Brazil: Legal and Statutory Liability of Boards and Committees Members in Brazil

Walter Douglas Stuber and Manoel Ignácio Torres Monteiro are founding-partner and partner, respectively, of Stuber – Advogados Associados, and experts in Corporate Law, Banking Law and Capital Markets.

Originally published November 2004

I – Overview

The liability of administrators (Directors and Officers), auditors and consultants has been of great concern, especially after the advent of the Sarbanes-Oxley Act in 2002.

The Brazilian Corporation Law puts Directors and Officers on the same footing to establish the limits of their liability. Thus, members of the Board of Directors or of the Supervisory Committee (Conselho Fiscal) have the same obligations and liabilities as Officers. On the other hand, the members of the Audit Committee, as regards their duties and liabilities, are put on the same footing as the members of the Supervisory Committee, as opinion of the Securities and Exchange Commission on the matter.

Directors must comply with the provisions contained in the By-laws and the laws and regulations in force, acting diligently in the discharge of their duties, subject to being held answerable for any damage caused to the company, to the partners and to third parties.

An administrator’s liability may be twofold: (i) indirect liability; and (ii) direct liability.

Direct liability means that the Director is personally liable.

Abuse of power, violation of laws or the By-laws and negligence in the discharge of the duties are direct liabilities of the Directors.

Indirect liability means that a Director is not personally liable, as there is no provision to that effect in current laws and regulations. In this case, the company will answer for the damage caused by the Director, but will have right of recourse against the administrator, that is, it may file action to recover the amount it may have been awarded to pay as indemnification.

Because the Board of Directors is a deliberative collegiate body, only decisions taken at properly called meetings are valid. In this sense, any decision taken individually by any Director is ineffective.

However, omission or lack of diligence of the part of the Directors may sometimes give rise to liability.

The fact that the Board of Directors is a collegiate body makes their members collectively liable. However, joint liability of their members is not presumed.

The law makes provisions on the joint liability of administrators in the event of non-compliance with formalities complementary to the company’s incorporation or in the case of failure to record the extinction of debentures on the respective books.

Included in the duties of the Board of Directors is the oversight of the management by the Officers, examining, at any time, the corporate books and documents, requesting information on agreements made or about to the made, and any other act to be performed by the company’s Officers.

In this case, the Directors will be joint-liable if they fail to act diligently in the discharge of the supervisory duties as Officers, because they neglect their responsibility to discharge the legally provided duties.

The Directors, however, are not liable for acts of the Officers of which the Directors have no knowledge or that are hardly or even impossible to detect during the regular business of the company. In this case the liability of the Directors may not be presumed.

Officers are elected, and removed, by the Board of Directors only.

Directors cannot be held liable for the unsatisfactory performance of an elected Officer. However, the Directors will be held liable for the election of any unfit Officer, where it is possible to determine such unfitness by way of search of commercial, judicial and other information.

Failure to remove an elected Officer, after his/her incompetence or unfitness is determined makes the Directors liable for damages caused to the company or third parties.

Because the Board of Directors and the Supervisory Committee are collegiate bodies, the Director may, and should include in the minutes his/her vote and the reason of his/her disagreement or description of the matter considered of relevance to the company, as a way to display diligence and exempt from liability. It is important to stress out that any disagreement must be communicated before the deliberations, never after. The minutes of the Meeting of the Board of Directors as drawn up on the Book of Minutes of the Board of Directors’ Meetings are, therefore, a very important proof of the administrators’ liability.

Should it be impossible for a Director to record his/her disagreement in the minutes, he/she should communicate it immediately and in writing to the Board of Directors, Supervisory Committee, if any, or the Shareholders’ Meeting.

The Brazilian Civil Code (2002 Civil Code), enacted in January 2003, contains provisions as to the disregard of the corporate entity so that the effects of certain obligations of the company can apply to the administrator’s private property, included therein the Directors. The disregard of the corporate entity will apply in the case of abuse of the corporate entity, characterized by digression from purpose, or assets mix-up (confusão patrimonial.)

The decision whether or not the corporate veil will be pierced will be made by the court, as a result of motion by party to the suit (shareholder or third party creditor) or by Public Prosecution Office, where it is up to that Office to interfere with the suit.

The 2002 Civil Code further establishes more strict rules of administrators’ accountability for acts performed during their management of the business, even without negligence (i.e. the administrator shall account for any damage caused, irrespective of his/her intention.)

That new scenario has made administrators in general, including the Directors, to turn to liability civil insurance, the so-called D&O insurance, in an attempt to mitigate any financial loss, where acts are performed that result in inclusion of personal property for payment of indemnifications.

That sort of insurance is commonly a benefit in the employment policy of companies, which bear all the costs. Even, many administrators fix as a condition for their election that the company purchases that kind of insurance.

We, however, draw the attention to the fact that it is important to check the limitations of the D&O insurance policies relating the effective protection Directors and companies electing them will enjoy, since said policies may protect only the company and not the administrators themselves, should they be held liable.

II – Tax Liability

The National Tax Code (CTN) establishes that a company’s administrators, as well as the so-called Officers, Managing-partners or representatives of the legal entity, will be held liable for the acts performed in excess of their powers, violation of the law, of the Articles of Incorporation or the By-laws, that resulting the failure to pay taxes (art. 135, item III.).

Such rule deals with the personal liability of the administrators, excluding the obligation of taxpayers. That is, the original taxpayer is replaced with the people listed in the rule that perform the acts in excess of power, violation of the law, of the By-laws or the Articles of Incorporation. That is why some scholars use the definition "liability from replacement."

It is important to stress out that, as a rule, there is joint liability among the administrators and those involved in the performance of acts in violation of the law or the By-laws, under the terms of article 158, § 2 and § 5 of the Corporation Law.

However, it is important to emphasize that, specifically in the case of Officers their liability is individual, that is, each Officer is accountable individually for the above-mentioned acts. Differently from the members of the Board of Directors who are jointly liable, that is, the liability is invariably attributable to all members, save if the dissident(s) record their disagreement on the minutes.

Regarding Supervisory Officers, they are joint liable with the administrators in the event of violation of laws or the By-laws and performance of acts of abuse. Such liability will arise, for instance, when the Directors approve management accounts and reports which violate the law and/or the By-laws, or which omit information or contain false information about the financial statements, distribution of profits and dividends.

is important to emphasize that the liability according to article 135 of the CTN is dependent on the performance of acts of violation or abuse, which characterizes the strict liability of the administrators. Negligence or malice must be present in the performance of those acts.

Thus, in order for liability from replacement to exist, the following two conditions are required: (i) the partner discharges management duties in the company; and (ii) the partner performs acts in excess of his/her powers or in violation of the law, the Articles of Incorporation or the By-laws. This is the understanding found in the case law.

Another aspect that should be first clarified to better understand the coverage of an administrator’s liability is the concept of breach of the law and whether or not tax default should be construed as violation of the law.

The way we see it, default of taxes is not violation of the law. Such a standing is reinforced by recent decisions of the Superior Court of Appeals (STJ).

This is because not paying a tax on the maturity date is default and consequently being in arrears and not violating the law. In this sense, the effective accountability will only arise if there is confirmed fraud and abuse in the discharge of an administrator’s duties.

It is important to stress out, that such acts may characterize crimes against economic policy, which would give rise to criminal liability as well.

As to financial and other institutions accredited by Central Bank of Brazil ("Bacen"), as well as the clearance and settlement houses and providers of these services, Resolution nº 3198, of May 27, 2004, of the National Monetary Council, establishes, essentially, that the audits by independent auditors is a requirement.

Such Resolution further establishes the creation of an Audit Committee in the situations listed therein. We will discuss the liability of the members of said Committee.

The members of Audit Committees, unlike the members of the Supervisory Councils and Boards of Directors, do not have management powers, they only issue reports/opinions and make assessments and recommendations to the Board of Officers and the Board of Directors.

Therefore, in view of the above rationale and based on article 3, sole paragraph of said Resolution, it is our understanding that the members of Audit Committees account, jointly with the company’s administrators, for the preparation of audit reports or opinions, in violation of the law, the Articles of Incorporation or the By-laws. This liability too can be debated due to the consultative nature of the Committee.

III – Labor Liability

Administrators, Directors and Officers, although not personally liable for the obligations assumed in the name of the company, are jointly and unlimitedly liable to the company and to third parties (art. 1016 of the Civil Code), for any excess in the discharge of their duties or acts that violate the By-laws or the law.

In this sense, the administrators, Directors and Officers, are regarded as direct responsible for the company’s payables that result from mismanagement or excess in the discharge of their duties when hiring employees or outsource companies.

This becomes specially evident with the increase, at the Labor Courts, of the use of that institute coupled with the mechanism of on-line attachment, which allows for the immediate freeze of administrators’ financial investments.

In many cases, even before all the alternatives available to foreclose company’s assets have been exhausted, it is not uncommon for the Labor Courts to determine the attachment of the administrators’ property, which ensures the fast satisfaction of labor credits, overriding the strict the theory of officer liability.

For these reasons, it is important to pay special attention to labor aspects in order to avoid the use of the theory of administrators’ liability and that the on line attachment comes to cause unfortunate freezes and unexpected losses to the administrators, Directors or Officers. The same reasoning applies to the members of the Auditors Committee.

IV – Liability in the case of Financial Institutions

The liability of administrators (Officers and Directors) of financial institutions is dealt with in articles 39 and 40 of Law nº 6024, of March 13, 1974, which makes provisions on the intervention and extra-judicial liquidation of financial institutions ordered by Bacen.

The administrators and members of the Supervisory Committee of financial institutions are accountable, at any time, for their actions and inaction. Such liability applies equally to individuals and legal entities providing independent audit services to the financial institutions subjected to intervention or undergoing extra-judicial liquidation, by operation of article 3 of Law nº 9447, of March 14, 1997, which, among other things, deals with the accountability of audit firms and independent auditors.

The liability of administrators and members of the Supervisory Committee, and consequently of the auditors, shall only cease where there is extinguishing limitation of the action or inaction. Additionally, the administrators of financial institutions are co-liable for obligations assumed thereby during their management, until their complete satisfaction. However, such co-liability is limited to the damages caused.

The rules regulating the administrators’ liability apply to the members of any body created by the By-laws with technical roles or aimed at advising the administrators, that is all members of the Technical and Consultative Councils, including the Audit Committee, under the terms of article 160 of Law nº 6404, of December 15, 1976 (Corporation Law).

Another important aspect to consider when determining the liability of the members of Councils and Committees, in the specific case of financial institutions, is the risk of unavailability that may affect the administrators’ personal assets, if the financial institution is undergoing intervention or extra-judicial liquidation or even has bankruptcy adjudicated. This matter is governed by articles 36, 38, 50, and 51 of Law nº 6404/1974.

The immediate effect on the administrators is the suspension of the terms of office, in the case of intervention, or loss of office, upon extra-judicial liquidation or bankruptcy. That is, in any case, the administrators are not liable for the Management of the financial institution, which is assumed by the intervener, liquidator or receiver, and become former administrators.

As a consequence of the suspension or loss of office, all the former administrators’ assets become unavailable until the final determination and liquidation of the liabilities to ensure payment of the creditors of the institution undergoing intervention, extra-judicial liquidation or bankruptcy, should such institution have insufficient assets to satisfy its debt.

This unavailability means that the assets may not, by any means, whether directly or indirectly, be disposed of or encumbered (that is, create mortgages, pledge, antichresis). Disposal means the transmission of rights to another person by way of an inter-vivos act. Unlike the adjudication of bankruptcy, where the former administrators are disposed of their assets, in an intervention or extra-judicial liquidation, the unavailability limits exclusively to the right to dispose of the assets (jus abutendi), but former administrators remain in office and regularly managing their own assets. In an intervention or extra-judicial liquidation there is, therefore, no restriction as to the right to use (jus utendi) or right to enjoy (jus fruendi) the assets of the former administrators.

With respect to the time limitation, unavailability of assets affect all discharging the job of administrator during the twelve months preceding the act adjudicating the intervention or extra-judicial liquidation or date of the adjudication of bankruptcy. It however does not affect the former administrators discharging their duties before that.

In addition to the administrators, the unavailability may affect other employees of the financial institution. As proposed by Bacen, and approved by the National Monetary Council, the unavailability may extend to assets belonging to managers, tax officers and all of those that, up to the limit of estimated liability for each of them, may have incurred, in the preceding 12 months, determination of intervention or extra-judicial liquidation or adjudication of bankruptcy. Thus, in very special cases, such unavailability may also extend to the property of the members the Boards and Committees of the financial institution.

It is also important to consider the implications of assets transferred by former administrators to third parties within this twelve months. If Bacen deems that the assets were transferred with a view to dodging the law, it may extend the unavailability to the assets of those who have acquired them, under any pretext, the former administrators of the institution undergoing intervention, extra-judicial liquidation or bankruptcy, in the preceding twelve months.

Certain assets are not subject to such unavailability. Included in the exceptions are the non-disposable or non-pledgeable assets, as determined by laws and regulations in force, such as: (i) residential property owned by the ex-administrator; (ii) meal and fuel provisions necessary for the support of the ex-administrator and his/her family for one (1) month; (iii) retirement and pension paid by official and private funds or donations from third parties, where intended to support the former officer or his/her family; and (iv) life insurance.

Equally, non-disposable are the assets under sale, sale and purchase promise and right assignment agreements, provided that those instruments have been drawn up by the relevant public records office prior to the date the intervention or extra-judicial liquidation have been determined or bankruptcy adjudicated.

The unavailability of assets should be informed to the public records offices. Upon determination of the intervention or extra-judicial liquidation or adjudication of bankruptcy, the intervenor, liquidator or trustee shall inform the competent public records office and the stock exchanges that the assets of the former administrators are unavailable. While this situation continues, the assets may not be disposed of, transferred, assigned, traded or registered

Upon receipt of such communication, the authority will be precluded from perform the following acts with respect to the unavailable assets:

(a) to make copies, entries or annotations to public or private documents;

(b) to file acts or contracts that cause the transfer of shares or founder’s shares;

(c) to draft or record transactions and titles of any kind;

(d) to process the transfer of ownership of automobiles.

The effects of the intervention, extra-judicial liquidation or bankruptcy may also extend to other non-financial companies. Bacen may determine equal treatment to legal entities whose operations are integrated with or have a relationship of interest in the institution undergoing intervention, extra-judicial liquidation or bankruptcy, affecting the administrators of these non-financial companies as well. The purpose of such a measure is to protect the low-income savings accounts and the integrity of the financial institution’s assets, preventing administrators from fraudulently siphoning off financial funds to other companies.

Finally, it is important to define integration of activity or interest connection. "Integration of activity" or interest connection exists: (i) where non-financial legal entities have been debtors of an institution undergoing intervention or extra-judicial liquidation or bankruptcy; or (ii) where partners or shareholders of non-financial legal entity hold over 10% of the financial institution’s capital stock; or (iii) where those partners or shareholders are spouses, or relatives up to second degree, by blood or otherwise, of the Officers or members of the Consultative, Administrative, Supervisory Committees or the like, of the financial institution.

Footnotes

1 STJ, 1ª Turma, RESP nº 396.270, Rel. Luiz Fux, DJ 23/09/2002, STJ, 2ª Turma, AARESP nº 487.076, Rel. Luiz Fux, DJ. 29/09/2003

2 STJ, 2ª Turma, RESP nº 450.538, Rel. Ministro Franciulli Netto, DJ 30/08/2004; STJ, 2ª Turma, RESP nº 184.325, Rel. Laurita Vaz, DJ 02/06/2002; STJ, 2ª Turma, AARESP nº 302.257, Rel. Eliana Calmon, DJ 19/05/2003

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Authors
Walter Stuber
 
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