The legal qualification of discharge depends on the timing as well as the quality of the information available to the shareholders. Both elements might have an impact on the legal implications of such discharge.
In the context of an M&A transaction, granting discharge to the resigning directors (often also the sellers) is very common. The share purchase agreement typically contains a specific closing and post-closing undertaking, relating to the granting of (interim) discharge. However, the validity of such (interim) discharge is sometimes questionable and might conflict with the company’s best interest.
Definition and legal qualification
Definition and legal qualification
Granting discharge is an act of the shareholders’ meeting, by which it states that it does not have the intention to bring a claim against the directors. Granting discharge is a waiver of a legal right. For such discharge/waiver to be valid, it must meet a number of legal conditions, both provided by civil law as well as by company law.
A preliminary discharge is granted before the performance of an act. Such discharge is used for example when directors have to take decisions with far reaching consequences. In practice, the board of directors will ask the prior confirmation from the shareholders’ meeting. It is apparent that a preliminary discharge is not equal to a traditional discharge. Contrary to a traditional discharge, which offers directors general absolution, a preliminary discharge must be interpreted restrictively. A preliminary discharge, therefore, only covers the specific actions for which discharge was granted. Furthermore, a preliminary discharge cannot be granted for violations of the law or the company’s articles of association.
An interim discharge differs from a traditional discharge with regard to the timing, as such discharge is granted during the course of the year. Consequently, there are no draft annual accounts on which the shareholders’ meeting can base its decision.
As we will discuss later, for the discharge to be valid, the shareholders’ meeting has to decide with full knowledge of the facts. Therefore, an interim discharge can only be granted in case the director reports on the exercise of his/her mandate. Like the preliminary discharge, an interim discharge does not grant general absolution, but is limited to the flaws reported to the shareholders’ meeting. It is therefore in the best interest of the directors to report in a careful and diligent way, so that the validity of a granted discharge cannot be questioned afterwards. To meet this specific condition, the board of directors could provide interim accounts and an interim board report in order to properly inform the shareholders’ meeting.
Conditions for granting a valid discharge
The Belgian Company Code stipulates that discharge is granted after the approval of the annual accounts, meaning at the annual shareholders’ meeting. This has led some to believe that granting discharge is only possible at this specific period in time.
A vast majority of the legal doctrine and case law, however, is of the opinion that granting discharge is possible at any time. The Court of Appeal of Brussels (12 April 2002) ruled that the mere fact the shareholders’ meeting must decide on the discharge after the approval of the annual accounts, is not a restrictive condition to grant discharge. Basically, the Court states that the shareholders’ meeting must decide on the discharge at least once a year. The shareholders are however free to decide on the discharge whenever they want. The Court’s reasoning is logical, because the need for discharge does not always align with the date of the annual shareholders’ meeting. Following the above, it could be concluded that the timing of the discharge is not a condition for its validity. However, it must be reminded that the timing, and as a mere result thereof, the availability of information, does have an impact on the qualification of the discharge and, therefore, its legal implications.
The Belgian Company Code sets out another condition for the validity of the discharge. Granting discharge is only valid in case the shareholders’ meeting could deliberate with full knowledge. In theory, this is assured by the draft annual accounts to be prepared by the board of directors within the framework of the approval thereof.
However, discharge is frequently granted during the financial year, when the annual accounts have not been prepared yet. This problem could be solved by drafting interim financial accounts. The Belgian Supreme Court (12 February 1981) nuanced this. It has ruled that it is sufficient that, even in case of an irregular balance sheet, the shareholder’s meeting could verify the situation by any other means. In practice, the shareholders’ meeting thus could verify the situation, for example, through drafted special reports, interim accounts, or by exercising its right to ask questions to the directors. Whether the shareholders’ meeting was duly informed or not, will be subject to the courts’ appreciation. Not every flaw, omission or negligence makes the discharge invalid. These must be of such a nature that they obscure the true view on the company. Furthermore, the courts will consider the shareholders’ level of expertise. This case law has in some way led to the fact that the conditions for validity of the discharge have been eased.
Discharge specifically in an M&A context
In case of a transfer of shares, the current directors will generally resign at closing. To offer legal certainty to the resigning directors (who often also are the sellers), the share purchase agreement typically contains the contractual undertaking for the buyer to grant interim discharge at the closing. As already indicated, the legal value of interim discharge is limited as it does not grant general absolution.
Therefore, the buyer typically also takes up the contractual engagement to procure that the general shareholders’ meeting will grant discharge at the first upcoming annual shareholders’ meeting. These contractual undertakings are intended to avoid the possibility of dual recourse. Otherwise the buyer could potentially get dual advantage by bringing a claim under the share purchase agreement and by bringing a claim for directors’ liability against the directors.
However, one important thing must be kept in mind when drafting such clause. As a principle, granting discharge is only possible when it is in the interest of the company and not in the interest of the shareholders only. This could mean that a buyer takes up the obligation to grant discharge, but later finds out that it is not at all in the interest of the company to grant discharge.
Impact on potential claims
The situation may for example occur that there are still skeletons in the closet. In that case, the buyer may ultimately refuse to grant discharge, contrary to its contractual obligations under the share purchase agreement, as it is not in the best interest of the company. However, when the target company brings a claim against a director, this can result in the director claiming that his contractual damage originates in the fact that the company brings a director’s liability claim. This situation, however rare, can potentially cause some trouble concerning legal certainty.
Granting discharge is a very common practice within the framework of an M&A deal. The common interim discharges granted within the framework a share deal are, however, limited and do not grant general absolution. It is in the best interest of directors to provide all necessary information to the shareholders’ meeting, so that it can decide with full knowledge. This way, directors avoid the potential nullity of the discharge in any later stage.