions on the re-election of supervisory board members whether and to what extent they have violated their supervisory duties towards the management board and their reporting obligations in the past, particularly during crisis.

The reasons of the judgement

The Regional Court I of Munich then declared the discharge resolutions of the board members null and void by judgment (section 248 subsection 1 AktG). The judgement thus applies to and against all shareholders as well as the members of the management board and the supervisory board.

a) Inadequate report by the supervisory board to the annual general meeting

The supervisory board’s report to the annual general meeting was deemed insufficient. The purpose of the supervisory board’s report to the annual general meeting is, in particular, to inform the annual general meeting about the audit of the annual financial statements and the supervisory board’s monitoring activities. Only this report enables the annual general meeting to make an informed decision on the discharge.

These requirements were not met in the specific case, with the lack of information on the frequency of supervisory board meetings being identified as a problem in addition to the use of meaningless phrases. Simply referring to the extensive information and answers to questions provided by the management board is not sufficient.

It is generally accepted that the supervisory board’s monitoring role intensifies in times of crisis. This judgement confirms this principle once again. This usually also necessitates an increased number of meetings of the supervisory board. In any case, the supervisory board must report to the annual general meeting on the measures it has taken, such as requesting reports from the management board, inspecting Company documents, and imposing approval reservations. Without specific information on this, shareholders cannot form an accurate picture of the extent to which the management board has fulfilled its duties. This inevitably leads to a deficiency in the discharge of liability, which can be challenged by means of an action for annulment. This deficiency also affects the discharge of liability of the management board, as the supervisory board’s report also forms the basis for its discharge of liability.

In the specific case, the Company’s objection that the supervisory board wanted to keep the costs for the Company as low as possible by limiting the scope of the supervisory board’s report – in view of the crisis – was justifiably not tenable. Especially in times of crisis, shareholders must be particularly well informed about the actions of the management board and the supervisory board.

b) Contestation of the re-election of supervisory board members

For the same reason, the re-election of two of the supervisory board members was also declared null and void, as the incorrect report pursuant to section 171 subsection 2 AktG also constitutes the relevant basis for re-election. The extent to which members of the supervisory board have violated their duties in the past in connection with their obligations under section 111 AktG to monitor the management of the management board can be significant for the shareholders’ decision on the re-election of members of the supervisory board.

c) Breach of duty to disclosure

In addition, there were further violations of law which the court also declared null and void. There was a violation of the shareholders’ right to ask questions at the annual general meeting (section 131 AktG). In the specific case, shareholders’ questions regarding the number of supervisory board meetings, the participants in these meetings, and other supervisory board mandates held by one of the members of the supervisory board were not answered properly.

d) Failure to convene the annual general meeting in a timely manner

Furthermore, contrary to the provisions of section 175 subsection 1 sentence 2 AktG, the annual general meeting did not take place within the first eight months of the Company’s financial year. This breach of duty by the management board may be serious enough to declare the discharge of the management board null and void if it is at fault, as within this period, the annual financial statements, which are intended to inform the public about the economic situation of a corporation as soon as possible, must also be presented. In the specific case, the management board itself had contributed significantly to the failure to meet the deadline by submitting the annual financial statements late and failing to set a deadline for the supervisory board. This resulted in the successful annulment of the discharge resolution, also due to the late convening of the annual general meeting by the management board.

Conclusion

The judgement highlights the importance of the supervisory board’s increased monitoring, reporting, and disclosure obligations, particularly in times of crisis. The increased requirements for the activities of the board members must be reflected in the report in order to provide shareholders with a valid basis for their decision.

In addition, it is advisable to check prior to the annual general meeting whether and how detailed answers to shareholders’ questions are to be provided. This is because even a violation of the right to ask questions may lead to an action for annulment.

Finally, it is evident that, especially during crisis, it is advantageous to consult professional advisors at an early stage. This ensures compliance with legal requirements, such as the deadline for the timely submission of the annual financial statements and the convening of the annual general meeting. Since the interests of the management board and the supervisory board are not always aligned, it may even be advisable for the supervisory board to consult its own advisor. The board members can then focus their attention and efforts fully on overcoming the crisis.

From the Newsletter
Corporate Law, Deals & Capital Markets