It is not uncommon to have 'front' persons, or 'straw men', registered as managing directors in the commercial register when the actual managing directors are not eligible for registration due to criminal convictions or other obstacles. This can have devastating consequences for the 'front directors' as a ruling by the Hamm Higher Regional Court (OLG) shows. According to the Court, they are not covered by D&O insurance if they have failed to disclose their 'front director' status to the insurer. This also applies if the insurer has waived the insurer's right of avoidance but the insurance policy provides for an exception in the event of fraudulent misrepresentation.
'Front directors' are often registered as managing directors in the commercial register for reasons of liability or for reasons preventing registration (e.g. a criminal record of the actual managing director). This means that other individuals are in charge of the company as de facto managing directors who cannot be registered for various legal or factual reasons. The Hamm Higher Regional Court held that there is no insurance cover for the 'front director' under the D&O insurance on the grounds of fraudulent misrepresentation if this fact was not disclosed to the D&O insurer (ruling of 28 February 2024, case no. 20 U 224/23).
In the case at hand, the 'front director' sued the D&O insurer for payment. He had stepped in when the founder of a German private limited liability company (GmbH) joined the civil service as a police officer and had to resign as managing director for legal reasons. As a result, the plaintiff had himself entered in the commercial register as managing director in June 2018 and granted the former managing director power of attorney for all commercial matters (Prokura). The former managing director continued to run the company's business alongside his main occupation as a police officer. The plaintiff was - in his own words - a 'managing director on paper' only.
In May 2020, the plaintiff, as the legal representative of the GmbH, took out a D&O insurance policy with the defendant. When doing so, he failed to disclose the true management situation. The policy contained a clause stating that the defendant waived the right to contest the contract on the grounds of fraudulent misrepresentation, but that the persons committing the fraud were excluded from insurance cover.
On 1 October 2022, insolvency proceedings were opened over the company's assets and the insolvency administrator made a claim against the plaintiff under section 64 of the old version of the German Limited Liability Companies Act (GmbHG) (now section 15b of the German Insolvency Code (InsO)) for payments made by the company after it had become insolvent. The plaintiff sought indemnification from the insurer, who refused to provide cover. After the plaintiff had lost the first instance and lodged an appeal, the Hamm Higher Regional Court issued the commented decision.
The Hamm Higher Regional Court ruled that the defendant did not have to provide any insurance cover. The plaintiff had fraudulently misled the defendant when taking out the policy. Under the principles of good faith, he should have informed the defendant of this circumstance even without being asked about it.
The Court concluded this from the explanatory memorandum on section 19(1) of the German Insurance Contracts Act (VVG), which did not exclude avoidance for fraud. According to this rule, there was only an obligation to provide information on circumstances involving a significant risk that was requested by the insurer. A spontaneous duty of disclosure therefore had to meet high standards. It only applied where there existed obviously risk-relevant circumstances that were so rare and remote that the insurer could not be blamed for not having enquired about them.
It was evident that a merely formal managing director who is neither willing nor capable of fulfilling his duties as managing director was not acting with the due care of a prudent businessman. He therefore significantly increased the risk of becoming liable to pay damages to the company. This certainly applied if, as was the case here, the de facto managing director was unable to fulfil his corporate responsibilities due to his other, principal professional activities. Since the insurer would not have issued the policy if the required information had been provided and the Court assumed wilful intent, the Court affirmed fraudulent misrepresentation.
D&O policies usually cover the liability of all managing bodies and senior executives of a company and its subsidiaries. This generally includes all formal and actual directors. Before an insurance policy is issued, the insurer regularly assesses the risk on the basis of a more or less standardised list of questions. Hence, insurers are free to ask risk-related questions to determine the circumstances that are relevant for deciding whether or not to issue a D&O policy to a company. If an insurer does not ask a question about a particular circumstance, the policyholder can generally assume that this circumstance has no relevance for the insurer's risk assessment.
With the commented decision, however, the Hamm Higher Regional Court makes it clear that the policyholder's duty to provide information to a D&O insurer is not limited to answering the risk-related questions truthfully. The Court sets high standards for a spontaneous duty to provide information and follows the strictest view expressed in legal literature, which has become the predominant view in the rulings of higher regional courts by now. A policyholder only has to disclose such circumstances without being asked that, on the one hand, have an obvious risk potential and, on the other hand, are so unusual that an insurer cannot reasonably be expected to ask any specific questions about them. In the commented decision, the 'front director' status of the sole managing director was such a circumstance.
The decision is therefore hardly surprising. In a ruling of 4 May 2016 (case no. 1 O 143/14), the Mönchengladbach Regional Court had also considered the status as a 'front director' to require disclosure. The Mönchengladbach Regional Court, however, found no evidence of fraudulent misrepresentation in that case, as it remained unclear whether the insurer was informed of the 'dummy' construct when the insurance was taken out. The plaintiff nevertheless did not receive cover in this case either, as the defendant D&O insurer was able to invoke exclusion on the grounds of wilful breach of duty. According to the Mönchengladbach Regional Court, the timely filing of an insolvency petition is a cardinal obligation where a breach of duty is presumed to be intentional.
The fact that the insurer became aware of the 'front director status' and was also able to prove this in court was, in the commented decision of the Hamm Higher Regional Court, largely due to the statements made by the formal managing director following the notification of the claim.
The risk for 'front directors' is extremely high: they may be held liable with their personal assets (e.g. under section 15b(4) sentence 1 InsO, section 69 sentence 1 of the German Fiscal Code (AO) or section 43(2) GmbHG) even if they stay completely out of the company's business, and they must also fear that a D&O insurer may refuse to provide cover. The commented decision once again underlines that a registration in the commercial register as a matter of courtesy and without the intention of actually running the company's business can have devastating consequences and should not be made without careful consideration.
Dr Florian Weichselgärtner
Etienne Sprösser
This article was first published in the Versicherungsmonitor magazine on 13 January 2024. Here you find the original article (available in German only).
