Incompetence does not protect against liability - on director liability due to incapability

The director of a limited liability company (GmbH) does not have to be able to do everything and can delegate tasks. However, the director must choose any delegee carefully and supervise their work. They cannot rely on their own incompetence to avoid personal liability. The Federal Fiscal Court (Bundesfinanzhof, BFH) confirmed this in a recent judgment.

Judgment of the Federal Fiscal Court of 15 November 2022 in Case No. VII R 23/19

Facts of the case

Since it was founded in 2002, the claimant had been the sole director of A-GmbH and held 90% of the shares. His grandson held the remaining 10% of shares in the company and took over its management on 23 April 2012. Meanwhile, the claimant’s son was an authorised officer (Prokurist) of the company and effectively acted as the executive director. Between 19 March 2007 and 11 July 2011, the GmbH reduced its VAT, corporate tax, and business tax by not submitting certain tax declarations and providing incorrect information in others. These were based on a system of fake invoices and accounting entries without receipts.

On 19 March 2014, a liability assessment was issued against the claimant, his son, and his grandson for the tax liabilities of the GmbH. The claimant filed a protest, and on 30 January 2015 the tax authority reduced the amount of the liability. It also rejected the legal remedy sought as unfounded.

The process

The claimant applied to the Regional Fiscal Court in Münster to have the liability assessment in the form of the objection ruling of 30 May 2015 nullified. He challenged both the basis of the claim and the amount of the liability. The Fiscal Court rejected the application.

Judgment of the Federal Fiscal Court of 15 November 2022

The Federal Fiscal Court unanimously dismissed the appeal as unfounded without hearing any further oral arguments in accordance with § 126a of the Code of Procedures of the Fiscal Courts (Finanzgerichtsordnung, FCO). The liability assessment did not infringe the claimant’s rights.

The managing director of a limited liability company shall be liable in accordance with §§ 69 first sentence and 34 (1) of the Fiscal Code (Abgabenordnung, AO) in combination with § 35 (1) first sentence on the Limited Liability Company Act (Gesetz betreffend die Gesellschaften mit beschränkter Haftung, GmbHG) when the GmbH receives tax rebates or refunds without any legal grounds because the director wilfully or through gross negligence breached the duties imposed on them resulting in the liability arising from the tax debtor-creditor relationship of the company not being determined or not being determined in time. The Federal Fiscal Court held that these conditions were fulfilled.

Following the jurisprudence of the Federal Fiscal Court, the objective breach of duty indicated culpability within the meaning of § 69 first sentence of the Fiscal Code. The claimant tried to release himself from liability by claiming his son actually managed the business of the GmbH and his advanced age and knowledge and abilities meant he was not in a position to reproduce the business transactions in the company software. He claimed that he therefore no fault could be attributed to him. The Federal Fiscal Court countered this line of argument.

Failure to appropriately supervise

First, the BFH held that the claimant failed to appropriately supervise. A director can transfer responsibility for dealing with tax matters of the GmbH to another person. However, he may not blindly rely on this person, but must carefully select them and continue to monitor their work. Under the case law of the BFH, failure to appropriately supervise establishes a grossly negligent breach of duties within the meaning of § 69 of the Fiscal Code. More stringent requirements must apply to supervisory measures, the less the director is able to form a judgment based on the facts and depending on whether the person(s) delegated with dealing with the tax matters of the company provides the necessary guarantees that they will deal with these matters reliably.

The BFH also did not accept the claimant’s argument, that a managing director acting with due diligence would not have identified the fake invoices and accounting entries without receipts, which the son had entered in the accounts, without any further investigation and knowledge. In the Court’s view, the claimant could have easily ascertained that 34 entries were made without receipts had he looked in the accounts. Further, the claimant sanctioned the de facto management by his son and allowed him to do what he did without sufficiently supervising him.

Incompetence is not an excuse

In particular, the BFH countered the claimant’s argument that, due to his knowledge and abilities and in particular his advanced age, he was not able to follow the business transactions in the company software.

If a director has the lack of skills and knowledge that the claimant described, they should not manage a GmbH at all. If they are no longer able to perform their duties, the director must resign.

Practical significance

The judgments show that neither the delegation of duties nor incompetence can exonerate a director from their (tax) liability.

These principles apply to more than just the personal liability of directors for the tax liabilities of the company. The legal situation of the internal relationship between the company and the director is similar. Every director must exercise their duties with the care of a prudent businessman. If the director intentionally breaches their duties, they must make good any arising damage to the company, § 43 (2) of the GmbHG. The standards for diligence will depend on the specific relationship of each company, as well as their size and activities. Neither the extent of the director’s duties nor the question of liability depends on the personal qualities, age, or experience of the director.

This does not mean that a director must know and be able to do everything. Certain aspects of management may be delegated to lower levels of the company or third parties. The duty to keep orderly accounts, which was the subject of this judgment, is something that the director must “ensure” under § 41 of the GmbHG. They are not required to perform the work themselves, but the responsibility for the proper discharge of the duty remains with them. If they delegate the accounting role to employees or an external tax advisor, the director has the duty to select this person with care, and to carefully instruct them and monitor their work. In addition, they must always be able to access accounting documents and take corrective action where necessary.

A director can seek expert advice on specific legal or even tax questions and thus be released from liability. If a director follows the advice they receive and still breaches their duties, they will not be acting culpably when the mandated (tax) advisor is independent and professionally qualified, the director provided the advisor with the correct and full facts and the director performs their own plausibility control of the advice received.

At its core, the judgment confirms that where a director is personally incapable of performing their duties, they should not take up the position of director or should resign. However, this needs some clarification. Directors have responsibility for the company management, but do not have to perform every task personally. If they delegate a task, they must select the delegee with care and instruct and supervise them. If the director is unable to fulfil these selection and supervision duties, they should refrain from taking up a position as director given the strict standards of officer liability.

Dr Barbara Mayer
Etienne Sprösser