On personal liability of members of the board.
Under Norwegian law, representatives of the company, including board members, the company CEO as well as shareholders, may be held personally liable for damages caused by their actions or omissions on behalf of the company. Personal liability is especially applicable if the company is in financial distress, if the damage is caused to the company or if a claim towards the company otherwise would be meaningless or not compensate for the loss inflicted. An example of the latter is where the company is acquired based on misleading information.
This article is written for those contemplating putting forth a claim of personal liability against representatives of a company and for the representatives who have such claims brought against them. It is written based on our experience with board liability cases on behalf of our Norwegian and international clients.
If you have a similar case, and are contemplating procuring our legal services, please do not hesitate to contact me by email, through our chat services or by phone.
1. Background and legal framework
Section 17-1 of the Norwegian Limited Liability Companies Act stipulates that board members, including the chairman of the board, as well as the CEO or shareholders, may be held personally liable for the economic damage they, in their role as representatives of the company, intentionally or negligently have inflicted on others. Section 17-1 states the following:
[Section] 17-1. Liability for damages
(1) The company, a shareholder or others may hold the general manager, a member of the board of directors, member of the corporate assembly, independent expert, investigator or shareholder liable for any damage which they, in the capacity mentioned, have intentionally or negligently caused such party.
(2) The company, a shareholder or others may also hold a party who, intentionally or negligently, has contributed to damage as mentioned in first paragraph, liable for the damage. Damages can be claimed from the contributor even though the person who caused the damage cannot be held liable because he or she did not act with intent or negligence.
Claims of personal liability are usually brought forth by the following entities:
- The company itself
- The company’s creditors
- Shareholders of the company
- Other business connections such as suppliers or employees, and sometimes public authorities.
Personal liability presupposes that the board member or other representative negligently has breached the obligations that incur in their role as board member in accordance to:
- The Norwegian Limited Liability Company Act, or
- The company’s articles of association.
Claim for compensation might also follow from a shareholder agreement, though such a claim would formally be grounded in contractual breach of that agreement, rather than from Section 17-1. A shareholder agreement often also stipulates provisions on penalty by default as well as exclusion as shareholder based on breach of the agreement.
The number of cases concerning personal responsibility has been steadily rising in Norway. The cases are often complicated, both on a legal and factual basis. They often result in economic distress or perhaps even personal ruin of the board member. This is especially the case if the representative is not insured.
The remaining article will deal with claims of personal compensation against board members. I would nevertheless like to emphasize that many of the same assessments apply for personal liability cases against the company CEO.
For cases brought against shareholders the assessment is somewhat different as the shareholder usually does not represent or act on behalf of the company in the same way. Cases against shareholders usually concern situations where the shareholder has misused the protection of limited liability which follows from the private limited company form, for instance through underfinancing the company.
1.1 What are the responsibilities and role of the board?
A personal liability case is based on a breach of the board members’ duties. The starting point for such a claim would therefore be an analysis of which of the duties that fall on the board that has been breached. The Norwegian limited Liability Act Section 6-12 stipulates that the board is responsible for the following:
- Proper management of the company
- That the company’s accounts are subject to satisfactory control
- Adequate supervision of the CEO’s general management and the company’s activities, as well as
- That necessary information is provided to shareholders and others, cf. Sections 6-12 and 6-13 of the Limited Liability Companies Act.
From our experience there are two main reasons why a board member breach his or her duties:
- Reckless misconduct, for instance due to ignorance of facts or law
- Wilful misconduct, for instance by wilfully setting aside the best interest of the company in pursuit of personal interest or other colliding interests.
1.2 Personal liability means an individual assessment
Even though each board member is held personally liable based on an individual assessment, the board members act as a collective body that act as a single entity through board decisions. The starting point for a personal liability case against a board member is therefore either;
- that a negligent board resolution has been made, or
- that the board has failed in reaching a necessary board resolution it should have made (for instance to declare bankruptcy).
Individual responsibility means that the board members may be held liable on an individual basis. This entails that some of the board members may be held personally liable, while others are viewed as not liable for the same actions. Whether there is reason for personal liability is assessed on a case-to-case basis. Relevant factors in the assessment are:
- The board member’s exact role in the liability triggering action: For example, were some members of the board dissented or been absent in the liability triggering board decision? Did some of the members prepare the decision or have a more active role?
- Board member’s term of function: How long has the board member been appointed and how involved has he or she been with the company? If the board member has functioned for a relatively brief period or if the person was called into capacity as a deputy board member (alternative director), it is for instance less likely that the person would be held accountable, even though the person participated in the damage triggering board decision.
- The specific nature of the action: Was the economic loss caused due to indemnifying acts or omissions? What harm was done and to what interest? Was mandatory legislation violated? These questions are relevant in the assessment of whether the board member acted negligently, or not.
- The degree of guilt. To what extent is the board member in question to blame? Is this a case of wilful misconduct, gross negligence, or negligence? Has the board relied on advice from an auditor, accountant, attorney or other professionals? Was the case prepared by a CEO or management and are these more to blame?
- The general expectation for board member in question: What could be expected of the board member? What background does he / she have and what role do they have on the board? Are the members paid / professionals, or does the board consist of members who participate on a voluntary basis, for example in housing association boards, charities, sports clubs, etc.
The assessment of liability of the board’s actions must ultimately be made based on the actual information that came to the board at the time they made their decision. This means that although the issue of board responsibility will be assessed retrospectively on the basis of a loss that subsequently arose, the assessment must nevertheless be based on the situation the board was in when the decision was made.
Nevertheless, the board has a duty to establish reporting systems, so they have sufficient information to make adequate decisions. If such reporting systems have not been sufficiently implemented, and that has subsequently resulted in erroneous decisions, the board members may be held personally accountable.
2. What kind of board liability cases do we see in Norway?
In recent years, the number of cases has increased, and currently consists of about 100 board liability cases per year. A general trait of the cases we see is that they are relatively complicated, both with regards to facts and law, and that legal expenses are relatively higher compared to other cases.
Another trait is that liability cases are often raised as part of the company’s bankruptcy, either by individual creditors, suppliers, bankruptcy estates or – more exceptionally – by shareholders.
In Dalan law firm we see a variety of cases each year. There are nevertheless some trends that we would like to point out. Overall, in our experience, the most common liability cases in Norway are these:
- The Board of Directors violates its duty to declare bankruptcy in time, cf. Section 6-18 of the Norwegian Limited Liability Companies Act cf. Section 287 of the Penal Code.
- The Board of Directors provides incorrect or misleading information on the company’s finances which results in economic loss for third parties (e.g. shareholders, suppliers and creditors who act upon that information).
- A board member goes beyond his or her authority, assigned powers of attorney or otherwise violates mandatory legislation causing an economic loss to third parties.
- There is a failure in establishing control routines for the company’s activities, supervision and control of daily management and / or the CEO.
- Approval of an agreement with close associates which is not in the best interest of the company. For example, agreements that would constitute unlawful distributions from the company to associated parties.
- Approval of unfavourable agreements or handling of agreements in such a manner that the company suffers a financial loss, for instance through unlawful termination of agreements such as employment agreements or lease agreements, or handling of contractual agreements in a way that causes the company economic loss.
3. The different grounds for board liability
3.1 The Board fails to declare bankruptcy in time
A common board liability case is where the board fails to declare bankruptcy in time, so that the company’s continued operations in reality is an unrealistic and indefensible speculation at the expense of the company’s creditors.
The board could either act;
- wilfully, meaning that the board knows that continued operations are financially untenable, or
- due to negligence or gross negligence, for example by not keeping track of the company’s financial developments and thereby fails to meet managerial and financial responsibilities of the company.
It is important to be aware that general ignorance from the board as an entity or from some members of the board, is not sufficient grounds for discharge of personal liability in accordance with Section 17-1. The reason being that each member of the board has an independent and ongoing duty to obtain sufficient and correct information so that sound decisions can be made on behalf of the company.
3.1.1 Is the company in such a financial situation that the board has a duty to act?
The starting point for liability due to failure to declare bankruptcy, is whether the company is in a position where the board of directors has a duty to act pursuant to Section 3-5 of the Norwegian Public Limited Liability Companies Act. Section 3-5 states as follows:
“[Section] 3-5. Obligation to act on loss of equity
(1) If the equity is presumed to be less than adequate in terms of the risk and scope of the company’s business, the board of directors shall forth with deal with the matter. The same shall apply if the company’s equity is assumed to be less than half the share capital. The board of directors shall within a reasonable time call a general meeting and report to it on the company’s financial position. If the company does not have adequate equity in accordance with [Section] 3-4, the board of directors shall propose to the general meeting measures to restore the equity. In such cases as mentioned in the second sentence of this paragraph, the general meeting shall be convened within six months at the latest.
(2) If the board of directors does not find it justified to propose measures as mentioned in first paragraph fourth sentence, or such measures are not feasible, it shall propose liquidation of the company.”
If the board has a duty to act pursuant to Section 3-5, either by proposing dissolution and liquidation or by proposing a share capital increase, the question would then be whether failing to do so would constitute sufficient grounds for personal liability pursuant to Section 17-1.
3.1.2 Has the grounds for personal liability been met?
The underlying theme here is that personal liability requires something more than just the fact that the board is in breach of its obligations in accordance with Section 3-5.
Traditionally, it has been assumed that operations, despite insolvency, can still be maintained if the board has a realistic and concrete plan that would lead to the company becoming solvent within a foreseeable future. Furthermore, any misjudgement or reprehensible conduct would not in itself result in the board being held accountable. These facts have several implications:
- The board of directors should ensure that it has sufficient written documentation of its steps and measures to rectify the company’s financial situation.
- The board’s documentation should include a realistic plan with concrete measures, so that the board subsequently, if necessary, can document that the basis for its decisions was prudent and verifiable. It is often advisable that the board includes the company’s auditor or other professional advisors (such as attorneys) in the process, so that the board can document that professional assistance was obtained and that the board acted in accordance with the obtained professional advice.
- The board of directors has some leeway as to what are essentially also business decisions, as long as there is a documentable, sound basis for the decision-making and the board has the company’s best interests in mind.
- If the board acts loyally in accordance with its plan to save the company from bankruptcy, the board would as a main rule not be held liable unless they fail to declare bankruptcy within a reasonable time, see the Supreme Court case cf. HR-2017-2375-A.
The presumption in these cases is that all directors of the board be held personal liability, given that the board has acted in violation with Section 3-5 and 17-1. However, it is conceivable that certain members are not held responsible based on specific circumstances that apply to them.
Examples of this may be employee representatives who are on the board to act in the best interest of the employees. It is often in the interests of employees that the company seeks to avoid bankruptcy for as long as possible.
3.2 The Board of Directors provides incorrect information about the company that third parties have acted in confidence of
3.2.1 Some common traits of liability cases due to misinformation
A relatively common board liability case is where third parties (for instance investors, creditors, suppliers) suffer a financial loss due to the board or management providing incorrect or misleading information of the company.
A common denominator of these cases is where the company itself is not damaged, but on the contrary enriched. An example is where investors participate in a capital injection in the company based on incorrect information. As the damaged party are third parties, resulting in the company being enriched, a lawsuit against the company would be meaningless as it would not compensate for the economic loss.
The damaged party and plaintiff in these cases would thus be;
- shareholders who subscribe for shares, convert debt to shares or buy shares in a company based on information from the company, which turns out to be incorrect. The misinformation can come from a prospectus or other information prepared in connection with the transaction itself or it may be general company information such as the company’s financial statements.
- suppliers, banks or other creditors who provide credit to the company based on information from the Board of Directors that turns out to be incorrect.
- public authorities that provide grants based on incorrect information.
Sometimes the company’s professional advisors such as auditor, accountant, broker or attorney, have contributed to the preparation of the erroneous information in such a way that they are jointly liable or that they are liable instead of the board or management. An example of the latter is if the misleading information is given by the company based on their professional advice or prepared material.
This means that when considering making claims due misinformation, one should weigh a claim against the members of the board against a potential claim against the professionals facilitating or participating in the transaction.
It may also be that it is the CEO and not the board who should be held liable for damages caused. This could for instance be the case if the transaction, for all practical purposes, was prepared and organized by the CEO and management. An example of this is the Blaalid verdict, HR-2017-2375-A. This case is described in Section 3.4. below.
Lastly, board liability must be weighed against making claims against the seller. The same could apply for a capital increase, where the subscriber of the shares in a share capital increase is barred from claiming compensation from the company itself, cf. the Norwegian Limited Liability Companies Act Section 10-7 (3) cf. Section 2-10 (2).
3.2.2 The assessment of board liability
A starting point for liability cases due to misinformation, is often whether the information provided is so inadequate that the subscriber, lender, etc., cannot be deemed as bound by his / her own disposition (loan approval, subscription of shares, purchase of shares, etc). There is a decision from the Norwegian Supreme Court which illustrates this. In the Supreme Court case Rt. 1996 p. 742, the court noted as follows:
“In order for liability to be imposed, it must first be noted that the information provided was so inadequate that the lenders were not bound by the pledge they provided.”
One must thus first assess whether the incorrect information provided, or the information withheld, is of such a nature that another party can no longer be viewed as contractually bound by the transaction, for instance to provide loans or credit, subscribe to or buy shares.
Given that this is the case, personal liability for board members would require something further. The crucial question is often whether the board as a whole or one of its directors has acted recklessly in connection with the incorrect information in such a manner that personal liability would seem natural and justifiable.
Furthermore, board liability in these matters will primarily be applicable if the company itself is unable to settle the claim, for instance due to insolvency, or where a claim against the company will be meaningless.
One example in which the company is unable to settle its obligations due to weakened liquidity is the Supreme Court’s decision in Rt. 2011 p. 562. In this case a claim for compensation was made against the chairman of a foundation on the basis that a deposit scheme was maintained even though the economy of the foundation was greatly weakened. The Supreme court concluded that the chairman was personally liable as he did not stop a deposit scheme the court found questionable and because he thus exposed depositors to a risk of loss due to the foundation’s weak finances.
3.3 The board member has gone outside his authority, granted powers of attorney or violated mandatory legislation in such a way that the company or third party suffers a financial loss
Liability cases could also arise due to a member of the board acting outside his or her authority, leading to the company or third parties being financially harmed. Inflicted third parties may be creditors, shareholders, suppliers of public authorities, etc. When a representative acts outside his or her authority it might be due to;
- the actions or negligence being in violation of mandatory legislation; or
- the actions being in violation with his or her assigned authority within the company.
If actions are in breach of mandatory legislation, and those actions have caused financial damage to third parties, the grounds for personal liability are usually met. The legal question would then often be whether the third parties were partly to blame and if the company is financially capable of compensating the financial loss.
If a representative acts outside his or her assigned authority, the situation is more complicated with regards to personal liability:
It follows from the Norwegian Private Limited Liability Companies Act Section 6-33 that the transaction on behalf of a company is binding, unless the company can document that the other party to the transaction understood or ought to have understood that the authority was being exceeded and that it would be dishonest to invoke the transaction.
If such can be proven by the company, the transaction would no longer be legally binding and the grounds for personal liability would, as a main rule, not be met. If the company is unable to prove that conditions are met for the transaction to be viewed as non-binding pursuant to Section 6-33, the third party can demand fulfilment of the contracted duties from the company. Personal liability claims from the other party would then only be practical in case the company is unable to fulfil, see Section 3.1 above. Outside these instances the harmed party and plaintiff in a personal liability case would be the company. The question would then be whether the company’s representative has acted against the company in a way that entails personal liability pursuant to Section 17-1.
3.3.1 The concrete assessment of personal liability in case of breach of authority
If breach as described above can be documented, the court must then conduct a concrete assessment as to whether there also are grounds for personal liability. The Supreme Court lays out their assessment in the following way in Håheller, HR-2016-1440-A, Section 41:
“When assessing whether the conditions pursuant to Section 17-1 have been met, it must be based on whether the shareholder/chairman has breached the obligations that objectively apply to the person concerned. Where these duties have been violated, there will be a presumption that the person in question has acted negligently…”
As laid out by the Supreme Court above, there would often be a presumption of personal liability where there is a breach of obligations that objectively applies to the representative. The question would then be whether there are grounds for ascertaining an exemption from liability due to specific circumstances in the relevant case. As there would be a presumption of responsibility, it would be up to the board member to clarify why personal liability should not be imposed. The representative in question would be obliged to substantiate this and thus also have the burden of proof.
Relevant factors in that assessment include the following:
- The nature of the breach or the form of breach of authority: Some violations are more excusable than others. It is for instance more likely with an exemption from personal liability in a case of pure formality errors or breaches of procedural requirements, than if the actions violate provisions set to protect legitimate third-party interests (e.g. consideration of creditors’ requirements for the protection of company capital, employees’ salary requirements, public requirements for taxes and fees, etc)
- The board member’s association with the action: If the board member has a more peripheral affiliation with the liability triggering action, for example because he/she participated in the relevant board decision as a deputy member, exemption is more likely than for the board member who actively participated in relation to the said action or omission.
- The degree of guilt and reproach that can be directed at the board member: Personal liability requires that an element of guilt can be directed at the representative concerned. This can be formulated into a question of whether the board member was ignorant of facts or the law. As a main rule, ignorance of neither facts nor law absolves liability. However, there are exceptions such as in the Supreme Court decision Rt. 1995 s. 1350 where the breach was deemed as “somewhat peripheral” and there were furthermore disagreements between legal scholars on the state of the law in that particular area.
- The board member’s qualifications and competence: It is assumed that special knowledge of the actions that triggered the damage is of relevance for the question of personal liability. In Rt. 1926 p. 471, the Supreme Court ruled that the members of the board were “ship-savvy” and had knowledge of older enlistments and that this was of relevance for the assessment of responsibility. In contrast, there may be grounds for ascertaining an exemption if the directorship has a voluntary character without remuneration and furthermore if a board member cannot be described as a “professional” board member. This may be the case for board members in housing cooperatives, condominiums, foundations, associations, voluntary sporting clubs etc. Such exemptions are nevertheless unusual, as the main rule is that lack of qualifications “…clearly cannot be given any weight in assessing responsibilities”, The Supreme Court decision Rt. 2011 p. 562.
- Whether the board member profited from the breach. If the board member has profited from the breach, there would be virtually no exceptions from personal liability. The violation of authority will then have the character of disloyalty and violations would be deemed as intentional. Examples of this may be a breach of the Stock Exchange Act’s prohibition against insider trading or entering into agreements in violation of the Norwegian Limited Liability Companies Act’s rules on distribution from the company.
3.4 Inadequate supervision of general management as well as control of business accounts and wealth management
Section 6-13 (1) stipulates that the board shall supervise the day-to-day management and the company’s business in general. Furthermore, it follows from Section 6-12 (3) that the board shall keep itself up-to-date on the company’s financial position and is obliged to ensure that its activities, accounts and capital management are subject to adequate control.
Overall, these provisions impose supervisory duties on the board with regards to the enterprise’s financial business and general management. In order to limit the prospect of personal liability the board ought to establish the following:
- Sufficient routines to be informed of the company’s financial position, general management and the company’s business in general
- Sufficient control in accordance with its established routines, as mentioned above.
In practice this means that the board should document its supervision routines, for instance by establishing written routines and having supervision as a regular topic in its board meetings.
The characteristic of liability due to inadequate supervision is that the damaging action or omission is caused by another representative, for example the general manager, the CEO, the accountant etc. The question will then usually be if the members of the board may be held jointly personally responsible due to violations of their duty to supervise and to stay informed.
An example of a case where this was the issue is the Blaalid verdict, HR-2017-2375-A. Here, the CEO was held liable for creditors’ losses because of giving inadequate information about the company’s real financial position. The creditors also brought forth claims of personal liability against the board members, alleging that the board was in breach of its duty to supervise and stay informed. However, the question was never tried because a settlement between the board and creditors was reached out of court.
If, on the other hand, routines have been established and the board can document satisfactory supervision in accordance with those routines, then there should be no basis for personal liability against the board members. The starting point for an assessment is thus whether there is a failure by the board to either establish or conduct satisfactory control and if such a failure is deemed to be a contributing factor to the occurred loss for the company or third party.
As routines for being properly informed and for supervision are often the starting point for these cases, personal liability due to lack of routines are confined to the following sort of enterprises:
- Smaller and informal enterprises
- Enterprises where board members fulfil their duty on a hobby basis without payment and are otherwise viewed as not professional
- Family enterprises. In such enterprises the dialogue is often more informal and proper supervision and routines not enacted
- Enterprises that are in financial distress. For such enterprises it is especially important for the members of the board to be vigilant and to seek advice from professionals. Furthermore, if the company’s financial situation is challenging, higher demands will be placed on the board, including its supervisory duties.
Lastly, it is not in itself sufficient for fulfilment of the supervisory duty of the board that the company has procured an external accountant. The Board of Directors has an independent duty to oversee the company’s accounts and to carry out proper control of the finances of the company. This responsibility cannot be delegated.
3.5 Abuse of power at the expense of the company or other shareholders
Another common cause for personal liability cases are cases of illegal distributions from the company. A common trait is that the members of the board or other representative of the company misuses his or her power in order to give unreasonable benefits to himself / herself, certain shareholders, representatives or business associates at the expense of the company and other shareholders.
The distribution can follow directly from the transaction, for instance in cases of illegal loans, waiver of debt, distributions or cash payments from the company to benefiting parties. The distribution can also be concealed in its form whereas a test of substance would show that it in reality is a distribution to the associated party, as there are no matching remunerations from the party to the company. Instances of concealed distributions might be overpriced acquisitions or undervalued sales as well as overpriced products or services.
Illegal distributions would most often be considered an illegal loan or dividend pursuant to Sections 8-1 or 8-7 of the Norwegian Limited Liability Companies Act or that it is in violation of the Norwegian Limited Liability Companies Act’s rules on agreements with the company’s close associates, cf. Section 3-8 of the Norwegian Limited Liability Companies Act.
Examples of agreements that could constitute illegal distributions are:
- Agreements between the company and related parties on the purchase and sale of assets (e.g. property, machinery and plant, cars, etc.)
- Ongoing agreements, such as employment agreements, bonus schemes, consultancy agreements, loan agreements, leases (e.g. of commercial premises) advisory agreements etc.
Within cooperative housing entities or condominium entities, there are often certain variants where the condominium or housing cooperative enters into unprofitable renovation and development agreements with companies where the board members have direct or indirect affiliation.
Claims of personal liability due to illegal distribution and misuse of authority are usually put forth by the following persons /entities:
- Shareholders, for instance as part of shareholder disputes and cases of misuse of authority at the cost of the company or amount
- Creditor or bankruptcy estate by extension of the company’s bankruptcy proceedings (especially in combination with reimbursement claims against the benefiting party pursuant to the Creditors Security Act), or
- A new shareholder as part of the acquisition situation, where it subsequently turns out that the company’s value has been reduced as a result of such agreements compared with what the buyer was envisaged, for example as part of a DD (due diligence process).
Furthermore, the board is often sued together with the benefiting party at the time of the transaction. If a board member is the beneficiary and the contracting party for the disputed agreement, the assessments of board liability and reversal requirements will overlap.
3.5.1 The starting point for board liability where a company engages in loss-making agreements with the company’s close associates
Distributions are often concealed as part of a reciprocal agreement between the company and its close associates, whereas a test of the agreement’s substance would show that the performance of the company exceeds the value of the service in return.
The actual starting point for such matters is usually that the board of directors has breached the procedural rules for transactions between the company and its close associates. In that regard it follows from Section 3-8 of Norwegian Limited Liability Companies Act that the Board of Directors shall approve agreements:
“… between the company and a shareholder, a shareholder’s parent company, a director or the general manager if the fair value of the obligations of the company under the agreement at the time of the conclusion thereof exceed 2.5 per cent of the balance sheet amount of the company’s last approved annual financial statement.”
Section 3-8 third subsection subsequently states that the board shall ensure that an account of the transaction is prepared by the auditor pursuant to Section 2-6. Furthermore, Section 3-8 third subsection states that the board shall issue a declaration stating:
- That the agreement is in the interest of the company,
- that the value of the obligations of the company is reasonably proportionate to the value of the rights of the company, and
- that the adequate equity and liquidity requirement under Section 3-4 will be met following the transaction.
Section 3-8 of the Norwegian Limited Liability Companies Act must be read in connection with Section 6-28 (1) of the same act, which stipulates the following:
“Members of the board of directors and others who represent the company pursuant to Sections 6-30 through 6-32 may not adopt any measure which may tend to give certain shareholders or others an unreasonable benefit at the expense of other shareholders or the company.”
Finally, the first sentence of Section 3-7 (2) of the Norwegian Limited Liability Companies Act states that the board is liable for ensuring that the unlawful distribution is returned to the company. Section 3-7 (2) states the following:
“Anybody who on behalf of the company assists in adopting or carrying out a resolution for unlawful distribution and who understood or ought to have understood that the distribution was unlawful, is liable for ensuring that the distribution is returned to the company”
A liability case would thus concern whether the above-mentioned provisions have been breached. If that is the case, the question would further be whether the board member has acted in a sufficiently indemnifying manner for him or her to be personally liable for the caused economic loss in accordance with Section 17-1.
Even though the board may have acted in an indemnifying manner, it might be that there was no economic loss. The reason is that the undertaking has a right to reimbursement or reversal of the performance of the agreement, given that the company demonstrates that the other party to the agreement understood or ought to have understood that the board of directors had not approved the agreement, se Section 3-8 (5).
Lastly, Section 3-7 states that if a distribution has been made by the company contrary to statutory provisions of this act, the recipient shall return the received assets. In the event of a distribution of dividends or repayment following a capital reduction, merger, demerger or liquidation, the preceding rule is inapplicable if the recipient, at the time he received the distribution, neither understood nor ought to have understood that it was unlawful. If the unlawful distribution has been returned in accordance with the above, this would limit the economic loss and thus reduce the risk of personal liability for the participating board member or other company representative.
3.5.2 The Board’s approval of agreements with the company’s close associates pursuant to Section 3-6 of the Norwegian Limited Liability Companies Act
Often, non-compliance with the above rules will entail board liability pursuant to Section 17-1. The question will then often be whether there are special reasons for exemption from liability that apply to the board member in question, whether board members caused the loss (or if there were other contributing factors) and what the economic loss consisted of.
If the Stock Exchange Act’s procedural rules for transactions with close associates have been followed, but there are misjudgements, for example because the transaction is not in the company’s interest, the assessment is more complex.
In those cases, it must first be clarified whether the conditions pursuant to Section 3-8 are met.
This assessment can be complicated as the assessment pursuant to Section 3-8 firstly involves discretionary elements, for instance if the transaction is in the best interest of the company.
Secondly, it must be clarified whether the members of the board have acted in an indemnifying manner pursuant to Section 17-1 for the misjudgement made. Here, too, the board members will be admitted some leeway before board liability pursuant to Section 17-1 is asserted.
If the board in its decision has relied on an assessment by the company auditor pursuant to Section 2-6, a possible lawsuit of board liability must be weighed against a claim against the auditor for misconduct or misjudgement in connection with the auditor’s written assessment.
Where a board member is himself the benefitting party of the transaction, personal liability for the board member is almost always the outcome, if a breach of Section 3-8 is found to have taken place. The reason is that such wilful abuse of authority and disloyal disregard of the best interest of the company qualify as indemnifying actions pursuant to Section 17-1.
3.6. The board or CEO has agreed to an unremunerative agreement on behalf of the company or have handled an ongoing contractual relationship in an indefensible way
Personal liability cases for board members or the company CEO occur from time to time due to mishandling of contractual agreements with third parties. There are two main categories:
- The company has entered into an agreement on terms it should never have agreed to on behalf of the company. It might be a loss-making or onerous agreement that is not in the company’s best interest. For instance, due to the terms being of such a nature that they constitute a loss for the company or because the contract requires expertise or competence that the company does not possess. In such cases, the company is usually the damaged party, though it might also be the other contracting party.
- A contractual relationship is handled by the company’s representative in such an indefensible or reckless way that the representative is personally liable for the occurred loss either from the company or from the other contracting party.
3.6.1 Board liability due to entering into unremunerative agreements
Cases concerning conclusion of unremunerative agreements are often characterized by the board acting recklessly by choosing to enter into an agreement on behalf of the company on such terms as laid out in the contract. Examples are the following:
- The contract lays out terms that are indefensible. The threshold for personal liability in these cases are quite high, given that the representative is not the benefitting party, see Section 3.5 above. The reason is that the company has some leeway in how bad an agreement can be for it to be deemed as unremunerative or simply constituting a loss. Furthermore, personal liability requires a form of recklessness that makes personal liability the natural consequence.
- The contract requires expertise, payments or other sorts of contribution by the company which the company will not be able to fulfil.
These types of cases are usually confined to instances where the board members are viewed as non-professional. In turn, this means that such cases are usually confined to smaller enterprises, housing cooperatives, condominiums, foundations, associations, voluntary sporting clubs etc. They are furthermore not that uncommon where the board and CEO are foreign and were the person’s knowledge of Norwegian norms and the legal framework is limited.
When it comes to unremunerative agreements, there is a distinction between agreements that are loss-making relatively speaking – i.e. that there were more advantageous alternatives that the company should have entered into instead – and loss-making agreements in absolute terms – i.e. agreements that lead to pure loss for the company. When it comes to pure loss-making agreements, personal liability is more likely than is the case for loss-making agreements in relative terms.
Board liability cases for relative loss-making agreements require an analysis of alternatives, and that the chosen option is so unfavourable that the board’s choice in connection with the conclusion of the contract triggers board responsibility. Examples include the purchase of services (such as development agreements) or the purchase of goods where the company ends up clearly overpaying, or if assets are sold or services given at a clearly undervalued price.
Furthermore, it may also be the case that procurement of services or purchase of goods are so distantly related to the company’s operations that they must be deemed unnecessary and thus loss-bearing to the company. This may include unnecessary rent of premises, purchases of services or goods that the company does not need, etc. Where a board member or close associate is the counterparty of the contract, which is not uncommon, the entering into an agreement will have the character of abuse of authority and of disloyalty. Personal liability would in these circumstances be a likely outcome, see Section 3.5 above.
Lastly, personal liability can be a possible outcome where the CEO or representative on behalf of the company have taken on assignments that the company will not be able to perform. It might be that the company does not have the resources or competence. Personal liability would then depend on an overall evaluation of the case, including the recklessness of the behaviour of the said representative.
3.6.2 Board liability as a result of indemnifying contract follow-up and terminations
We also see cases of personal liability due to follow-up of a contract in such a manner that the company or the other contracting party suffers a financial loss. Personal liability would presuppose that the representative exhibits such an indemnifying way that not only the company is in breach of its contractual duties, but that personal liability seems natural due to the recklessness of the representative.
A common trait for these cases is that the representative acts in an obstinate manner and that others within the company, who should have been included, were not drawn into the decision-making process. Another trait is that mandatory provisions are violated in such a way that the actions are deemed indefensible.
Personal liability could also follow from failure to inform others within the company of cost overruns or that the company is in breach of its contractual obligations. Examples can be development or renovation agreements where the representative fails to follow up in accordance with the company’s role as proprietor or developer. We also see instances within employment law and financial law, for instance due to unlawful dismissals of employees or failure to follow up fiscal responsibilities as laid out in loan contracts.
4. Final advice to board members
This article has sought to identify and clarify different grounds for personal liability. When read in its entirety it may seem that personal liability is more likely than is the case in accordance with the law. I would like to point out that there is a threshold for personal liability, even though errors have been made. The threshold furthermore varies depending on the type of case / situation.
In general, board responsibilities will rarely be relevant for the board member and representatives of the company, including CEO, who takes care of the following:
- Adequately familiarizes himself with the case
- Focuses on the company’s interests
- Does not follow special interests or self-interests
- Ensures sound organization of the business
- Establishes adequate control routines, for example through attestation rules
- Provides good documentation of the decisions made and the assessments that have been made, for example through written board protocols, memos etc.