On this basis, acting with proper managerial care means showing required loyalty, required knowledge and care (thoroughness).

When considering the responsibility of a member of the Board of Directors in a particular case, it is necessary to examine the general rules under Act no. 89/2012 Coll., the Civil Code, as amended and then assess how provisions of Act no. 90/2012 Coll., the Business Corporations Act, as amended affect these rules. The Civil Code contains general rules which apply to all legal entities regardless of their nature. The Business Corporations Act sets out special provisions which only apply to business corporations, i.e. companies and cooperatives.

Section 159(1) of the Civil Code sets forth that “any person who accepts a position in an elected body undertakes to perform all tasks with the necessary loyalty, knowledge and care. A person will be presumed to have acted negligently if this duty to act with proper managerial care is not discharged and despite the fact that the person must have known about it when accepting the position or later on, they did not act accordingly.”

The law uses the term “proper managerial care”. At the same time, it gives the phrase a definition.  On this basis, acting with proper managerial care means showing required loyalty, required knowledge and care (thoroughness).

The loyalty duty is undefined, but it is traditionally understood as meaning that the Board member must act in the company’s interest and avoid all acts that could jeopardise that interest. The Civil Code adds the word “required” to its provision on loyalty. This means that loyalty is not interpreted in an objective way; it must be examined whether or not the persons acting knew or could have known that their acts were disloyal.

The Civil Code sets forth the duty to act with required (not expert) knowledge. This reflects the statute’s broad application to all legal entities, including objects as diverse as associations and joint-stock companies. The Civil Code provides a certain amount of flexibility, and courts will have to evaluate the knowledge required in each particular case.

At the same time, taking risks is generally desirable since risky decisions tend to return the highest profits. The pursuit of profit is the reason for companies’ foundation and existence.

The Business Corporations Act requires only such care (thoroughness) as can be reasonably expected of a Board members in connection with their status or profession under section 5 of the Civil Code. The company’s Articles of Association may, however, impose stricter requirements.

The Civil Code sets forth basic rules on proper managerial care, and the Business Corporations Act sets out some special rules which only apply to business companies and cooperatives. 

Business judgement rule

The business judgement rule is one such special rule. This is borne of the fact that businesses always face the risk of failure. Regardless of the quality of decision-makers, this risk can never completely be eliminated since the succeess of an investment depends on many circumstances, and these are not usually under an entrepreneur’s control. At the same time, taking risks is generally desirable since risky decisions tend to return the highest profits. The pursuit of profit is the reason for companies’ foundation and existence.

Since risky investment decisions may be beneficial to a company, laws in many jurisdictions often motivate top managers to make such decisions. If an investment is unsuccessful, then so long as these managers have followed the legal procedure, they have protection against the claims of the company. This is often called the safe harbour doctrine.

Since risky investment decisions may be beneficial to a company, laws in many jurisdictions often motivate top managers to make such decisions.  If an investment is unsuccessful, then so long as these managers have followed the procedural requirements, they have protection against the claims of the company. This is often called the safe harbour doctrine.

In many jurisdictions[1] managers are protected by the business judgment rule if they observe the correct procedure (procedural requirements) when making decisions. According to this doctrine, decisions must usually be based on adequate information and made in good faith that such decisions are in the company’s interests. A court will only consider whether or not these procedural requirements are fulfilled; it will look closely at the process leading up to the decision rather than the decision itself. This reflects the presumption that courts have expertise in the field of law, and not in economics. Not only do courts lack the capacity to examine the decision itself, but it is usually impossible to judge decisions objectively. An exception applies for decisions that were obviously excessive (completely outside the range of all possible reasonable actions). In these cases, the court will probably also examine the decision itself. As a rule, however, in many jurisdictions, top managers are only liable for following due process and not its outcome.

The Business Corporations Act sets forth that managers acted with care and required knowledge when making business decisions if they could reasonably and in good faith have believed that their action was based on adequate information and in the justifiable interests of the company. This rule only applies, however, if the decision was made with the required loyalty.

The Business Corporations Act sets forth that managers acted with care and required knowledge when making business decisions if they could reasonably and in good faith have believed that their action was based on adequate information and in the justifiable interests of the company. This rule only applies, however, if the decision was made with the required loyalty.

Members of the Board of Directors must prove that they compiled adequate information which they then assessed in order to make a decision; they must also show that they were convinced that they had a sufficient understanding of the issue and were acting in the justifiable interests of the company. If managers can prove this, they will be deemed to have acted with loyalty, care and required knowledge, i.e. with proper managerial care.

Under the Business Corporations Act the directors are awarded with a privilege to make mistakes in the business judgment, and they do not need to be afraid of the liability for their decisions, which caused damage to the company, if it is proved that they acted with due managerial care.

The business judgement rule is a protective shield for business decisions, i.e.  investment decisions where there is a risk of failure. The rule does not extend to any other activities. It only applies to companies and cooperatives and not, for example, to associations.

Proper management

There are two basic ways to approach a duty of care: objective approach or subjective approach.

Under the subjective approach, directors must manage their company’s affairs with the same care which they would bring to managing their own affairs. The qualities, abilities and experience of each individual are important. If directors are inexperienced or lack educated and manage the company’s affairs poorly, then they will not be liable for harm if they can prove that their affairs are managed in the same way. On the other hand, a director who has a lifetime of experience, special education or other exceptional qualities and abilities may be liable for damage in cases where other directors would not.

The objective approach to due care holds that members of the Board of Directors must exercise the care that would be taken by a properly acting manager. For these purposes, a properly acting manager is a fictional legal person against whom the actions of the director are measured. The director’s subjective qualities, abilities and experiences are not important. Under this objective approach, directors are not liable for harm if they can prove that a properly acting manager would not have been able to prevent it, even if the exceptional qualities of the particular director would have allowed them to do so. On the other hand, members of the Board of Directors who do their best according to their qualities and abilities, will remain liable if it can be proved that a properly acting manager in their situation would have prevented the harm.

Members of the Board of Directors must prove that they compiled adequate information which they then assessed in order to make a decision; they must also show that they were convinced that they had a sufficient understanding of the issue and were acting in the justifiable interests of the company. If managers can prove this, they will be deemed to have acted with loyalty, care and required knowledge, i.e. with proper managerial care.

Section 52(1) of the Business Corporations Act states that when assessing proper managerial care, consideration should be paid to the care which another reasonably thorough person would have exercised in the same position. This reflects the objective approach: in each individual case, it must be assessed what actions would (or could) have been taken by another reasonable person acting with proper managerial care. On this basis, it can be judged whether or not the manager’s behaviour was appropriate.

While it may appear that Czech law exclusively adopts the objective approach since the Business Corporations Act does not explicitly mention the personal qualities or abilities of directors, this is not entirely the case. The subjective approach enters the picture via section 2912(2) of the Civil Code. It sets forth that if persons (directors) who caused harm have demonstrated special knowledge, abilities or thoroughness, or promised to carry out an activity for which special knowledge, ability or thoroughness was necessary, and they failed to apply these special skills, then their negligence is presumed.

As such, it seems likely that a combination of the subjective and objective approaches will prevail in the Czech Republic. This means that all members of the Board of Directors must meet a certain standard of care and those who have extraordinary qualities, abilities or skills, have a duty to apply them.

Reverse burden of proof

In practice, it very often happened that a company involved in a dispute with a director could not furnish evidence of that individual’s breach since all that evidence was in the hands of the director who predictably refused to surrender it. For this reason, legislators transferred the burden of proof to directors in this situation. This meant that directors had to prove that there had been no breach of their duty to act with proper managerial care.

Under the Business Corporations Act the directors are awarded with a privilege to make mistakes in the business judgment, and they do not need to be afraid of the liability for their decisions, which caused damage to the company, if it is proved that they acted with due managerial care.

The Business Corporations Act states that in court proceedings, the burden of proof falls on the director unless a court decides that this would be unjust. As such, the burden of proof remains with the director, however courts may now transfer it to the company in certain justified cases. This provision reflects that directors are obliged to return all documents to their company when their position terminates. If a company later sues the (ex-) director for damages, then that individuals must both explain their actions and cite evidence in their defence since they bear the burden of proof. There are, however, circumstance when a company receives all documents and then denies their existence. In this scenario, the directors will have no evidence and lose the case although they acted with proper care and the evidence exists.  In the past, this situation opened up a space for constitutional complaints because directors could persuasively argue that their right to due court process, which is guaranteed by the Czech Charter of Fundamental Rights and Freedoms, had been breached.[2]  Under the Business Corporations Act, directors can contest this situation as early as in the court of first instance where they can insist that they should not bear the reverse burden of proof. 

Consequences of breach of due care

The business judgement rule is a protective shield for business decisions, i.e. investment decisions where there is a risk of failure. The rule does not extend to any other activities. It only applies to companies and cooperatives and not, for example, to associations.

The Business Corporations Act states that a person who breaches the duty to act with proper managerial care must provide the company with all benefits gained in connection with the breach. Where a benefit cannot be transferred (returned), the director must provide monetary compensation.

These rules reflect the fact that by breaching their duty to take proper managerial care, directors can gain both monetary and non-monetary benefits. This is the justification for the required transfer of benefits. Monetary compensation is only payable to the company when the transfer of benefits is impossible.

As such, it seems likely that a combination of the subjective and objective approaches will prevail in the Czech Republic. This means that all members of the Board of Directors must meet a certain standard of care and those who have extraordinary qualities, abilities or skills, have a duty to apply them.

At the same time, the transfer of benefits may not be sufficient to fully redress and cover the harm incurred. This harm includes not only damage to property, but also intangible loss. The company has the right to receive compensation for both kinds of loss. Intangible harm is compensated by way of reasonable satisfaction, which is a form of monetary compensation, unless the harm can be genuinely and effectively remedied in some other way.

The Business Corporations Act allows liable directors to conclude a settlement agreement with the company over the harm caused by a lack of due managerial care. The settlement agreement must be approved by the supreme body of a company accepted at least by two-thirds majority vote of all company members.

Executing this agreement has advantages for the company since if the directors fail to discharge their duties, the company will not need to prove the existence of harm. Moreover, if the agreement takes the form of a notarial deed and includes consent to enforcement, the company may use it to file for enforcement and so avoid time-consuming court litigation.

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[1]          Examples are England, the US and Australia.

[2]          Art. 36(1) of the Charter of Fundamental Rights and Freedoms.