My understanding of the current economic crisis isdrawn from several recent meetings and conferenceswith such distinguished luminaries as David S. Ruder,the Former Chairman of the SEC, who currently teachesat Northwestern Law School and Eric Talley, who is aVisiting Professor at Harvard Law School, as well asseveral securities lawyers from Arnold & Porter.According to David Ruder, we are in a period of

“Shock and Awe.” The U.S. Government is bailing outbanks, fixing the housing crisis, and engineering abailout. This period all started with subprime loans thatwere encouraged by the Federal Government.Financial institutions then sold the loan to a third partyto free up their balance sheets to make more loans.Until very recently, the third party buyers were GinnieMae, Freddie Mac or Fannie Mae, which were U.S.Government owned or sponsored entities, along withprivate institutions. The buyers then bundled the mort-gage loans with others and sold off the payment rightsto investors in the form of mortgaged-backed securities(MBS’s).MBS were then collected and securitized, becoming

pools of bonds backed by pools of other bonds, whichare referred to as collateralized debt obligations(CDO’s). Investment banks bundled these CDO’s,sliced them into different tranches based on theirinvestment grade, diced them again and sold them toinvestors. Neither the investments banks nor the

agencies that rated the investment banks and theirproducts understood the CDO’s.Credit default swaps (CDS’s) were derivative

trading instruments that were used by buyers to hedgeagainst the possibility of losses from MBS’s andCDO’s. The largest traders of CDS’s were BearStearns, Lehman, and AIG.An enormous proportion of the U.S.’s total debt was

invested in a single market, which was housing,through the offering of CDO’s. At the top of this

Uniting Plaintiff, Defense, Insurance, and Corporate Counsel toAdvance the Civil Justice System

Spring 2009

INTERNATIONALCOMMITTEE

CommitteeNewsCommitteeNews

IN THIS ISSUEMessage From The Chair . . . . . . . . . . . . . . 1D&O Liability Under ItalianBankruptcy Law. . . . . . . . . . . . . . . . . . . . . . 4Corporate Insolvency And D&O LiabilityIn The Netherlands - Dutch Bargain ForTrustees? . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5Liability Of Managing Directors In AGerman Corporate Insolvency . . . . . . . . . . 6France Clarifies D&O Liability InBankruptcy . . . . . . . . . . . . . . . . . . . . . . . . . . 7TIPS 2009 Calendar. . . . . . . . . . . . . . . . . . 12

Continued on page 3

MESSAGE FROM THE CHAIRPerry Granof chaired the C-5 16th D&O Liability Insurance Conference in London, England, on March 25, 2009.This message is an excerpt from his opening remarks.

2

ChairPerry S Granof

1147 Longmeadow LnGlencoe, IL 60022-1022

(847) 242-9932pergran5@aol.com

Chair-ElectGary L Gassman

Meckler Bulger & Tilson LLPSte 1800

123 N Wacker DrChicago, IL 60606-1770

(312) 474-7994Fax (312) 474-7898

gary.gassman@mbtlaw.com

Last Retiring ChairShirley J Spira

Apt 10KE315 E 86th St

New York, NY 10028-4794(917) 576-6691

Fax: (212) 427-8009knoibn@gmail.com

Membership Vice-ChairJohn C McMeekin IIRawl & Henderson LLP

Fl 161339 Chestnut St

Philadelphia, PA 19107-3597(215) 575-4324

Fax: (215) 563-2583jmcmeekin@rawle.com

Newsletter Vice-ChairShirley J Spira

Apt 10KE315 E 86th St

New York, NY 10028-4794(917) 576-6691

Fax: (212) 427-8009knoibn@gmail.com

Website Vice-ChairPaul Jeff Perez

67-09 150th StFlushing, NY 11367-1423

(212) 351-4758pperez06@nyls.edu

Vice-ChairsTerry Bruner

US Department of HUD3015 Clearview Cir

Houston, TX 77025-5917(713) 478-1647

terry.c.bruner@hud.gov

Michael DisilvestroMedia Professional Insurance

Ste 8002300 Main St

Kansas City, MO 64108-2404(913) 652-6858

Fax: (816) 471-6119mike.disilvestro@mediaprof.com

Rusty Monet MesserKoch & Messer533 Europe St.

Baton Rouge, LA 70802(225) 927-9477

Fax (225) 336-4734rusty@messerfirm.com

Ronald L OhrenBaker & McKenzie LLPOne Prudential Plaza

130 East Randolph Drive, Suite 3500Chicago, IL 60601-6342

(312) 861-8000Fax (312) 861-2899

ronald.l.ohren@bakernet.com

Sarah Powell200 Whixley Ln

Lexington, SC 29073-7019sarah22184@earthlink.net

Law Student Vice-Chair

Yaschar SarparastDistrict Attorney

316 Main St.Klamath Falls, OR 97601

(509) 318-0119ysarpa@lawschool.gonzaga.edu

Joseph TornbergAmerican International Group

L4-022929 Allen Parkway

Houston, TX 77019-7100(713) 831-6190

Fax (713) 831-4427joseph.tornberg@aig.com

Mark E WojcikThe John Marshall Law School

315 S Plymouth CtChicago, IL 60604-3968

(312) 987-2391Fax: (312) 427-99747wojcik@jmls.edu

©2009 American Bar Association, Tort Trial & Insurance Practice Section, 321 N Clark St, Chicago, Illinois 60610; (312) 988-5607. All rightsreserved.The opinions herein are the authors’ and do not necessarily represent the views or policies of the ABA, TIPS or the International Committee.Articles should not be reproduced without written permission from the Tort Trial & Insurance Practice Section.Editorial Policy: This Newsletter publishes information of interest to members of the International Committee of the Tort Trial & InsurancePractice Section of the American Bar Association — including reports, personal opinions, practice news, developing law and practice tips by themembership, as well as contributions of interest by nonmembers. Neither the ABA, the Section, the Committee, nor the Editors endorse thecontent or accuracy of any specific legal, personal, or other opinion, proposal or authority.Copies may be requested by contacting the ABA at the address and telephone number listed above.

Visit theInternational web site at:www.abanet.org/tips/international/home.html

market, the prevailing view was that people did notnormally default on mortgages, and if they did, realestate values would rise to offset mortgage losses.However, MBS’s grew from U.S. $157 billion in 2000to U.S. $1.2 trillion in 2006. Further, the overallissuance of subprime MBS’s grew from U.S. $96billion in 2001 to U.S. $483 billion in 2006.Then, a rise in interest rates of 17 percent between

2004 and 2007, with concomitant increases in mort-gage rates, ignited a crisis. Delinquency and defaultrates soared, and homeowners with subprime mort-gages could not easily refinance or sell their homes.Sales of homes in default forced by subprime mort-gagors caused further downward pricing pressure.The GAP rule that required that CDO’s be valued on

the basis of “mark to market,” trigger unprecedentedinsolvencies of such venerable U.S. financial institu-tions as Bear Stearns, Lehman Brothers, Merrill Lynch,Freddie Mac, Fannie Mae, Citibank and AIG. Equallyrespected foreign institutions, including ING and theRoyal Bank of Scotland, and nations such as Icelandand Poland were also rendered effectively insolvent.The U.S. Government response to the crisis was

inconsistent. Certain institutions were shepherded intoforced mergers with financial assistance: Bear Stearnswas merged with JP Morgan and Merrill with Bank ofAmerica. The U.S. Government effectively took overFreddie Mac and Fannie Mae, and TARP funding was

provided for myriad financial institutions, whether theyneeded it or not. Other financial institutions, notablyLehman, were allowed to fail, while significant finan-cial guarantees were provided to AIG and CitiGroup.The natural result of this crisis has been a plethora of

lawsuits. Initially, there were borrower class actions,primarily against mortgage companies, commercialbanks, and thrifts. The core allegations of these caseswere fraud in the borrowing process; misrepresentationof interest rates, fees and mortgage terms; and violationsof state unfair business practice statutes. The secondwave of lawsuits were U.S. securities class and deriva-tive actions filed in connection with stock value losses,and were primarily filed by financial institutions.Shareholders claimed that public companies madematerially false and misleading public statements, andalleged a fundamental failure to disclose institutionalexposure to subprime risks. The last tranche of casestargeted originators and underwriters, and was filed bypurchasers of subprime assets alleging misrepresenta-tion in offering documents and suitability, as well asstate law claims for, e.g., common law fraud, breach ofcontract, and breach of fiduciary duty.To assist our readers in assessing the global impact

of the current financial crisis on corporate insurancecoverage, the International Committee of TIPS offerssummaries of the D&O laws of European nations asthey relate to claims in bankruptcy. This issue will befollowed with a similar issue addressing the laws ofcommon law nations on D&O claims in insolvency.We hope that this brief overview will prove as fasci-nating to read as it was to edit.

3

MESSAGE FROM THE CHAIR...Continued from page 1

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D&O LIABILITY UNDER ITALIAN BANKRUPTCY LAWBy: Riccardo Buizza, Partner, Eversheds, Milan, Italy

Riccardo Buizza is a partner with Eversheds Piergrossi Bianchini in Milano, Italy. He heads the firm’s dispute resolution group and leads itsinsurance and reinsurance advisory and dispute resolution group. Riccardo focuses on domestic and international litigation and arbitration, as wellas other complex commercial litigation, including product liability, environmental disputes, financial services and bankruptcy-related disputes.1. A Bit of HistoryThe word bankruptcy derives from the Italian word

bancarotta (broken desk), which was the typical sanctionapplied in medieval Italy to bankrupt tradesmen orbankers – the desk breaking - i.e. the breaking of thetradesman/banker’s money table. The Italian city-statesof Siena and Vercelli, during the 1220’s and 1240’srespectively, already had bankruptcy laws providing fora collective recovery of debts directed by public officialsand having a criminal nature, since they aimed to punishinsolvent debtors. The most common sanctions werevery harsh, such as banishment or even the death penalty.Jumping to modern times, the current Italian

Bankruptcy law was introduced in 1942 and remainedunchanged until 2007, when it underwent a rather radicalreform. While the previous regime was mostly based ona judicial liquidation structure, the new law has intro-duced a number of alternatives which aim at preservingthe company’s business and, whenever possible, itsrestructuring and continuance. Since most D&O liabilitycases in a bankruptcy context take place in a “pure”bankruptcy procedure, i.e. a judicial liquidation, thisarticle addresses D&O liability within such a scenario.2. Basic Rules of the Italian Bankruptcy System.All companies having their registered office or prin-

cipal place of business in Italy, except for so called“small” companies,1 are subject to Italian bankruptcy law.Bankruptcy proceedings in Italy are usually

complex and capable of lasting several years.Generally the proceedings run as follows:• filing of the petition by one or more creditors, orby the debtor itself, or by the public prosecutor;

• the Court issues the bankruptcy declarationorder (“sentenza dichiarativa di fallimento”)and appoints the Bankruptcy Receiver (“cura-tore fallimentare”);

• the Receiver prepares the creditors’ list and rankorder (“verifica dello stato passivo”);

• the Receiver liquidates the debtor’s assets;• the proceeds of the bankruptcy estate (if any) aredistributed to the creditors2.After declaring bankruptcy, the debtor cannot

continue trading, unless the Court expressly authorizesthis for a limited period of time, which rarely happensin practice in a “pure” bankruptcy. The Bankruptcydeclaration results in the immediate suspension of thepayment of all debts and liabilities of the debtor, anylegal actions brought by creditors are stayed, and somepayments made, securities given or transactions enteredinto by the debtor within the so-called “suspect period”prior to the declaration of insolvency are subject toclaw-back actions.The Court-appointed Receiver has the power to

collect assets, bring legal actions in relation to thedebtor’s claims and otherwise manage the debtor’s assets.3. Who are the “Directors and Officers” of a

Company under Italian Law?They are:• the members of the Board of directors or the soledirector;

• the members of the Board of internal auditors3;• the company’s General Manager4;• the Liquidator(s), if prior to the bankruptcy thecompany underwent a voluntary winding-upproceeding.

4. Who can Sue the Directors and Officers?If a company is in good standing, the liability action

against its directors and officers may be brought by thecompany itself or by the company’s creditors or by thecompany’s shareholders. However, D&O liabilityactions are very seldom brought by shareholders in Italy5.The vast majority of such actions are brought either bythe company itself or by the company’s creditors.

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1 Commercial companies are subject to bankruptcy only if they meet all of the criteria: the average value of the business assets during the previous three fiscal years must exceed€ 300,000.00; the average gross annual turnover during the previous three fiscal years must be higher than €200,000.00; the total debts must exceed € 500,000.2 Privileged creditors typically are the company’s employees and creditors holding a mortgage or pledge over the debtor’s assets.3 The Board of internal auditors has the duty to supervise the company’ management in order to safeguard the interests of the shareholders and of the creditors of the company.4 The General Manager is the highest ranking employee of the company, immediately below the Board of directors and is subject to the same liability of the directors only ifappointed by the shareholders’ meeting.5 This is due to the fact that shareholders must prove to have suffered a “direct” damage, as opposed to an “indirect” damage such as a decrease in the values of their shares; such“indirect” damage does not entitle a shareholder to sue the company’s directors and officers.

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CORPORATE INSOLVENCY AND D&O LIABILITY IN THENETHERLANDS - DUTCH BARGAIN FOR TRUSTEES?By: Annemieke Hendrikse, Lawyer, Van Doone N.V., Amsterdam, The Netherlands

Annemieke is a lawyer at the Dutch law firm Van Doorne N.V., based in Amsterdam. She specializes in D&O liability and insurance lawin both contentious and non contentious matters. She represents various D&O liability insurers and/or their insureds in high profile casesand has a particular interest and experience in disputes with an international element.Ceteco N.V., the Dutch top holding of an interna-

tional concern, went bankrupt in May 2000. Its activi-ties included not only the production and wholesale ofaudiovisual equipment and white goods, but also retailand consumer finance. Ceteco focused strongly on theLatin-American market. Between 1991-1996 Cetecoimplemented an ambitious growth model for its retailactivities by selling its products to the financially weakon credit. As from 1993 an accelerated growth planwas put into effect and Ceteco gained access to fivenew markets by acquiring local companies.The trustees of Ceteco have brought claims against

the managing and supervisory directors among others.In December 2007 the district court of Utrecht honoredthe trustees’ claims to a large extent. The directorswere held liable for the deficit in the bankruptcy, as yetto be assessed in separate proceedings, and ordered tomake an advance payment in the amount of EUR 50million. The judgment was criticized as, in short, beingtainted by hindsight bias of the court, and appealproceedings are currently pending. The judgment is notenforceable pending appeal.In the Netherlands, most claims against managing

and supervisory directors of limited liability companiesare made by trustees in bankruptcy. This is largely dueto the specific statutory ground for personal liability ofdirectors’which can only be invoked by trustees, as laiddown in S. 2:138 of the Dutch Civil Code (DCC) forpublic companies and S. 2:248 DCC for privatecompanies. For reasons explained below, the threat ofdirector’s liability on the basis of these provisions is amuch used route for Dutch trustees to increase theestate’s assets, in particular if covered by D&O liabilityinsurance.This article aims to provide a brief introduction to S.

2:138/248 DCC. It also highlights recent court deci-sions in the Ceteco case on the (im)possibility of anattachment on D&O liability insurance in theNetherlands.S.2:138/248 DCC stipulate that in the event of bank-

ruptcy of a company each of its directors severally shallbe liable for the amount of debts remaining unpaid afterrealization of the company’s assets, if they havedischarged their duties in an obviously improper

manner and there is prima facie evidence to showthat this has been a major cause of the company’sbankruptcy.The risk of liability regards bonafide directors

(acting negligently) as well as directors who act in badfaith. “Obvious mismanagement” should be read tosignify: a grave mistake which exceeds the free marginof entrepreneurial risk. This concept is construed rela-tively broadly.Although the trustee is faced with a double burden

of proof in respect of the obvious mismanagement andit being a major cause of the bankruptcy, S. 2:138/248DCC also provide for two irrefutable presumptions. Inthe event of inadequate compliance with accountkeeping or publication obligations in respect of theannual accounts, first an obviously improper dischargeof duties is given and no evidence to rebut this conclu-sion is allowed. Secondly, in such case the obviousmismanagement is deemed to be a major cause of thecompany going bankrupt. D&O’s can, in such situation,only escape liability by making a reasonable case thatother facts and circumstances are an important cause ofthe company’s bankruptcy. An example may be thecredit crunch.If the court establishes obvious mismanagement on

the basis of S. 2:138/248 DCC, the directors are jointlyand severally liable for the whole deficit of the estate.Furthermore, a previous discharge will not bar anyclaims of the trustee on this ground.The harsh consequences of liability on the basis of

these provisions are mitigated by their application onlyto mismanagement in the period of three years prior tothe bankruptcy, the possibility of exoneration if an indi-vidual director proves that he or she is not to blame forthe improper discharge of duties and has not beennegligent in taking measures to avert the consequencesthereof and the power of the courts to mitigate theamount of money the directors are liable to pay.However, mitigation of damages will not be ordered ifthe damages are covered by an insurance policy or, ithas been argued, should not be ordered if insurancereasonably should have been taken out in respect ofthese damages.

Continued on page 10

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LIABILITY OF MANAGING DIRECTORS IN A GERMAN CORPORATEINSOLVENCYBy: Dr. Oliver Sieg and Corinne SeidelIn 2004 about 40,000 corporate insolvencies were

registered in Germany. By 2008, in the wake ofGermany’s economic boom, insolvencies decreased toaround 30,000. Although the global financial crisis didnot lead to a noticeable rise in corporate insolvencies in2008, a considerable increase is expected in 2009. Asthe global credit crunch increases insolvency risks, sowill concomitant personal exposures on the part ofcorporate directors. We offer a preliminary summaryof those exposures below.The Classic ScenarioIn a classic scenario a company becomes insolvent

because of illiquidity or over-indebtedness. Conse-quently the company is unable to repay its creditors.Creditors are unlikely to recover the full amount of

their unsecured claims against the insolvent corpora-tion; as a result, their incentive to file personal claimsin tort or negligence against the managing directorsincreases. The insolvency administrator (whose roleresembles that of the U.S. Trustee) is charged withincreasing the amount of insolvency assets, in order toincrease the funds available for the creditors. One wayof increasing the assets is to prove that a managingdirector tortiously or negligently caused the company’sassets to diminish.Tortious WrongdoingAs a general rule, German liability statutes provide

that only a company, not its managing directors, can beheld liable for a wrongful act. However, in some casesthe managing directors can be held directly liable to theinsolvent company itself. For example, when a majorpublicly listed German corporation became insolvent in2001, the insolvency administrator filed a claim againstits managing directors for damages in the amount ofapproximately € 2,000,000. The claim was based onthe allegation that the managing directors had grantedloans without sufficient solvency checks and collateral.The court sustained the action, and the managing direc-tors were held liable to indemnify the corporation forthe resulting damages.A managing director can also be held liable in tort

under Section 15a of the German Insolvency Code –“Insolvenzordnung” if he is proven to have delayed infiling the corporate bankruptcy petition. This isreferred to as obstruction of bankruptcy. Themanaging director who is found to have obstructed the

bankruptcy is held personally liable for any paymentsmade despite the insolvency and for any damagesarising from the belated filing of the petition. Thus,the claimant in these cases can either be the creditorsof the insolvent company or the insolvent companyitself.The Corporate ClaimThe insolvent company can claim damages for

payments that were made by the managing directorswhen the company was in fact insolvent. Either section92 paragraph 2 of the German Stock Companies Act(“Aktiengesetz”) or section 64 of the German LimitedLiability Company Law (“GmbH-Gesetz”), will apply,depending upon the organizational form of thecompany. Section 64 of the German Limited LiabilityCompany Law (“GmbH-Gesetz”) is similar to thestatute of the German Stock Companies Act, and can betranslated as follows:“The managing directors are obligated tocompensate payments which were made after theoccurrence of illiquidity of the company or afterthe identification of over-indebtedness. This doesnot apply for payments which are even after thispoint of time consistent with the diligence of arespectable manager. […]”(Sec. 64 GmbH-Gesetz)The claiming company bears the burden of proof

that it was already insolvent when the managingdirector initiated the payments in dispute. In themajority of these cases the managing directors contesteither the fact of insolvency at the time of payment orthe illegality of the payment.In 2007 the Federal Court of Justice heard a case in

which the managing director of a start-up companydisputed the illegality of payments that he had made onbehalf of the company. According to an auditor’sreport prepared in August 2001, the company had beeninsolvent since the end of 2000. Despite knowing ofthe corporate insolvency, the managing director madepayments to the social security system in the totalamount of approximately €80,000 after August 2001.As the company had been indisputably insolvent bythe time the payments were made, the managingdirector would generally have been liable to reimbursethe corporation for the payments. However, in this case

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FRANCE CLARIFIES D&O LIABILITY IN BANKRUPTCYBy: Sylvain RieuneauSylvain Rieuneau is a partner with Bernard Hertz Bejot, a medium-sized firm of French attorneys, located in Paris, France, providing global legalservices both in transactional and litigation matters, with an emphasis cross-border relations. Sylvain Rieuneau chairs the industrial liability andinsurance department and specializes in Directors’ and Officers’ liability insurance, typically in stock-exchange and bankruptcy matters.

Although no statistics are available, directors and offi-cers of French companies are most likely to incurpersonal liability when their corporations declare bank-ruptcy. French statutory law has provided for manydecades that where the corporation’s assets prove insuffi-cient to cover its outstanding liabilities, any de jure or defactomanager (“dirigeant”) may be held personally liableto pay for the corporation’s residual liabilities. Suchliability arises if he or she, prior to the bankruptcy judg-ment, committed a “management fault” which somehowcontributed to the corporation’s insolvency, whether byincreasing its liabilities or by diminishing its assets (art.180 of the law No.85-98 of 25th January 1985, codified in2000 as art. L.624-3 of the Commercial Code, thereafterrenumbered as art. L.651-2 of the Commercial Code bythe law No.2005-845 of 26th July 2005).A French corporation’s de jure managers are its

general manager and members of the board of directors,including the permanent representative of any directorthat is a legal entity. It is also worth noting that someFrench corporations have adopted a German-stylecorporate management structure, which is composed ofa Directorate that manages the company under thesupervision of a Supervisory Board. In this model, onlythe members of the Directorate are “dirigeants”, i.e.managers of the corporation. A de facto manager may,for example, be a majority shareholder/parent company,or possibly a creditor (e.g. a bank) that is directlyinvolved in the day-to-day operation of the company.The French notion of management fault is very

broad. In practice, virtually any conduct that caused acorporate loss is likely to be qualified as such in retro-spect. Typical instances of management fault include,e.g., failure by the directors to exercise adequatecontrol over the CEO, including by failure to attendboard meetings, permitting a company that chronicallyoperates at a loss to continue doing business, andfailure by the CEO to file for bankruptcy within theperiod of time prescribed by law (currently 45 daysfrom the date when the corporation becomes unable tomeet its due and payable debts with its available cash).Managerial responsibility to cover the bankrupt

corporation’s asset deficiency departs significantlyfrom ordinary principles of French liability law. In fact,its application is left to a very large extent to the discre-tion of the bankruptcy courts, which makes case law onthe subject rather arbitrary and unpredictable. Where

the defendant is also a shareholder, the practice alsofrustrates the principle of limited liability.Thus, legal action may be instituted against some

directors and not others, liability may be ordered on ajoint or on a several basis, etc. In addition, a directormay be held liable for the full amount of the insuffi-ciency of assets, even though he was in fact onlypartially at fault in causing the corporate bankruptcy.The only statutory requirement is that the faultsomehow “contributed” to the insufficiency of assets.This was the outcome in the famous Nasa Electroniqueprecedent decided by the French Supreme Court (“Courde cassation”), on January 3, 1995 (Cass. com., 3rd Jan.1995, Nasa Electronique, Bull. Joly 1995, § 84, p.266,n. Couret),where the defendant, who was the permanentrepresentative of a legal entity director holding only 5percent of the voting shares of the corporation, was heldliable, jointly and severally with the other directors, topay for the whole insufficiency of assets (about € 61million), regardless of the fact that his fault had admit-tedly caused only a modest portion of the damage.Conversely, the bankruptcy court may validly decide toimpose no damages on a director who contributed to theinsufficiency of assets through his faulty management,if such impunity is deemed appropriate in view of theparticular circumstances of the case.Although directors’ and officers’ liability for corpo-

rate losses is considered to be an insurable “civil”liability, in practice it operates as a personal sanction.This is illustrated by the fact that, regardless of themagnitude of the loss, the court has discretion either toadjust the amount of the damages imposed on eachdefendant to the seriousness of his/her fault or, in thealternative, to each defendant’s financial wherewithal.To that end, the Commercial Code authorizes the bank-ruptcy court to investigate the financial status of thedefendants with third parties like the tax authorities,any professional secrecy notwithstanding.D&O Direct Responsibility for CorporateLiabilitiesLaw No. 2005-845 of July 26, 2006 changed French

bankruptcy law substantially, by creating a new debtorin possession process (“procédure de sauvegarde”)similar to Chapter 11 in the U.S., and by granting banksa legal immunity from lender’s liability where theborrower is later adjudicated bankrupt. This law also

Continued on page 9

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9

created a new kind of liability bearing on D&Os knownas the obligation to bear the corporate debts (“obliga-tions aux dettes sociales”, art. L.652-1 of theCommercial Code).In case of liquidation of the corporation, any de jure

or de facto manager found to have committed one orseveral specifically listed faults evidencing fraud ordishonesty, may (again, not “must”) be held liable topay for all or part of the company’s liabilities (notsimply the insufficiency of assets), where said fault(s)somehow contributed to the company’s inability tomeet its due and payable debts with its available cash,namely:1. using the company’s assets as his/her own;2. carrying out business in his/her personal interestunder the guise of the corporation;

3. using the corporation’s assets or credit toachieve a personal interest, or to promote a thirdparty entity, or business in which the defendantholds a direct or indirect interest;

4. abusively maintaining, for his/her own benefit,a chronically loss-making operation that couldonly end up in the corporation’s insolvency;

5. concealing some of the corporation’s assets orfraudulently increasing its liabilities,When the French Legislature enacted art. L.652-1 of

the Commercial Code, which went into effect onJanuary 1, 2006, it clearly intended to create a new kindof civil sanction. The insurability of this penalty wasaccordingly debatable, because under French law,criminal, administrative, fiscal and even civil penaltiesare uninsurable as against public policy. It should bepointed out that it is not clear that U.S.-style punitive ortreble damages are insurable under French law. Asregards domestic law, a panel of prominent scholars

issued a draft report a few years ago, aimed atreforming the sections of the Civil dealing with “oblig-ations”. This report recommends creation of a new art.1371 in the Civil Code introducing the new concept of“punitive damages” into French civil law in case of“manifestly deliberate fault, including a lucrativefault”. The draft art. 1371 of the Civil Code ends byproviding that “punitive damages are not insurable.”This report has not been shaped into a bill submitted toParliament yet).Scholars and practitioners criticized art. L.652-1 of

the Commercial Code as superfluous, because it over-lapped with art. L.651-2’s provisions regarding mana-gerial liability for corporate insolvency. Accordingly,presidential ordinance No.2008-1345 of December 18,2008, effective February 15, 2009, repealed art. L. 652-1 of the Commercial Code. Liability actions based onthe repealed article that were pending as of February15, 2009 remain unaffected.As a result, the only pecuniary liability that a

director or officer may now incur in a bankruptcycontext is the liability to pay for the corporation’s insuf-ficiency of assets under art. L.651-2 of the CommercialCode, the wording of which was somewhat adjustedby the December 2008 ordinance. In particular, art.L.651-2 of the Commercial Code was expanded toprovide that where at the same time a creditor of thebankrupt corporation (which is often the case of aparent company holding a shareholder current accountin the corporation), the defendant may not participate inthe distributions of liquidation proceeds up to theamount he is ordered to pay (in other words, the defen-dant may not receive as liquidation dividends what hewas ordered to pay as damages).All in all, the ordinance of December 18, 2008

brought a welcome clarification to French bankruptcylaw on D&O exposure, although liability to cover thecorporation’s insufficiency of assets remains poten-tially severe and in any case unpredictable.

FRANCE...Continued from page 7

the Federal Court of Justice held that the payment ofsocial security contributions constitutes diligentconduct by a managing director, based on the fact thatthe non-payment of social security contributions is acrime.Claims by CreditorsIn practice, section 15a of the German Insolvency

Code, distinguishes between “old” and “new” creditors,i.e., creditors who had that status before, as opposed to

those who acquired it after, the corporation’s insolvency.The old creditors, who in these cases are always repre-sented by the insolvency administrator, can only claimdamages in the amount of the reduction of the insol-vency estate due to the delay of insolvency proceedings.These claims, however, are rather rare, because of thedifficulty of proving the actual amount of damages.By contrast, the Federal Court of Justice has issued

numerous decisions holding that new creditors canclaim damages caused by their detrimental reliance onthe company’s assurances that it would continue inbusiness.

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D&O InsuranceAlthough managing directors face great risks of

personal liability in corporate insolvencies, theclaimants bear the risk that they will be unable torecover from a managing director if he becomes

insolvent. Hence, claimants are encouraged to filewhen they know that the corporation has a policy witha solvent D&O carrier. It is therefore imperative thatD&O insurers analyze all potential risks with regard toinsolvencies, and that they provide for these risks intheir D&O insurance contracts.

S. 2:138/248 DCC not only apply to managingdirectors, but also to supervisory directors and toso-called shadow directors. These are persons whohave determined the company’s policy as if they weredirectors.In the Ceteco case, the trustees only invoked the

applicability of the assumptions of proof explainedabove in a late stage of the proceedings. The districtcourt was, however, of the opinion that the trustees hadsufficiently proven that obvious improper managementwas a major cause of the bankruptcy in any event.According to the district court, such improper manage-ment consisted of the continuation of the acceleratedgrowth model, whereas the directors knew that thisinvolved the risk of over extension and knew or shouldhave known that this risk materialized, causing thecompany to be out of control. Timely measures couldhave prevented the company from having to file forbankruptcy.Shortly after having obtained this favorable judg-

ment and while the directors had lodged appealproceedings, the trustees tried to obtain a garnishmentorder to attach the D&O liability insurance. Both theD&O’s and the D&O liability insurers argued againstsuch attachment in court, in particular against anattachment in connection with any claims for thecompensation of defense costs as it could effectivelybar the D&O’s from putting up a proper defense, whichwould harm the interests of both the D&O’s and theinsurer. For this reason, the district court refused togrant leave for the attachment, although it recognizedthat the trustees had an interest in protecting theirmeans of recovery. The fact that the trustees had prom-ised that they would not object to reasonable defensecosts being paid notwithstanding the attachment, did

not alter the court’s opinion that such attachment wouldharm the interests of the D&O’s and their insurerdisproportionately and violate the principle of equalityof arms, as the trustees, being the D&O’s opponents,were not to decide upon the reasonableness of anydefense costs (to be) incurred.The appeal court came to the opposite conclusion,

mainly because it assumed that the D&O’s were in aposition to pay for their defense costs themselves andwould do so as well, having regard to their obligationvis-à-vis the D&O liability insurer to defend them-selves against claims. Accordingly, the court rejectedthe argument of the D&O’s and the insurer that theattachment on defense costs would violate the nemoplus principle, as it would not place the trustees asgarnishor in a better position vis-à-vis the D&Oliability insurer than the D&O’s as insureds. It alsorejected the argument that the attachment would violatethe non peius principle as it would not harm the D&Oliability insurer. Not surprisingly, it concludes thatequality of arms is not at stake.The Dutch Supreme Court will have to cut the knot.

It should be noted that many Dutch D&O policiesmeanwhile try to eliminate the risk of attachment, byentitling the insurer to use cover to pay external counseldirectly instead of granting the insureds the right toobtain compensation. Another possible solution couldbe the assignment of the rights of the insureds to theD&O liability insurer, prior to the attachment.The Ceteco case illustrates the serious threat of

successful claims by trustees against the directors of aDutch company for the whole deficit of the estate. Inpractice, this is Dutch bargain for the trustees, as theassumptions of proof are often triggered, whereas thepossibility of exoneration only offers Dutch comfort tothe directors and their insurers, as it is difficult to meetthe relevant burden of proof.

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When a company declares bankruptcy, both thecompany’s and the creditors’ causes of action passautomatically into the hands of the Court-appointedBankruptcy Receiver, which is entitled to bring suitupon the prior approval of the Bankruptcy Court.Any proceeds resulting from the liability action(s)

brought by the Receiver go into the bankrupt estate andmust be used to pay off the company’s creditors.5. What Court Has Jurisdiction?Only the Court of the place where the registered

office of the company (or its principal place of busi-ness) is located has the power to issue an insolvencyorder and has exclusive jurisdiction for any actionbrought by or against the bankrupt company. It hasalso been clarified that – in order to avoid the risk of“forum-shopping” – any change of the place of busi-ness made on the part of the debtor within the year priorto the filing of the petition is to be regarded as ineffec-tive when determining the competent court.6. What is the statute of limitations?The statute of limitations is five years.

7. What Criteria are Used to Quantify Damagesin a D&O Bankruptcy Liability Action?Until very recently, the bankruptcy Courts simply

quantified the damages by calculating the differencebetween the assets and the liabilities of the company atthe time of the bankruptcy declaration. Such a punitiveand unsophisticated approach (in an Italian bankruptcy,assets seldom exceed 5 percent of the liabilities) hasstarted to change lately, in favor of a precise quantifica-tion of the damages resulting from the specific viola-tion(s) of the D&O duties that are the object of the claim.8. How Does a Liability Action Work and HowLong Does it Last?In the Italian legal system the concept of pre-trial

discovery does not exist, and oral arguments play aminor role. In 2005 a special procedure for corporatelitigation (including D&O liability actions) was intro-duced, but it is expected that this special procedure willshortly be superceded by ordinary procedural rulescommon to other actions. Typically, the trial starts withthe plaintiff serving a summons upon the defendantsand then continues with the exchange of written briefsamong the parties, with the Court holding short hear-ings approximately every six months. In bankruptcyclaims, which typically involve complex accountingissues, in the majority of cases, the Court appoints an

accounting expert to carry out a Court supervised audit.The parties may appoint their own experts, whoparticipate to the audit, and may file briefs.The initial trial takes place before the Tribunal

(Court of first instance) and usually lasts two to threeyears. The Tribunal’s judgment can be appealed beforethe Court of Appeal, which is by no means bound bythe Tribunal’s decision. TheAppeal procedure may alsolast several years. Any final appeal is to the ItalianSupreme Court (Corte di Cassazione), which can onlyaddress legal issues.9. What are the Legal Costs for the PartiesInvolved?Court costs are very low in Italy. As for legal fees,

litigation in Italy is much cheaper than in the UnitedStates. This is mainly due, as already mentioned, to theabsence of any pre-trial discovery. In the Italian legalsystem, the losing party has to reimburse the legal costsof the winning party. However, such reimbursementdoes not reflect the actual legal costs incurred by thewinning party, because the reimbursement of costs isdetermined by the Court, which applies a tariff systemmainly based on the value of the case and on thenumber of activities performed. Typically, D&O insur-ance coverage in Italy covers the insured’s payment(usually anticipated) of legal fees, including legal feesin criminal proceedings.10. When is an Italian Bankruptcy Receiver MostLikely to Bring a Liability Action Against theCompany’s Former Directors and Officers?The directors and officers of a company are auto-

matically removed from office upon a declaration ofbankruptcy. As a consequence, the potential liability ofdirectors and officers stems from the violation of theirduties for actions carried out while the company wasstill in good standing. In general terms, directors’ andofficers’ liability arises from the violation of the dutiesimposed upon them by the law and by the company’sby-laws. The Bankruptcy Receiver most frequentlysues the company’s former directors and officers for thedirectors’ alleged violation of the rules set forth insections 2485 and 2486 of the Italian Civil Code.These sections provide that whenever the companyincurs losses that exceed its net equity and reduce thatnet equity to less than the minimum statutory level(€120,000 for an s.p.a. type of company and € 20,000for an s.r.l. type of company) the company is automati-cally placed in liquidation, unless the shareholdersprovide the necessary capital injection upon the direc-tors’ request. In liquidation, the directors becomesolely responsible for the preservation of the integrityand value of the company’s assets for the purpose of

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liquidation. In practice, it is very common for the direc-tors of a company to try to “save” the company bycontinuing to do business, but in case of subsequentbankruptcy of the company, such continuity constitutes aper se violation of their duty to basically stop operatingfor the purpose of preserving the company’s remainingassets. Approximately 90 percent of the liability actionsbrought against the former directors of Italian corpora-tions are based on the violation of the above rules.11. Criminal liability“Bancarotta fraudolenta” (bankruptcy fraud) is the

major bankruptcy-related crime under Italian law. It isdefined as “diversion, concealment, dissimulation,destruction or dissipation” of the company’s assets,and/or the registration or the recognition of

non-existent liabilities for the purpose of harming cred-itors. “Bancarotta fraudolenta” can also be perpetratedby removing, destroying or falsifying the company’sbooks for the purpose of obtaining an undue profit or ofharming creditors, or by keeping the company’s booksin such a way that it is impossible to identify thecorporate assets. The penalty for this crime is three toten years of imprisonment. Another type of fraudulentbankruptcy is the “bancarotta preferenziale” (preferen-tial bankruptcy), which forbids creation of fictitiouspriority claims. The penalty for preferential bankruptcyis from one up to five years of prison.

This article is purely informative and it does not constitute legaladvice. It is only a general introduction to the subject matter andbefore taking any initiative based on the information contained hereyou must seek specific legal advice.

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