By Ádám Illés, Partner, Director for Hungary
Overview
After more than fifty years, Civil Law in Hungary has been completely rewritten by the New Civil Code effective since 15th of March this year. Back in 2012, Hungary introduced a brand new Labour Code and a new Criminal Code came into effect as of 2013. These are significant changes to the legal system and it is difficult for one not to be affected by them.
One of the most significant and comprehensive changes was introduced in connection with different concepts of liability. This article seeks to summarize, in ten short chapters, the most important changes regarding the typical forms of liability for the executive officers of a company. We will also give you hints on how to have clear legal sight if you, as an executive officer, might face liability, and how to prepare yourself to avoid or handle the different liability issues an executive officer might face.
1. First step: clear sight
There are various liabilities which do not necessarily have the same meaning in everyday life as they do in legislation. Generally, we can say that liability is the consequence of an act resulting in material or intangible damage to someone. This consequence may be moral and legal as well. The legal consequences can be diverse and usually are enforceable simultaneously: for instance, if someone causes an accident by negligence his/her criminal and civil liability may be determined as well. The reason for diversity is that these liabilities do not have the same objectives. Criminal liability aims to protect society by punishing a person who commits a crime, while the objective of civil liability is to compensate the injured person.
In the course of adopting decisions related to the management of a company, which are beyond the responsibilities of the shareholders, the executive officer shall represent the interest of the company. Different kinds of liabilities may arise during the operation of the company. These direct liabilities may be of a criminal or civil nature, depending on the scope of activity of the company, or arise based on other fields of law, e.g., environmental law or competition law.
Due to the above indicated complexity, the determination of the nature of an executive officer's liability requires precision and we also have to define the legal relationship carefully in order to see the legal regulation which applies and also the possible solution for the given situation.
2. Civil liability in general
The executive officer cannot be instructed by the shareholders or by any third persons; he/she carries out his/her office independently. For this reason, the activity of the executive officer may result in liability in case of damages occurring relating to the activity.
The new Civil Code has introduced significant changes in relation to the civil liability of executive officers affecting both their internal liability, i.e., the liability of the officer towards the company and their external liability, i.e., the direct liability of the officer towards third persons. There were many misconceptions about the changes and their relation to these two categories which we will try to clarify by explaining each kind of liability separately.
3. Internal liability
According to the new Civil Code, the executive officer shall be held liable for damages caused to a legal entity resulting from his/her management activities in accordance with the provisions on liability for damages for loss caused by non-performance of an obligation. This is the territory of contractual liability and is applicable if there is a breach of a contract. The new Civil Code changed the entire concept of contractual liability as follows: the party causing damage to the other party shall be relieved of liability if it is able to prove that the damage occurred as a consequence of unforeseen circumstances beyond his/her control, and there had been no reasonable cause to take action to prevent or mitigate the damage.
4. Preventing contractual liability in general
Although this new concept results in a more strict liability, the concept of foreseeable damages softens this liability by limiting the amount of damages to the value of such losses only, which were or should have been foreseeable for the breaching party as a potential consequence of the breach of the contract at the time of the conclusion of the contract. The burden of proof for the foreseeability lies with the injured party.
The new Civil Code also has extended the opportunity to restrict and exclude contractual liability in advance. Accordingly, a contract term limiting or excluding liability for premeditated non-performance of an obligation is permitted unless such non-performance is intentional or would results in loss of life or harm to physical integrity or health. On the contrary, the previous civil code permitted the restriction or exclusion of liability only if such limitation was compensated by the reduction of price or the contract provided another advantage for the party and if not only an intentional, but also grossly negligent breach of contract was illimitable.
In order to minimize the liability of the company for any breach of a contract negotiated by the executive officer, such contract may have liability restriction clauses, and might enlist potential losses in case of the breach of the contract by the other party in order to secure the foreseeability of such consequences.
5. Agreement with the company on limitation of liability
The most simple and obvious solution in order to disregard these changes or adjust the level of liability is to agree on a tailor-made limitation of the internal liability of the executive officer with the company, concretely, with the shareholders.
6. Restructuring of the organization as a means of decreasing liability
Another opportunity for lowering the executive officer's liability is to delegate it to subordinates, employees of the company. In addition to an explicit delegation of responsibilities -- by appointing a chief executive, emphasizing the liabilities of the employees in their job descriptions, changing key employees to employees in managing positions resulting in unlimited liability for any actionable misconducts and stressing those areas of misconduct which shall be considered as grossly negligent resulting in unlimited liability under the Labour Law are all also subtle tools for adjusting liability levels.
7. Discharge of liability by the shareholders of the company: a special solution
If the company's supreme body provides a hold-harmless warrant to an executive officer at the time of approval of the financial report, thus acknowledging the executive officer's management activities during the previous financial year, no claim for damages against the executive officer on the grounds of breaching management obligations may be brought by the company unless the facts and information underlying the hold-harmless warrant proved to be false or incomplete.
8. External liability
In accordance with the new Civil Code if an executive officer causes damage to a third party in connection with his/her office, he/she shall be liable in relation to the injured person with the represented company jointly and severally.
Considering the fact that these provisions are specified under the part dealing with non-contractual liability, this liability affects only cases arising outside contractual relationships. Apart from concluding contracts, the executive officer deals with the daily operations of the company during which damages beyond any contractual relationship may arise, for instance, in case of an accident.
However, in such case the executive shall be relieved of liability, if he/she is able to prove that his/her conduct was not actionable, which means a much lower level of liability than contractual liability. Nevertheless, how jurisprudence will indicate the broad lines of such direct and external liability of an executive officer is far in the future.
9. D&O Insurance as the ultimate solution?
In regard to external liability, the conclusion of a Directors and Officers insurance contract covering the activity of the executive officer may facilitate liability management. However, this solution may be expensive in certain cases, so the company should consider the level of the threat of liability in light of its scope of activity. Naturally, such D&O insurance contracts at the group level covering the officers of subsidiaries are a great tool for allocating liability.
10. Liability of executive officers in cases of liquidation
The executive officer has a special liability determined in the Act on Bankruptcy and Liquidation Proceedings.
On the basis of this regulation in the event of a business association's dissolution without succession due to insolvency, creditors may bring action for damages up to their claims outstanding against the company's executive officers on the grounds of non-contractual liability, should the executive officer affected fail to take the creditors' interests into account in the event of an imminent threat to the business association's solvency. It shall be noted, that prior to the new Civil Code, such interests of the creditors were to be prioritized and therefore this change is in favour of the executive officers.
We note that in Hungary is quite difficult to determine the liability of executive officer by courts in this case because during the operation of the company it is almost impossible to prove the time of the "imminent threat to the business association's solvency" and because of the fact that financial difficulties are usually cured by further developing business, even if such development is questionable.
Conclusion
The legal issue concerning the liability of executive officers is a complex issue requesting comprehensive analysis of the legal background and of the company's activities and other circumstances in advance. Areas of liability shall be determined clearly and precisely in view of the eventual consequences of the breach of contract as well as the impact of each employee on the performance of the contracts concluded by the executive officers in order to involve them in bearing the eventual consequences.
On the other hand it can be a good idea to review the opportunities provided by insurers regarding executive officers' liability taking into account the risks which can arise due to the activity of the company.
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