Liability of advisors

Entrepreneurs know: in business there are opportunities, but also risks. And advisors do not participate in a company’s success, but do share in the risk. Particular caution is required if a company is in financial difficulty.

Advisor’s liability means that advisors are not only required to pay for loss or damage incurred as a result of incorrect advice given in the course of an actual engagement – they are also liable for failure to notify clients of important facts and for well-meaning informal advice – both to the company and possibly later to an insolvency administrator. And in some cases insolvency administrators require consultants to return fees previously paid.

Consultant in a company in crisis?
Act quickly.

Focus

Who is affected?

In principle, this affects any advisor who provides support to a company and whose expertise is taken into account in relevant company decisions. The general rule is: The larger the group of potentially injured parties, the greater the advisor's liability risk.

The focus is often on:

tax advisors
auditors
business consultants
lawyers

When does it get risky?

1. Non-distressed situations

In general, an advisor’s obligations are laid down in his or her consultancy agreement. This agreement can be drafted to eliminate some risks. Contractual protections are ineffective, however, when laws have been broken. There is particular risk in the following situations:

Legal advice
If legal services are provided by a person who has experience in the relevant field but does not hold the necessary licences, he or she is not protected in case of errors. It is often possible to cross the threshold into giving legal advice without noticing. Drafting contracts, opening settlement negotiations or entering into agreements regarding subordination of claims are all examples of activities equivalent to providing legal advice. If that advice is erroneous, and the errors result in loss or damage, the advisor is liable to the company.
Advisory errors
Advice given can turn out to be wrong, especially in the business consultancy field. If the advisor culpably gave incorrect advice – i.e., if the expert engaged should have foreseen the financial consequences of the advice – he or she may face claims for damages. In these cases expert status often becomes an issue. Typical errors relate to e.g. supplementary finance, provision of additional collateral or restructuring.
De facto directors
The greater an advisor’s influence over a company's managers and the closer his or her involvement in business decision-making processes, the bigger the risk of being considered a “de facto director”. In such cases, the advisor has a liability risk comparable with that of the original management – but unfortunately without the equivalent insurance cover.

2. Distressed situations

When a company gets into financial difficulties, its management needs expert advice more than ever. Unfortunately, the risks of providing advice to companies in this situation also increase. Advisors need to tread carefully when the company enters insolvency, if not before. Even assuming that his or her motives are entirely honourable: if there doesn’t seem to be a solution for the situation, this throws up some fundamental questions for the advisor: Should he or she let down a client that needs him or her more than ever? Should he or she leave the field to other advisors? Should he or she insist – in this difficult situation – on timely payment of fees, or even payment in advance?

There are particular risks in the following cases:

Liability for failure to notify client of material insolvency/liability for provision of incorrect information regarding material insolvency
Recent rulings of the higher courts have tightened the notification duties of tax advisors significantly. This affects both the duty to notify the company of the risk of material insolvency, and the associated duty to file for insolvency. This means that, where there are obvious signs of crisis, the tax advisor must notify the company of this – regardless of what his or her consultancy agreement says. If the advisor fails to give such notice, he or she may be held liable for subsequent loss of assets or damage.
Liability for aiding a delay in filing for insolvency
If the company and the advisor are aware that the company is materially insolvent but the advisor continues to provide advice to the company and the company continues to operate, this could even result in criminal liability – and associated civil liability. In cases like these, it is inadvisable to continue the business relationship, especially if the company has failed to act on advice that an insolvency filing is required.
Non-payment of fees/avoidance in insolvency
An advisor working with a company in financial distress is usually aware of the company’s economic capacity and liquidity. This is a risky situation because, if an insolvency administrator is appointed, he or she can demand the return of consultancy fees paid previously – retrospectively covering a period of up to four years preceding the insolvency filing. However, this can be avoided through forward-looking action.

Expertise

How can advisors protect themselves?

To protect themselves against liability and avoidance when working with companies in distressed situations, it is vital that advisors seek out experts with knowledge of insolvency and company law. Doing so limits the risk of lost fees and liability issues. And some notification duties pass to the experts being consulted.

At Schultze & Braun, we provide advice not just to companies in these situations, but also to advisors whose work exposes them to risks and claims as a result of errors in the advice they provide. This helps protect and maintain the advisor’s relationships with his or her clients. We show our clients what courses of action are open to them, accompany them until the crisis has been resolved, and represent affected parties in court.

Risks for tax advisors

Liability of tax advisors

Beware of this liability trap for tax advisors! Insolvency administrators are increasingly bringing liability actions against advisors who have acted for a company that later entered insolvency. Especially the liability risks lying in wait for tax advisors on retainer are often underestimated.

If you are a tax advisor, and your client is a German limited liability company (GmbH) or limited partnership with a limited company as general partner (GmbH & Co. KG), the liability risks resulting from such a retainer can be unpredictable. If a debtor files for insolvency late, and this can be attributed to the tax advisor, these risks can even be existential. The sums on the table in this kind of situation can quickly run into the millions.

Tips

We have put together some tips on how to handle these risks.

A tax advisor on retainer must proactively inform clients of any tax problems that come to their attention in their capacity as an advisor. They must protect clients against losses and damages, poor decisions and the consequences of those decisions.
But what is the situation in the case of insolvency? The determining factor here is the engagement terms. If they explicitly require the advisor to examine the client’s affairs for material insolvency, he is liable as tax advisor for loss or damage incurred by the client, its governing bodies (e.g. its directors) or creditors as a result of an incorrect examination.

Tip 1: Tax advisors must check whether their engagement terms require them to determine the existence of grounds for insolvency.

The Federal Court of Justice (Bundesgerichtshof) has held that if a tax advisor is not instructed to carry out such examination, he or she is not subject to a general obligation to notify. Advisors instructed by the client to provide general tax services are therefore not obliged to review the client’s affairs for material insolvency or to notify the client or its organs if material insolvency is present. If a tax advisor makes an erroneous statement, however, he or she may be liable both in cases where he or she has been specifically instructed to assess material insolvency, and where he or she gives advice to that effect without having been explicitly instructed to.

Tip 2: An instruction to examine whether the client is materially insolvent should always be given in writing.

As described above, there are liability risks if you exceed the scope of a general mandate and make statements regarding potential grounds for insolvency without being asked to do so – when preparing financial statements, for example. An erroneous assessment establishes liability risks in the amount of the liabilities entered into in the period between the date on which the client should have filed for insolvency if it had acted conscientiously and the date on which it actually did so.

Tip 3: Tax advisors should never make any statement regarding the presence of possible grounds for insolvency unless they were specifically instructed to carry out such an examination and actually did so.

If you do not have sufficient expertise in this field yourself, we strongly recommend that, in view of the large sums for which you could be held liable, you consult a recognised expert. Doing so reduces liability risks for you and helps your client by ensuring that experts in dealing with impending crises are involved at an early stage.

This improves your client’s chances considerably. Your liability risk is reduced and the chances of keeping your client for the future are increased.

Get in touch. We will be delighted to help.

Contact

Thomas Dömmecke
Rechtsanwalt (Attorney at law)

More contact persons

Call +49 421 43301-16 Direct message

Consultant in a company in crisis? Act quickly.

Cookie and Plugin Settings

Technical Cookies

Necessary Cookies

Statistics Cookies

Matomo

Consultant in a company in crisis?
Act quickly.