Corporations

Liability of the Board Members of Joint-Stock Corporations and Closed-Stock Companies

Liability of the Board Members of Joint-Stock Corporations and Closed-Stock Companies. A common question among those who are starting a business is about the liability that Directors are exposed to when serving their position on Closed-Stock (corporations that cannot trade stocks on the stock market) and Joint-Stock Corporations (Sociedades por Acciones or SpA).

Regarding this topic, the regulations regarding Directors in Chile are contained in the Corporations Law, its Ordinance, and other complementary regulations. Among them, we identified the following topics regarding liability:

I. A general rule of liability: Civil Liability

The Corporations Law establishes a general rule for liability, that refers to any action committed willfully or with gross negligence by a Director carrying out his duties, breaking the law, other regulations or the articles of incorporation. This is civil liability, which results in pecuniary payments in compensation for the damage caused.

The general degree of care that the Director must take carrying out his duties is established by law, and they must avoid breaking the law, other regulations or the articles of association. If an action committed willfully or with gross negligence produces harm to third parties or the company, the company or the harmed third party can legally seek compensation.

The following are examples of actions that can cause liability for Directors:

1) Blocking minority shareholders from exerting their legal rights

2) Harms caused by the mismanagement of the company, such as losses or excessive withdrawals for themselves or third parties

3) Not controlling the management of the company, preventing the company from having professional management

4) Not rendering an account when it is necessary or so requested

II. Criminal Liability

Outside of civil liability, in certain cases, criminal liability can apply to Directors. Specifically, for Closed-Stock and Joint-Stock corporations, there is a general rule for liability: Directors are criminally liable when they commit a crime through the company.

The statute of limitations for crimes committed by Directors through the company depends on the kind of crime committed. The most common cases of criminal liability are related to fraud that harms the company or its shareholders and the counterfeiting of documents. Both crimes have a statute of limitations of five years, counted from the moment the crime was committed.

III. Specific prohibitions and presumptions of liability

In addition to the general rule of civil and criminal liability that was described previously, the Corporations Law establishes a series of specific prohibitions for Directors:

1) To propose the amendment of the articles of association and/or agree to issue bonds or adopts policies or decisions outside of the social interest.

2) To block or hinder investigations destined to determine their own liability or that of the managers, administrators or chief executives of the company.

3) To persuade the managers, administrators or chief executives of the company or their dependents, the internal or external auditors and risk rating companies to render irregular accounts, present falsified information or hide essential facts.

4) To submit irregular accounts, falsified information or hide essential information from the shareholders.

5) To borrow the company’s funds or goods or use the goods, services or loans of the company for their own benefit or the benefit of their families, proxies or companies on which they participate, without prior legally issued authorization of the Board.

6) To benefit themselves or related third parties from commercial opportunities acquired because of their position, harming the company.

7) Generally, to commit actions that are illegal or that go against the articles of association or the social interest or use their position to obtain undue advantages for themselves or related third parties harming the social interest.

Executing any of the listed actions create liability for the offending Director, who must indemnify the harms caused.

Furthermore, article 45 of the Corporations Law (Ley de Sociedades Anónimas, in Spanish) assumes the liability of the Director on the following cases:

a) If the company does not keep their books or records updated.

b) If provisional dividends are distributed when accumulated losses exist. This presumption applies to the Directors that signed the respective agreement.

c) If the company hides its assets, recognizes supposed debts or simulates the sale of assets.

d) If one or more Directors benefit improperly, directly or through other persons or companies, from the company’s business that generates harm to the company.

If any of the aforementioned occurs, the Directors must indemnify the company jointly for the harm produced to the company, its shareholders or third parties.

IV Acts or contracts in which a Director has interest

On the ordinary operation of a Closed-Stock or Joint-Stock corporation (when the latter has a Board of Directors), there’s a likely possibility of needing to sign contracts on which one or more Directors has interest. In this case, there are a series of special rules established by law for the purpose of authorizing the operation.

If it is necessary to negotiate or sign a contract that involves a Director’s interest, the company must call a Board of Directors with the specific intent of deciding about the operation, excluding the affected Director. The minutes of the Meeting must expressly include the deliberations to approve the terms and conditions of the acts or contracts which involve the Director, and the Board must inform the shareholders about the operations on their next meeting, and this subject must be included in the summons.

First, for this authorization to be necessary, the amount involved in the operation must exceed 2,000 UF (about USD 88,495) and the 1% of the assets of the company. It is always necessary if the operation exceeds 20,000 UF.

Then, one or more Directors must have an interest in the operation. It is understood that a Director has an interest when:

a) The Director must intervene personally in the operation, or their spouse or relatives up to the second degree of consanguinity or affinity

b) Companies on which the Director holds a chair on the Board of Directors or is an owner, be it directly or through other persons or companies, of 10% or more of the social capital, are involved in the operation.

c) Companies on which the spouse or relatives up to the second degree of consanguinity or affinity of a Director are members of the Board or are owners of 10% or more of their social capital.

d) The controller of the company or related individuals must act if the Director wouldn’t have been elected as such without their vote.

These regulations are considered relevant if the company is the controller of several companies that share the same shareholders and/or controllers, in case it’s necessary to negotiate or sign contracts on which this interest exists.

V Safekeeping of the company books and availability to the public of the articles of incorporation and the shareholders’ registry

According to article 7 of the Corporations Law, the Board must conduct safekeeping of the company’s books and other registers (such as the minutes of the Board’s meetings, of the Shareholder’s meetings, the shareholders registry, among others), and oversee that they are kept with the regularity required by the law. However, this function can be delegated, in which case this delegation must be discussed and approved on a Board of Directors’ Meeting and registered on its minute.

The Board must also keep the updated articles of association, signed by the manager, and an authorized record of the shareholders, which must include their domicile and number of shares, on the main offices of the company. If this duty is not fulfilled, the Directors are jointly liable for the harm caused to the shareholders and third parties because of the unfaithfulness or outdatedness of the documents.

VI Consent for other forms of payment for capital stock

Generally, the shares of Closed-Stock or Joint-Stock corporations can be paid in cash money or with other goods. However, capital stock, which are shares issued to increase the capital of the company, which can be acquired by the shareholders or third parties, must be paid in cash, unless the articles of association include a different stipulation.

If a Director accepts a form of payment that is different from cash, he becomes jointly liable for the placement value of stocks paid this way.

VII Law of corporate governance and supervision of the securities and insurance superintendence

Law 20.382, published in October of 2009, modified both the Corporations Law and the Stock Market Law, aiming to increase the standards of corporate governance for private companies.

Some of the amendments introduced by this regulation apply to Closed-Stock and Joint-Stock corporations and were included above. The most important changes, which only apply to corporations whose shares are traded on the stock market, are the following:

a) Election of independent Directors, if the legal requirements apply

b) Designation of a Directors’ Committee

c) Rules about handling and disclosure of information

d) Use of confidential information

e) Regulations regarding public share offerings

It is also important to mention that Closed-Stock and Joint-Stock corporations are not supervised by the Finance Market Commission (CMF), the successor of the Securities and Insurance Superintendence (SVS), instituted on January 15, 2018. This means that administrative liability generally does not apply to them, and as such, the Finance Market Commission cannot apply sanctions (such as fines) to the directors of Closed-Stock and Joint-Stock corporations, as they are not in its jurisdiction.

VIII. Analysis of Key cases regarding the Director’s liability

The following is an analysis of certain key cases that involve Directors’ liability on stock corporations:

a) La Polar

This is one of the biggest-profile cases in Chile that involved a company’s Directors. The company offered a credit card to their customers and automatically renegotiated their debt when it got overdue, and over time this became common practice within the company. This regularization of debt started at the call center of the company, and then an automated process was created to apply it in bulk. The immense number of renegotiations started to impact the financial status of the company, as the default rate of the financial unit of the company was lowered to almost zero. When these actions became public knowledge, the individuals submitted to renegotiation stopped paying their loans, considerably lowering the payment rate, and thus the company started monitoring the situation, finally creating a collection committee.

The impact of unilateral renegotiations on La Polar’s business was included in reports prepared by the management of the company and contained more detailed information about them. However, it was only when the growing number of complaints with the customer protection agency and an eventual collective negotiation hit the company that it took action, and the Board of Directors and the Directors’ Committee started to analyze the situation. They were informed of the situation of the company with regular presentations, on which, according to the then SVS, included sessions where renegotiations were discussed. The Board of Directors and the Directors’ Committee only required the analysis of the impact of the renegotiations on the company. Only years later both entities became aware of the unilateral renegotiations and their real effect over the company’s assets and its financial situation.

Because of the aforementioned, the SVS filed charges against the Directors of La Polar, based on their lack of diligence for not adopting improvements for the internal checks of the company, for not having exerted their right as Directors to inform themselves about the financial situation of the company and for the infringement of the code of conduct established for those who hold that position. After hearing their defense, the SVS decided to apply a fine to each Director, based on the time each one had held their position and if they were members of the Directors’ Committee.

In this case, the sanctions applied against the Directors were administrative and were applied by the SVS as the overseer of a stock corporation traded in the stock market, based on the duties of the Directors and the general liability rules established on the Corporations Law. This kind of sanctions could not be applied to Closed-Stock and Joint-Stock corporations, as they are not supervised by the CMF. Liability would have to be pursued by the shareholders or the company itself at a Civil Court, in the form of a payment for the harm to the company, its shareholders or third-parties caused by their actions or negligence, and not through a fine. This process would undoubtedly take longer than the administrative process of the CMF.

b) FASA

Also known as the drugstores’ collusion, sanctions were applied mostly for limiting free competition. However, there were also direct sanctions for the executives and directors of the pharmaceutical chain Farmacias Ahumada.

The investigation started in the year 2008, and the irregularities started shortly before, in 2007. Before this date, the pharmaceutical companies were immersed in an intense price war, which noticeably lowered the earnings of the three biggest chains (Farmacias Ahumada [FASA], Salcobrand and Cruz Verde), and thus the main executives of this companies decided to shift their strategy, stopping their competitive actions.

In the second half of 2008, the Undersecretary of Public Health of the time denounced the existence of an agreement between the major chains, through which they presumptively raised the prices of medicines simultaneously. Thus, the competition between them did not exist, as the prices were significantly higher than market rate and were raised at the same time and were not correlated with the prices charged by the laboratories, which weren’t raised above the consumer price index.

Considering the aforementioned, the Undersecretary and the National Consumer Service (SERNAC) started a joint investigation to justify the claim and present it before the Chilean Competition Tribunal. The investigation, based on a Historical Price Ranking, uncovered that more than 200 medications had risen in price at the same time on the three chains. With this information, the National Economic Prosecutor’s office initiated a requirement against the three chains. It was detected that the causes and motivations for collusion were the price war, which impacted the companies’ profit margins, and the integration of executives of FASA and Cruz Verde to the governance body of Salcobrand, which produced strong bonds among the main executives of the three companies.

When the Chilean Competition Tribunal was about to finalize the requirement, Farmacias Ahumada decided to confess before the National Economic Prosecutor’s office, admitting guilt and confirming that there was effectively a price adjustment agreement between them, Cruz Verde and Salcobrand. This confession had the effect of significantly reducing the fine that was applied for breaking the laws of free competition.

Taking into consideration the result and the agreement met, the then SVS decided to apply fines, in addition to the sanctions applied by the Chilean Competition Tribunal, to the main executives of FASA, based not on the convenience of the business decision to arrive to deal with the National Economic Prosecutor’s office, but because of the procedure that must be followed on a company to arrive to this kind of decisions. The fines were applied to the following executives:

a) To the executive vice-president of FASA, for not reporting to the Board the investigation of the National Economic Prosecutor’s office.
b) To the President of the general committee, for not reporting to the Board of the deal reached with the National Economic Prosecutor’s office in an accurate and timely manner.
c) To the Directors, for not exerting their legal right to be informed, as they should have done considering the existing information they had access to.

Again, these sanctions are administrative fines, applied by the SVS as the regulatory agency of stock corporations traded in the stock market.

However, the liability caused by violating the free competition rules is separate from those of regulatory agencies, and as such, if the Directors of a Closed-Stock or Joint-Stock corporation decide to commit acts against free competition, the company could be sanctioned directly by the Chilean Competition Court.

IX. Conclusions

Considering the aforementioned, we can conclude the following:

a) The general rule for liability for Directors consists of civil and criminal liability. As such, Directors can also be responsible for their actions that violate the existing regulations or the bylaws of the company and must pay for the harms caused. The statute of limitations to prosecute this liability is four years, starting from the moment where the infraction was committed, or for crimes committed through the company, commonly fraud and counterfeiting.

b) The Directors have a series of specific prohibitions established by law, which seek to avoid that the Directors put their own interest before the ones of the company. Furthermore, the law assumes the liability of the Directors in certain cases (such as not keeping the company’s books)

c) In general, Directors must avoid negotiating and signing contracts on which they have a personal interest. They can be authorized to do so by the Board (excluding the involved Director) when the amount involved is considerable, and this must be reported to the shareholders. What is considered personal interest and considerable amounts was explained above.

d) The Boards must keep and safeguard the company’s records, and also keep the updated bylaws, signed by the manager, on the social domicile. If it fails to do so, the Directors are liable.

e) Generally, Closed-Stock and Joint-Stock Companies are not regulated by Law 20.382, about corporate governance, and are not supervised by the Financial Market Commission, as they do not trade stock on the stock market.

f) The analysis of the key cases that involved the Board and other elements of corporate governance of corporations, such as La Polar and FASA, makes us conclude that majority of the sanctioned imposed were administrative fines from the CMF. In any case, the liability that emanates from other areas, such as free competition, can also apply.

Last modified: 18/02/2020