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Site contribution
Date: December 2015
Prepared by:
Rolf Watter, Partner
Katja Roth Pellanda, Head Corp. Law, Novartis
Bär & Karrer Attorneys at Law
Brandschenkestrasse 90
8027 Zürich
Phone:   +41 58 261 50 00
Fax:   +41 58 261 50 01
E-Mail:   rolf.watter@baerkarrer.ch
katja.rothpellanda@novartis.com
Legal Developments for Directors and Officers of a company limited by shares in Switzerland
In Switzerland, the basis upon which the personal liability of members (the 'directors') of the board of a Swiss joint company (Aktiengesellschaft, herein a 'company') could be invoked is rather broad but court cases outside of the bankruptcy of a company are rare but rather frequent if a company becomes insolvent. However, directors' liability has become an increasingly sensitive topic and recently claims have been brought forward in the context of takeovers and going-private situations. One of the main reasons for the reluctance of shareholders to pursue legal action against board members is the financial risk associated with it. The preliminary draft of the revised Swiss Code of Obligations ('CO') tries to address this issue by obligating the company to pay for legal actions of shareholders under certain conditions as one of the main goals of the revision of the CO is to further strengthen corporate governance rules, in particular relating to shareholder's rights and board of directors (the 'board') and management compensation. In line with this aim, another major part of the revision is the implementation into formal law of the Ordinance against Excessive Compensation in Listed Companies ('Minder Ordinance'), which entered into force on 1 January 2014. The Minder Ordinance is the result of a popular initiative for a constitutional amendment in the area of board and management compensation, which was adopted in 2013 by a popular vote. The Minder Ordinance introduced among others binding "Say on Pay" for the compensation of the members of the board of directors and management by the shareholders at the annual general meeting. Certain contraventions of the Minder Ordinance are sanctioned by imprisonment of up to three years and a fine of up to the equivalent of six years' annual compensation. All offences have to be prosecuted ex officio.
Although no formal legal changes have yet been introduced, the global focus on corporate governance has generally resulted in a more rigorous standard for directors (through the Corporate Governance Directive issued by the SIX Swiss Exchange Ltd and by soft law, such as the Swiss Code of Best Practice for Corporate Governance, 'SCBP'), which increases the risk of claims against them.
This overview offers a brief description of the organization of a company before dealing with the main duties of its directors. The principles governing civil liability and indemnification of directors will then be outlined as will the criminal liability of directors.
In principle, Swiss corporate law provides for a one-tier board structure, the board is therefore by default the executive body of a company limited by shares and as such responsible for the management and representation of the company. The board may carry out any legal acts consistent with the company's purpose clause and is authorized to decide on all matters that are not reserved by Swiss law or the articles of association to the shareholders' meeting or to the auditors. However, the board has considerable organizational discretion. It may delegate some or most of its powers (save for the non-transferable duties set out below) to one director, to a board committee, or to non-members of the board, such as a CEO or to an executive management team. Such a delegation requires an authorization by the shareholders in the articles of association and must be specified by the board in organizational regulations. Thus, it is possible to create a two-tier structure, which is what listed companies typically do and which the SCBP recommends by asking for a majority of non-executive directors.
A board must consist of at least one or more director who need no longer be shareholders. Earlier rules on nationality and residency of directors have also been abolished but at least one board member or one member of management who is entitled to represent the company must be resident in Switzerland. While the law provides a term of office for three years unless the articles of association state otherwise, the members of the board of listed companies have to be elected individually and on an annual basis. In general, no formal requirements (such as a gender quota, specific knowledges) have to be met for being nominated to a board. Each board member may generally resign any time. However, if a board member steps down at an inconvenient time it might be liable for damages arising from such a resignation.
In case of several board members the organization of the board requires the nomination of a chair (to be elected in listed companies by the shareholders) and a secretary, but the latter does not need to be a board member. The organizational flexibility of the board is rather far-reaching and provides the possibility of assigning responsibility for preparing and implementing resolutions of the board, or monitoring transactions, to board committees or individual board members. In all instances, appropriate reporting to the (full) board has to be ascertained. However, the Minder Ordinance now provides that the members of the compensation committee, who need to be board members, need to be elected by the shareholders' meeting and therefore also implicitly stating that a compensation committee need to be established by listed companies. The SCBP also recommends the creation of an audit and nomination committee. As Corporate Social Responsibility also gains more importance in Switzerland companies start to establish today Corporate Social Responsibility committees.
Meetings of the board should take place as often as business so requires. As a rule of thumb, at least four meetings should be held each year. If fewer meetings are held, there is a risk of a Swiss court assuming that the board has not complied with its duties.
The tasks of the board are set out in various legislations and in soft law.
Non-transferable duties of a board
Swiss corporate law stipulates certain non-transferable duties of a board:
  • Strategy: The directors must develop a business strategy and determine the appropriate means to pursue it (eg establishment of a long-term and a medium-term business plan, issuance of appropriate directives and instructions, establishment of a risk control and management system). The aim must be to increase the long-term company value, considering the shareholders' interest.
  • Determination of the organisation: The board has to decide on the governance structure of the company and of the board itself by enacting organizational regulations. As seen above, the board may delegate management, appoint board committees (eg audit, nomination, compensation and risk committee). If the board chairman and the CEO are identical, the board should, pursuant to the SCBP, provide for adequate control mechanisms (eg by appointing an experienced nonexecutive director as senior independent director).
  • Structuring of the accounting system, financial control and planning: This duty covers not only financial accounting and the preparation of financial statements, where the board retains the ultimate responsibility (eg for determining the accounting standard, the reporting currency and decisions in those areas, where there is discretion) but also the necessity to establish a financial control system, including the monitoring of the liquidity of the company.
  • Appointment and removal of the persons entrusted with management and representation: Whereas the power to appoint the top executive management must remain with the board, appointments to lower levels may be delegated. Appointments (and succession planning) have to be prepared with all due care and persons who fail to carry out their task properly have ultimately to be dismissed.
  • Supervision: The board has to supervise management, in particular with respect to compliance with the law, the articles of association, organizational regulations and other internal directives. To fulfil this continuous task, the board has to define clear reporting lines and implement an adequate control system.
  • Preparation of the annual report as well as preparation of the shareholders' meetings and the implementation of the latter's resolutions: The annual shareholders' meeting has to be held within six months of the end of each business year. The board has to call for the meeting in due time, set the agenda and submit motions for every agenda item.
     
    Special duties arise' in the case of financial difficulties of the company:
  • Loss of capital: If the stand-alone statutory balance sheet of the company shows that the net assets no longer fully cover half of the share capital and the legal reserves, the board must call a shareholders' meeting without delay and propose restructuring measures to the shareholders.
  • Over-indebtedness: If there is concern that the company's net assets are negative, an interim balance sheet must be prepared and submitted to the auditors for examination. If the interim balance sheet shows that the claims of the company's creditors are neither covered by its assets on a going concern nor on a liquidation value basis, must the board file for bankruptcy. The board may only refrain from doing so if it takes immediate steps to reorganize the business (both operationally and financially) and/or improve the balance sheet such that a sustainable recovery of the company is highly probable; often, certain classes of creditors must in this context be convinced to subordinate their claims to cure the over-indebtedness.
    Further duties
    Besides these core duties, other duties can be relevant in connection with personal liability:
  • Duty to carry out a risk management and assessment, eg define the company's risk appetite and tolerance, set up an appropriate risk management framework and appropriate system for internal control and assess continuously the risk situation of the company
  • Duty to communicate and engage with shareholders while maintaining confidentiality of non-public information and ensure that the board is aware of any material changes in the share register and, thus, the shareholder base
  • Duties according to SIX Swiss Exchange Regulation for listed companies: rules on ad hoc publicity, disclosure of management transactions, corporate governance disclosure (eg on tasks and responsibility within the board and for each committee, work methods, compensation)
  • Duties contained in various other legislation such as the Minder Ordinance, Merger Act, Criminal Code (eg with respect to insider dealing, price manipulation) or the Old Age Insurance Act.
    Standard of care
    The directors and the management team must carry out their duties with due care, ie a judge would ask what kind of behaviour could be expected in the given situation from someone in the same situation who acts properly. Insufficient skills or 'no time' are no excuses. Directors must always act in the interest of the company (duty of loyalty) and must not compete with the company (eg lure away customers or grasp corporate opportunities). Furthermore, directors and persons related to them must conduct business with the company on an arm's length basis.
    With regard to the area where the board has delegated its duties to management, the liability of non-executive directors is limited to the proper selection, instruction and supervision of the managers. Supervision requires an adequate reporting system, and directors must read and analyse the information provided, ask for further information if needed, and take the necessary actions.
    In addition, the board must ensure that under like circumstances shareholders are treated equally. However, the board may also have regard to the interests of a specific shareholder if other shareholders are not disadvantaged and the decision taken is in the interest of the company. For listed companies, the principle of equal treatment is relevant with regard to the registration in the share register, share buy-back programmes and most importantly the information of shareholders.
    Qualification as corporate body and breach of duties
    In Switzerland, directors as well as other persons managing a company (ie everybody involved in the decision-making process including de facto directors such as potentially major shareholders or banks) are personally liable if (i) a damage is suffered by the company or the claimant, (ii) they have violated a duty set out by law, the articles of association, organisational regulations or other internal directives by (iii) an intentional or negligent act and (iv) this violation of a duty has caused the damage.
    Depending on who is damaged, a successful liability claim can lead to payments to the company, shareholders or creditors of the company. Whilst the company and the shareholders may bring a claim at any time, creditors can, in general, only do so once the company has become insolvent and is declared bankrupt. In other words, creditors may not bring claims against a solvent company based on directors’ liability, unless they have suffered a direct damage, in which case ordinary tort law principles apply.
    With regard to the burden of proof, it is the practice of Swiss courts that once a violation of duties is established, the defendant must exonerate himself.
    If several directors are liable for a damage, any one of them is jointly and severally liable with the other directors to the extent the damage is attributable to each one of them based on their own fault and the circumstances. Claims are barred after five years, calculated from the day the injured party has knowledge of the damage and the person liable.
    In practice, shareholders' actions against directors are rare outside bankruptcy but rather frequent if a company becomes insolvent. Recently, directors' liability claims have also been brought in the context of unfriendly takeovers to put pressure on the board.
    Measures to mitigate the risk of liability
    Boards can mitigate the risk of personal liability by:
  • following a decision-making process which leads to unbiased and informed business decisions (eg by taking decisions on the basis of appropriate and timely information after due discussion of the pros and cons, by considering alternatives and their respective risks, by consulting experts in areas where the board does not have sufficient expertise) and carefully drafting the board minutes so that they reflect the discussions or at least the fact that an in-depth discussion has taken place
  • ensuring an adequate organisation of the board and the company
  • delegating all tasks that can be delegated to management and applying due care in the selection, instruction, and supervision of the managers
  • ensuring compliance with the financial reporting obligations; closely following the financial situation of the company based on internal reporting; and, in the event of financial distress, taking immediate action.
    Even though the business judgment rule as applied by US courts has not been formally recognised by the Swiss legislator, it is widely agreed that adhering to the formal criteria provided by this rule significantly reduces liability risk. Consequently, Swiss courts are likely not to review a business decision which is based on (i) proper and meaningful documentation and taken (ii) without any conflict of interest interfering into the decision making process. However, boards must not only focus on formal and procedural requirements but also ensure that they comply with their non-transferable duties in substance.
    In practice, shareholders' actions against directors are rare outside bankruptcy but rather frequent if a company becomes insolvent. Recently, directors' liability claims have also been brought in the context of unfriendly takeovers to put pressure on the board and even more so in going-private situations. One of the main reasons for the reluctance of shareholders to pursue legal action against board members is the financial risk associated with it. The Preliminary Draft addresses this issue by obligating the company to pay for legal actions of shareholders under certain conditions.
    Insurance and indemnification of directors
    Swiss law does not explicitly address the question whether insurance and indemnification of directors is permitted. In a nutshell, the legal situation presents itself as follows:
    Advance of legal costs to directors: Such advances by the company are widely accepted. Although successful liability claims against directors are rare, and the legal costs are often shifted to the losing party, directors may encounter a significant expense burden for many years until the proceedings are closed. Several legal authors state as a precondition for such advances, that the company is not the claimant itself and that the claim is not based on a substantial or wilful breach of duties.
    Assumption of legal costs by the company: Usually, only part of the costs (ie attorneys' and other advisors' fees) will be covered by the losing claimant in the case of a positive outcome for a director; additionally, most of the law suits end up being settled, in which case no costs are reimbursed. In these cases, the assumption of costs by the company is generally allowed. However, a number of legal authors consider this unlawful if the director is held liable, particularly in cases of wilful or substantial breaches of duties; most authors allow, however, an assumption of cost in case the director has breached his duties only negligently.
    Indemnification clauses in articles of association or individual agreements: Such clauses or agreements are in general regarded as unlawful to the extent they also cover wilful or substantial breaches. An indemnification for mere negligence is generally accepted with the argument that forcing directors to be too careful will make them totally risk averse.
    Directors' and officers' insurance: There is wide consensus that directors may be held harmless by D&O liability insurance purchased by the company. Normally, intentionally wrongful acts are excluded in such insurance.
    Hold harmless clause by the major shareholder (eg the parent company): Such clauses are considered lawful. The parent company then usually also undertakes not to bring any claims against directors in subsidiaries – this of course does not bind shareholders who have not consented to such an agreement nor creditors of the subsidiary. In any case, it is not possible to indemnify directors from criminal liability.
    Directors can become subject to criminal liability if they do not comply with their corporate duties. Apart from fraud, misappropriation, general mismanagement or insider dealing, crimes or offences arising in connection with bankruptcy and debt collection are of particular relevance. In general, as opposed to claims for civil liability, mere negligence will not be sufficient grounds for a criminal liability.
    Further Information
     
    WATTER ROLF / ROTH PELLANDA KATJA, Switzerland, in:
  •  
  • Willem J L Calkoen (eds.), The Corporate Governance Review, 5th Edition, London 2015, p. 369 - 385