Corporate / M&A

Defective (Re-)Appointment of Management Board Members

Management board members of a stock corporation (AG) must be appointed for a definite period of time. A renewal of the appointment requires an express resolution by the supervisory board. What happens if a management board member is not compliantly re-appointed upon expiry of their term but simply continues in his role?

The “rudderless” ship?

Closely held corporations (eg family offices or companies controlled by family trusts) may not see regular changes to their management boards. If all goes well, continuity is, after all, very much in the interest of both sides. Since such privately held companies will typically also require a less elaborate corporate governance system, it cannot be excluded that a board member’s term may formally expire without the supervisory board immediately taking note. Even outside family companies, a management board member may, for example, eg initially be appointed for a shorter term than the five-year statutory maximum that exists in Austria – followed by an extension under which the total term may exceed the five-year maximum.

Why is this relevant? Consider the fact that the annual accounts are drawn up by the management board before being submitted to the supervisory board. What impact does a defective management board appointment have on their legal quality? Or, does it mean that contracts signed by such a board member in the day-to-day business are no longer binding?

The appointment of a management board member who simply continues to act in such capacity beyond the term of office without a compliant re-appointment resolution of the supervisory board is defective.

To remedy all acts undertaken by a board member whose appointment is defective would result in considerable difficulties and legal uncertainty. Hence, the goal must be to find a more general way out that leaves such acts intact and legally valid.

Keep going

The solution is to treat the board member concerned as a so-called de facto management board member. This is possible provided that there has been a valid original appointment and further that the board member continues to act in his capacity as a member of management board beyond the original term. Typically, both criteria are met in the case of a defective re-appointment, because the original (compliant) appointment is deemed to be sufficient to meet the first test and, at least in the examples used in the beginning, the company is generally fine with the board member continuing in his function.

The core consequence of this remedy is that measures undertaken by the management board member whose appointment is defective are valid both within the company concerned and vis-à-vis third parties.

A board member is a board member is a board member …

From the perspective of the management board member, this approach means that they remain subject to the same duty of care they were obliged to provide during their proper appointment and which they would have owed had they been re-appointed in a compliant manner.

At the same time, the general consensus is that such a management board member remains entitled to the agreed compensation (and not “only” a more abstract form of eg “market level” or “arms’ length” compensation, which may well be lower than what was agreed in a specific case).

Time to put it right

If and when the defective appointment comes to light, the supervisory board must react. It may choose to recall the management board member – in an exception from the general rules applying to stock corporations such a recall does not require a good cause (wichtiger Grund).

Or the decision may well be that what temporarily “survived” as de facto management should be put on sound legal basis (again). In this case, the supervisory board needs to pass a new (re-)appointment resolution – which must then comply with all statutory requirements, in particular the five-year maximum appointment term.

Mistakes in appointing of members of the management board may be rare. But the potential consequences are difficult to resolve. Thus, the solution developed and advocated primarily in German legal literature to treat the board member as a “de facto” manager and to uphold the validity of acts undertaken by it is a real lifeline and allows companies, their customers, creditors and other business partners to resolve such situations unharmed.