When can the distribution of the company’s funds be considered a damage?

1. When can a distribution of social funds be understood as harming the company, its partners or its creditors?
2. SAP Barcelona of 30 November 2013
3. STS of 11 September 2018
4. What should be done to claim irregular distribution of funds?
5. Conclusion

When can the distribution of company funds be understood as damage to the company, its shareholders or its creditors?

Logically, any distribution of funds that goes against the company’s interests constitutes damage to the company. But there is no list, no numerus clausus, of cases of distribution of funds that are understood to be harmful to the company. We also do not have a reference on what cases can be understood as damage in general terms. Neither case law nor regulations have given any clear definition on this subject. For that purpose, we should follow the provisions of directors’ contract and the company’s Bylaws. Therefore, we will look at some examples of damage caused by the actions of the directors as set out in case law.

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Can liability action and director’s liability action be joined in the same lawsuit?

Until 2012, the Supreme Court did not rule on the accumulation of two types of shares. The action for liability for debts and the action for liability of administrators.

(Second Instance Ruling) SAP Barcelona, November 30^th, 2013

This Ruling is applicable to the appeal lodged by one of the Directors of a company. The first instance ruling dismissed the claim of this director against the company. The actions exercised were the individual legal action against the director and of unfair competition against the company. The appeal was also dismissed. But what right now interests to us is to know what conduct the court considers harmful. The conducts of the director that the appellant director considered to have damaged his assets were:

1. The agreement revoking the proxy granted to the appellant director.
2. Modification of the registered office
3. To constitute a new company with the same social purpose as the company.
4. Change the ownership of a van owned by the old company and allocate the new company as the new owner of this van.
5. To use the same facilities previously used by the company in question for the activities of the new company.
6. Not to call AGM for the approval of the general accounts of one of the financial years.
7. To use the same mobile phone number previously used by the company involved for the activities of the new company.
8. Using the brand name owned by the old company for the new one.
9. Take over the stocks of the old company.

The court considered that most of these actions could not cause direct damage to the appellant’s assets. At most, they could be capable of causing indirect damage as a result of damage to the company.The only one that the court understood as possible direct damage to the director was the conduct described in point 6. Not to call a AGM for the approval of general accounts.

Explanatory note: This Judgment, in its context, did not consider these behaviors harmful. That does not mean that they can never be considered as such. Or that another court would consider it. But at least, they help us to understand how a Court – such as Section 15 of Barcelona Second Instance Mercantile Court – well considered as a reference for legal professionals in Spain, has understood it.

Supreme Court Ruling, September 11st,  2018

In this case, the Supreme Court rules on a withdrawal of funds by one of the directors. This disposition consisted of the advancement of several contracts and the granting of loans. Both the advances and the loans exceeded the amount required to obtain the approval of the risk committee. They were therefore contrary to the company’s internal rules.

The company had liability insurance for the directors and senior management. One of the partners sued the insurer for damages for the harm caused by the director. The lawsuit was dismissed at first instance, but shareholder’s subsequent appeal was upheld. The insurer appealed against this before the Supreme Court, which was granted.

The main reason for the appeal being upheld is the incorrect choice of liability action. It is clear from the lawsuit that the aim is to compensate for the damage caused to the shareholder’s assets. Not that of the company. Therefore, what is being exercised is an individual action.

The jurisprudence (Case Law) does not allow the shareholders to file a demand – the “individual legal action” –  when the damage to their assets is not direct. It is understood, both in doctrine and in case law, that the way to compensate this indirect damage is through “social legal action”. Supreme Court considers the disposal of funds described as direct damage to the company and indirect damage to the shareholders. Therefore, the individual action can´t obtain the output intended.

What should be done to claim an irregular distribution of funds?

Supreme Court has ruled on several occasions in this regard (STS 396/2013, 472/2016, 129/2017 or STS 485/2018). The irregular distribution of social assets is a direct damage to the company. But, according to the Supreme Court, this decrease in assets causes indirect damage to the shareholder. The value of the shares decreases and may result in no dividends being distributed.

Furthermore, the decrease may also constitute damage to the company’s creditors. The company’s assets constitute a guarantee for the collection of its claims. A decrease in the company’s assets thus constitutes a clear threat to this guarantee. This is all the more true because a reduction in assets may even lead to the company’s disappearance.

Therefore, when damage is directly caused to the company, the action to be filed – according the Supreme Court – is “social legal action”. Despite the fact that there is collateral or reflected damage to the assets of shareholders or creditors.

Conclusion

There are many cases of actions by directors that jurisprudence understands as damage. And whether it is to the company, the shareholders or third party creditors. One of these cases is the disposal of funds from the company’s assets to the detriment of one of the possible victims. But neither case law nor doctrine defines when a disposition of corporate assets can be understood as damage. Thus, any disposition of assets that contravenes the company’s internal regulations or the law will be considered as damage.

What the Supreme Court does clearly state is the liability action to be used.  There are two liability actions in the commercial field, social action and individual action.  The High Court understands that the disposal of a company’s funds constitutes direct damage to the company. But it can also mean indirect damage to the assets of the partners or creditors. In this case, the shareholders or creditors must use the corporate action, as subsidiary legitimated parties. They cannot exercise the individual action.

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Distribution of dividends