The importance of paper trails in corporate litigation: the Luxembourg example

Not only has the concept of the “interest of the company” gained autonomy (departing from the purely financial interest of the shareholders), but this concept has also evolved, pressuring company directors into taking into consideration the interests of a wider group of stakeholders (employees, customers, suppliers), albeit not the interests of the community as a whole (social and environmental issues).

It is thus becoming increasingly crucial for company directors to be able to prove that these interests have been taken into consideration in the decision-making process and the best way to achieve this is to make sure to leave an adequate paper trail.

Fighting the outcome bias

The “interest of the company” is a key concept in Luxembourg corporate law: voting agreements are void if contrary to the company’s interest, while failing to act in the best interests of the company is an act of mismanagement (faute de gestion) and the use of a company’s assets or credit contrary to the interests of the company is a constituent element of the misuse of corporate assets offence.

When determining whether an action was contrary to a company’s interest or not, Luxembourg courts will usually put themselves in the shoes of the director. For example, when assessing whether a business decision constitutes an act of mismanagement, they will assess – based on the director’s knowledge and level of skills – if the director manifestly departed from prudent and diligent behaviour.

Nevertheless, judges are human beings and like anyone can be influenced by outcome bias, which is the natural tendency to assess the quality of a decision based on its outcome rather than its merits. The more negative the outcome (e.g. the company becoming bankrupt), the stronger the bias is likely to be.

However, businesses and their directors must be able to take risks (as long as they are adequate and proportionate) without facing a liability risk each time the risk is realised. 

The only way to avoid the influence of this bias is to focus solely on the information that was available before taking the decision (i.e. to provide context for the directors’ decision). In a director liability claim, this means that directors will be in a better position if they are able to shift the focus of the court from the outcome of their decision to the context of the decision. That can include consideration of factors such as:

• the investigations undertaken by the directors before taking its decision (did the board conduct its own due diligence and/or seek external financial or legal advice?);
• the information or data on which the board based its decision (was it reliable, and/or was there a significant margin of error?);
• the aspects of the company’s interest taken into consideration (e.g. the company’s interests versus the group’s interests, or financial versus reputational interest);
• if there were contradicting interests, how the board balanced them;
• the evaluation of the risks and reward of each option; and
• the evaluation of the company’s capacity to face the risks, should they materialise.

To achieve this, directors must therefore make sure that they maintain a paper trail that adequately evidences the inquiries they made before reaching their decision.

The evidentiary value of paper trails

One underlying principle of the Luxembourg rules of evidence (derived from article 1315 of the Luxembourg Civil Code) is that one may not create proof on their own behalf (nul ne peut se constituer de preuve à soi-même).

However, this rule is widely misunderstood in several respects, the main one being that it only applies to the proof of the existence and content of legal acts, and not to facts – such whether a specific action is in the best interests of the company or whether a director has been diligent.

Therefore, by creating a paper trail of the decisionmaking process, directors are in fact creating admissible evidence of the matters they considered.

It is then only a question of the evidentiary value of the paper trail. Indeed, stating that one director has conducted an investigation into relevant matters is not irrefutable proof that he has in fact done it, or that he has done it diligently. However, it is good prima facie proof and the more detail provided regarding the investigations conducted, the stronger the evidence will be. 

Which medium for your paper trail?

The most obvious method by which a paper trail of the board’s investigations can be established is through the company’s board minutes. These are meant to reflect not only the resolutions passed by the board but also the debates between the board members and more generally the decision-making process. Moreover, it is a document that reflects – except where dissenting opinions are expressed – the views of the board as a whole, and not simply of one director.

However, it may sometimes be advisable to create a paper trail outside or in parallel of the board minutes, such as where the board is dealing with highly sensitive information or where the decision-making process is complex. In such cases, the board should make sure that it keeps a record of such information and of all the inquiries carried out in any appropriate form (e.g. internal memorandum, emails, etc.) and that this record is made available to the directors prior to a board meeting. In any event, board minutes should be prepared to give context to the board’s decision (e.g. by referring to any record prepared) and that they address the question of why the board takes the view that the contemplated resolution is in the best interests of the company.

Who is likely to have access to such paper trails?

Under the Luxembourg rules of Civil Procedure, there is no disclosure process. Parties come to court with their own evidence and courts will refuse to supplement the deficiency of one party in the production of evidence.
There is one exception. Parties can request that a court (either before or during trial) order the disclosure of a document that is likely to have an influence on the outcome of the trial. To be successful with such an application, the requesting party will need to specify with precision the relevant documents and demonstrate their likely existence. Any broad requests amounting to a fishing expedition will be rejected.

In practice, this means that – in the example of a director liability claim – shareholders or third parties will not be able to judicially request disclosure of “all exchanges and documents in the hands of the board” and relating to a particular matter. While it will be relatively easy for them to obtain the disclosure of the relevant board minutes (since they can satisfy the above criteria by simply requesting the disclosure of the board minutes that approved a specific resolution), it will be much more difficult for them to obtain disclosure of other documents relating to the decision-making process unless they are able to target specific documents, which they know exist.

What about privilege?

Luxembourg law approaches privilege differently than common law systems, and with restrictions. Its approach is in essence limited to client-attorney privilege, which only covers communications between a client and external attorneys (to the exclusion of in-house attorneys). Also, this privilege is not absolute. When facing a request to order the disclosure of a document protected by client-attorney privilege, courts will balance the legitimate interest of the party protected by such privilege and the legitimate interests of the party making the request.

This means that directors should not only be mindful of the paper trail they willingly create, but also of the paper trail they leave.