Supply chain liability of directors and officers

Introduction

This year’s demand letter to Shell’s board members by the NGO ClientEarth has drawn a lot of attention across corporate boards. Coupled with increasing regulation of supply chains across Europe, the liability of directors and officers for violations of regulatory duties has quickly come into focus.

As the German Act on Corporate Due Diligence Obligations in Supply Chains (LkSG) will enter into force on 1 January 2023, we take a closer look at the potential liability of directors and officers for duties under the LkSG and its coverage under D&O policies in Germany. First, we will look at potential external liability of directors and officers towards third parties, then, we will turn to potential internal liability towards the company and/or shareholders and conclude with liability for fines.

External liability

Bases for claims

Over the past 10+ years, there has clearly been a shift in targets of lawsuits brought by NGOs – initially, the targets were mostly governments. After the (from the NGOs’ perspective successful) Shell decision in the Netherlands, NGOs have focused more and more on corporates and widely rolled out the argumentation used in the Shell case across Europe. Now they are even going after the individuals responsible for a particular corporate strategy.

This raises the question whether such ESG claims against directors and officers would be conceivable in Germany, too.

The first precedents from ESG litigation against companies themselves are not encouraging for NGOs – claims based on the German general tort law provisions (Sec. 823, 1004 BGB) have had only limited success: a lawsuit against RWE is pending on appeal after the company prevailed in the first instance and Daimler prevailed over an NGO in the first instance in proceedings over injunctive relief. However, the LkSG could provide NGOs with another avenue for activist litigation by pursuing the directors and officers of companies instead.

LkSG denies “additional” civil liability

The LkSG itself does not provide a basis for civil liability for violations of the duties set out under the LkSG – Sec. 3(3) LkSG even goes as far as explicitly negating any civil liability for the violation of these duties. The legislative intent has been to not establish a new civil liability of companies or individuals with the LkSG, while at the same time allowing for liability under previously enacted provisions.

LkSG is not a protective law in the sense of Sec. 823(2) BGB

Two general tort provisions come to mind as potential bases for claims: Sec. 823(2) BGB, which awards damages for violations of so-called “protective laws” (Schutzgesetze) – and Sec. 823(1), 1004 BGB for interference with (and damage to) life, body, health, freedom, property or another comparable subjective right of a person.

The prevailing opinion within academia and practice seems to be that the provisions of the LkSG are not protective laws within that sense; the legislative intent also supports this assessment.

LkSG does not confer subjective and enforceable rights to third parties

This leaves Sec. 823(1), 1004 BGB as conceivable basis for claims. It seems highly doubtful, though, that the provisions of the LkSG can be construed as awarding third parties subjective and enforceable rights – the clear legislative intent was to establish a statutory basis for (administrative or criminal) fines only. The latter interpretation acknowledges that the enumeration of rights in Sec. 823(1), 1004 BGB covers the legal interests addressed in the LkSG quite well – there is no need to qualify the LkSG as giving subjective rights.

Ultimately, the correct interpretation will be for the German courts to decide though – as of now, it would be entirely conceivable for an NGO to bring a claim based on Sec. 823(1), 1004 BGB (if only for PR reasons).

D&O coverage

If such claims were granted in a final decision, D&O policies would likely cover any recourse claim for damages brought by companies against their directors and officers who violated duties stipulated by the LkSG (with the usual caveats for intentional behaviour, retention etc.).

Claims for injunctive relief would likely not be covered under D&O policies since the insured losses do generally not include loss of earnings by the company (compare for example A-6.1 of the general insurance conditions of the German alliance of the insurers (GDV conditions)) because of e.g. (i) changes of corporate strategy (even if such a change is court-mandated) or (ii) exclusion from public procurement under Sec. 22 LkSG.

Internal liability

Claims of the company

At least incorporated German companies (e.g. GmbH and AG) will usually have claims against their directors and officers if the latter violate the duties imposed on them by the LkSG since such a violation is also a violation of the directors’ and officers’ duty to act lawfully (e.g. Sec. 43(2) GmbHG, Sec. 93(2) AktG).

Damages (not lost earnings, see above) caused by such violations will generally be covered by D&O insurance policies.

Activist investor lawsuits (claims of shareholders)

ClientEarth’s argumentation in the demand letter to Shell’s board in the UK (i.e. that their status as a shareholder of the company gives rise to claims against the board members for specific performance) should not transfer easily to Germany: German company law sets high thresholds for such derivative shareholder lawsuits, with requirements which will only very rarely be met (see e.g. Sec. 148 AktG) as the company’s best interests will almost always be “overriding grounds” against the assertion of such claims: a cessation of large parts of its business, for example, causes large losses and might even violate the company’s articles of association.

Damages (not lost earnings, see above) caused by violations of the directors’ and officers’ duty to act lawfully (including compliance with the duties set out in the LkSG) would still be generally covered by D&O insurance policies.

Liability for fines

The LkSG stipulates fines (of up to €800,000 for individuals and up to two percent of the company’s annual turnover for corporates) for violations of the duties of care imposed on the directors and officers. Legally, the company acts through its directors and officers, which means that directors and officers (including human rights officers) are the perpetrators of such violations; fines can then be imposed on the directors and officers, on the company or on both. If the company is fined, it might try to claw back any damages from the responsible directors and officers.

Fine imposed on the director or officer

A fine against the director or officer will generally not be covered – the GDV conditions exclude such fines as they are not claims brought against the director or officer based on statutory liability provisions (see A-1 of the GDV conditions).

Fine imposed on the company

If the company has been fined, D&O insurance policies will generally not provide coverage (see A-7.10 of the GDV conditions). Policies from outside of Germany sometimes cover fines, however.

Recourse of the company against the directors and officers

It is a subject of great debate whether a recourse of the company (e.g. under Sec. 43(2) GmbHG or Sec. 93(2) AktG) for fines imposed on it due to violations of LkSG duties by its directors and officers is admissible under German law – some scholars and courts do not want to let the directors and officers off the hook, others argue the same way about the company. All sides eagerly await a clarifying decision of the German Federal Court of Justice.

Even if a recourse would be admissible under German law, it would generally be exempted from coverage under A-7.10 of the GDV conditions, which excludes all coverage for fines against the companies.

Conclusion

While civil claims for violations of the LkSG duties would appear to have limited success right now, companies (and their directors and officers) should already now assess LkSG compliance (for the mandatory risk analysis see our post here), the risk of potential litigation and fines, and insurance coverage. Damages for violations will generally be covered by D&O insurance policies – with the notable exception of fines against the companies or its directors and officers, which are generally non-recoverable under the policies.

In any event, documentation of all actions related to the duties set out in the LkSG is paramount for both companies and individuals.

Future regulation could even expand directors’ and officers’ liability: the “Annex to the Proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937”, which was published on 23 February 2022, explicitly stipulates that companies are liable for violations of their duties under the directive. This could lead to an increase in recourse claims brought against directors and officers.