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Directors and Officers Liabilities and Insurance

Directors and officers, of a commercial entity, are subject to certain liabilities resulting from their acts and decisions taken within a day-to-day business.

The purpose of this article is to determine the responsibilities and consequences arising from the activities performed by the directors, statutory auditors, and officers within a Mexican corporation, and mention the insurance coverage available in the Mexican market.

For the better development of this article, we have divided the responsibility of such members into four different sections:

i. Civil liability of the Board of Directors;
ii. civil responsibility of the Statutory Auditors;
iii. tax liability of directors, statutory auditors and officers;
iv. criminal liability of directors, statutory auditors and officers; and
v. insurance coverage with respect to the actions of the directors, statutory auditors and officers.

1.- Civil liability of the Board of Directors:

Pursuant to Article 142 of the General Corporations Law (“GCL”), the management of a corporation will be entrusted to one or more directors, whose position is temporary and revocable.

Furthermore, pursuant to Article 147 of the GCL, the position of director is personal and may not be carried out through an agent.

It is worth mentioning that pursuant to Article 154, directors will continue performing their duties, even when the term for which they were appointed has expired, as long as new appointments are not made and/or the newly appointed directors have not begun the performance of their duties.

Pursuant to the foregoing, obligations, and responsibilities of the members of the board of directors of a corporation originate from: i) the by-laws of the company; ii) the GCL; and iii) such inherent to their agency relationship.

In this regard, the rules of agency established in the Civil Code are applied, suppletory, to what is established in the GCL and, therefore, the rights and obligations of the agent with respect to the principal.

Thus, a director of a corporation must carry out his duties in accordance with the instructions received by the Shareholders’ Meeting and the by-laws, by always acting as if he was an owner of the corporation, never exceeding the powers granted to him by law and the by-laws. Failing to act in accordance with the by-laws or the instructions received, the director can be liable for the damages and lost profits caused by his actions, in favor of the company.

The Board of Directors has different responsibilities, which are listed below:

  1. Pursuant to Article 156 of the GCL, any member of the Board of Directors who has an interest, contrary to that of the corporation, must disclose such opposed interest to the other directors and refrain from any deliberation or resolution that may hinder or endanger the corporation. In case of failure to comply with the foregoing, said member may be obliged to pay, in favor of the corporation, the corresponding damages and lost profits originated by said omission.
  2. Pursuant to Article 157 of the GCL, the members of the Board of Directors of a corporation must maintain strict confidentiality with respect to the information and matters of which they have knowledge, when such information or matters are not public knowledge. This confidentiality obligation shall be in force during the performance of their duties and up to one year after the termination thereof.
  3. Pursuant to Article 158 of the GCL, the directors are jointly and severally liable2 with the corporation in connection with the following: a) the existence of the contributions made by the shareholders; b) compliance with the legal requirements and by- laws regarding payment of dividends to the shareholders; c) the existence and maintenance of the accounting, control, registry, filing or information systems provided by the law; and d) the exact fulfillment of the resolutions adopted by the Shareholders’ Meetings. Compliance regarding these obligations may be required by the shareholders, the corporation and/or the corresponding tax authorities.
  4. Pursuant to Article 160 of the GCL, the directors are required to report, in writing, to the statutory auditors any irregularities committed by those who administered the corporation before them, otherwise they will be jointly and severally liable with said previous directors.
  5. Finally, Article 163 of the GCL establishes that the shareholders representing at least 33% of the Capital Stock may, directly, sue the directors of the company for civil responsibility, provided the following requirements are fulfilled: a) that the action is brought in favor of the corporation for the total liability incurred, and not only for the individual interest of the plaintiffs; and; b) that the plaintiffs have not approved a resolution at a General Shareholders Meeting releasing the defendant-directors from their corresponding.

2.- Civil responsibility of the Statutory Auditors:

Pursuant to Article 164 of the GCL, the oversight of the corporation shall be entrusted to one or more statutory auditors whose appointment shall be temporary and revocable.

Furthermore, Article 165 of the GCL sets forth that, the position of a statutory auditor cannot be performed by: a) those unable to engage in acts of commerce; b) employees of the company, employees of the companies that are shareholders of the company in question in more than 25% percent of the capital stock, nor employees of those companies of which the company in question is a shareholder of more than 50% percent of the capital stock; and c) blood relatives of the directors, in a straight line without limitation of degree, collateral relatives within the fourth degree and relatives within the second degree.

In general, the duties of the statutory auditor involve, oversight of the management, operation and performance of a corporation’s business by reporting the financial, accounting, operational and recordable aspects of the corporation, informing the Shareholders’ Meeting of any irregularities and, if applicable, to the corresponding authority.

In this regard, the statutory auditor has different responsibilities, which are listed below:

  1. Pursuant to Article 169 of the GCL, the statutory auditors are individually responsible to the corporation for the fulfillment of all the obligations that the law and the by-laws impose on them.
  2. Additionally, pursuant to Article 170 of the GCL, the statutory auditors must refrain from carrying out any proceeding and/ or operation in which they have an opposed interest to that of the corporation and informs such situation to the Board of Directors. By failing to comply with this obligation, the statutory auditor is liable for any damages and lost profits caused to the company.

3.- Tax liability of directors, statutory auditors and officers:

  1. Pursuant to Article 26 of the Federal Tax Code (“FTC”), the members of the Board of Directors, general directors or managers of a corporation are jointly and severally liable to taxpayers primarily when: a) failure to file for registration of the corporation before the Federal Taxpayers Registry; b) failure to notify the corresponding tax authorities of any changes of the corporation’s domicile; c) the accounting records of the corporation are not kept, concealed or destroyed; d) the premises where the corporation has its tax domicile are vacated, without filing the corresponding notice of change of domicile before the corresponding tax authority; e) the corporation is not located in the domicile registered tax before the Federal Taxpayers Registry; f) the corporation fails to pay the tax authorities, within the term established by law, the amounts of taxes withheld or collected.
  2. In addition to the foregoing, pursuant to Article 95 of the FTC, the directors, statutory auditors and/or officers of a corporation are not exempted from any liability regarding tax offence.
  3. Pursuant to Article 172 of the GCL, over the first four months of each year, the Board of Directors must submit a report to the Shareholders’ Meeting in which, among other things, they shall brief the shareholders on the accounting, tax and financial situation of the corporation. In the event of failure to submit such report, the directors may be removed, notwithstanding any claims of any liabilities they may have incurred for such omission.

4.- Criminal liability for directors, statutory auditors, and officers:

Under Mexican criminal statute (federal and local) and the applicable judicial precedents, the shareholders, directors, officers, employees and other representatives of the corporation are criminally liable for their individual conduct and for crimes committed on behalf or in benefit of the corporation.

Notwithstanding, pursuant to Article 46 of Mexico’s City Criminal Code, corporations are obliged to repair the damage caused by the crimes committed by its shareholders, managers and/or directors.

Criminal liability of shareholders, directors, managers, officers, representatives and others will arise from their participation in the commission of illegal conduct, whether intentional, negligent, reckless or with or without knowledge of the law. Criminal liability may also arise from failure to comply with Mexican laws, rules, and regulations. In this case, the non- complying individuals will be liable for their actions.

In some cases, local legislation of the United Mexican States establishes that a crime can be committed by the shareholders and/or Board of Directors by voting and resolving in favor of committing a crime on behalf of a corporation. In such cases, the shareholders/board members who cast their affirmative vote will be considered participants in the commission of the crime. On the other hand, shareholders/board members who witnessed the vote, but abstained or voted in a negative manner, may be considered accomplices if they do not report the criminal conduct to the corresponding authorities.

Shareholders, directors, managers, officers, representatives and others, are generally not liable for crimes committed by others. However, if there is intentional, negligent, or reckless conduct related to the offense or acquiescence thereof, criminal liability may arise. Additionally, liability may exist if it is proved that others acted upon the instructions of such directors, managers, among others.

5.- Insurance coverage regarding the actions of the directors of a corporation:

Many insurance companies are willing and able to provide coverage to members of the Board of Directors, statutory auditors and/or officers of a corporation regarding non- compliance of their corresponding obligations which may result in civil, criminal and/or tax liability for the corporation or for such officers.

The purpose of providing coverage to directors and officers with a liability insurance is to protect their personal assets in the event of error or alleged error from decision making during their capacity as directors and/or officers and for which they may be legally liable. This insurance is purchased by the corporation to protect its directors and/or officers during the performance of their duties.

Generally, the corporation must reach out to the insurance company in order for the latter to carry out a specialized analysis and provide the specific coverage required.

Additionally, some insurance companies provide different coverages, including: a) administration coverage, which is paid on behalf of the director and/or officer who is legally liable for any error or omission, or alleged error or omission in the performance of his or her duties, where damage or harm has been caused to the company or a third party, including participation in external entities; b) reimbursement coverage for legal expenses of the corporation, which is provided to the corporation by reimbursing the legal fees paid by such, in connection with claims against a director and/or officer who is legally liable for any error or omission, or alleged error or omission in the performance of his or her duties, in which damage or injury has been caused to the corporation or to a third party; c) coverage for the corporation for securities claims, in which the insurance company reimburses the insured when it must pay a loss arising from a securities claim due to a corporate act.

Therefore, the cost for each insurance policy varies depending on the corporate purpose of the corporation and the extent of the coverage, which may include: i) covering the director or officer for any liability incurred for the specific purpose of protecting his or her personal assets; ii) covering a corporation from liability derived from its directors or officers; and iii) covering a public corporation, by protecting it from any securities claim arising from a corporate act performed by its officers and/or the corporation itself.

Commonly, most insurance policies offered by insurance companies include legal defense coverage. It is also important to mention that insurance companies may extend coverage (e.g. liability incurred by spouses, heirs, estate, legal representatives, representation of directors in other entities, appearance in investigations, breach of labor practices, violation of legal ordinances by willful misconduct, coverage for independent directors, compensatory payments to directors, coverage from frozen assets and deprivation of freedom, extradition proceedings, crisis management expenses, rehabilitation of public image, involuntary manslaughter, financial damages due to pollution, expenses for fines and penalties, among others). Insurance companies may also exclude from coverage certain conducts (e.g. willful misconduct or bad faith actions, fraudulent conduct and/or causing physical injury or damages, among others). Such extensions and exclusions vary depending on the type of insurance and the insurance company.

At Ibarra, del Paso y Gallego, S.C., we have the expertise and ample experience in advising entities during the procedure of hiring its D&O liability insurance and we have represented many national and foreign corporations in structuring this financial and legal mechanism for their directors and officers.


2 Joint and several liability implies that there is a plurality of “debtors” liable to creditors (e.g. third parties, authorities, shareholders, etc.). The directors that are jointly and severally liable, may acquire such quality of “debtors” towards different creditors, in specific cases. This implies that each of the creditors could require from them, the fulfillment of an obligation. The directors are (personally) obliged, to the same extent as the company, to respond to the creditors.

CONTACT

Rodrigo de los Rios Gordoa | Partner | [email protected]

Mariano Sotomayor Bustamante | Sr. Associate | [email protected]

José Mayagoitia y de Rosenzweig | Associate | [email protected]

T. 52+(55) 5202-0717

This alert does not constitute legal advice and is protected under copyright law.

For more information about Ibarra, del Paso y Gallego, S.C. and its Labor & Employment Practice, log onto www.ibarrapg.com.

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