What is Shareholders' and Directors' Liability in Panama?
Edgar Young, PhD.
Attorney-At-Law | Partner
TL; DR
Shareholders may not be held responsible for the acts or omissions of the company. The Corporation Law establishes that shareholders shall be personally liable to the creditors of the corporation only for an amount equal to any amount left unpaid on the par value or the subscription value (in case shares have been issued without par value) of the stock. However, no action shall be brought against the shareholder for any debt of the company, unless the corporate assets are insufficient to satisfy a judgment against it.
Directors shall not be personally liable for the liabilities of the corporation, but will be personally (several) or solidarily liable (joint liability), as the case may be, to it or to third parties, for the effectiveness of payments that appear to have been made by the shareholders; for the real existence of agreed dividends; for the proper management of the accounts and, in general, for the proper or improper execution or performance of the agency or for the violation of the laws, the articles of incorporation, the by-laws or resolutions of the General Meeting. Directors who were absent with cause or who protested in due time against the resolution of the majority shall be exempted from liability. The liability can only be demanded by means of a resolution of the General Shareholders Meeting.
A. Shareholder’s Liability
The concept of shareholder liability in Panamanian corporations, particularly under Law 32 of 1927, is a critical aspect of corporate governance that aims to balance the interests of investors and creditors. This article delves into the nuances of shareholder liability, exploring the legal framework, limitations, and conditions under which the corporate veil may be pierced.
Limited Liability Principle.
Under Article 39 of the Panamanian Corporation Law, shareholders are generally protected by limited liability. This means that shareholders are only liable to the extent of their unpaid share capital. They cannot be held personally liable for the corporation's debts until a judgment has been rendered against the corporation, and the corporation's assets have been exhausted without satisfying the debt.
The primary function of Article 39 is to delineate the boundary of shareholder liability. Under this article, shareholders' financial responsibility for corporate debts and obligations is limited to the amount they have invested or committed to invest in the corporation. This means that if a shareholder has fully paid for their shares, they cannot be required to contribute further funds to satisfy the corporation’s debts. Article 39 ensures that shareholders’ personal assets are shielded from claims against the corporation. This protection provides security for investors, allowing them to invest without the risk of losing personal assets beyond their capital investment in the corporation.
Panamanian courts have consistently upheld the principle enshrined in Article 39, reinforcing that shareholders' liability does not extend beyond their unpaid share capital. Nonetheless, there are exceptions to this rule as explained further in this article.
Corporations –Separate Legal Personality, Corporate Veil or Personhood
A corporation is an entity with its own legal personality, distinct from its shareholders. The obligations of the shareholder are limited exclusively to their contributions. It is also important to note that the legal entity acts through its organs, whose actions or omissions are considered those of the legal entity itself. Hence, the natural person who acts as the legal representative is one thing, and the legal entity is another. This is widely recognized by Commercial Law. In criminal matters, however, regarding punitive responsibility corresponding to the legal entity, it is attributed to its directors who committed the act. The legal entity would have its responsibility within the field of civil liability and, in some cases, in the administrative punitive part
The principle of separate legal personality is foundational to Panamanian corporate law.
The corporation is considered a separate legal entity, distinct from its shareholders. The general principle established in Panamanian positive law by virtue of which the commercial company has its own legal personality, distinct from that of its shareholders, and all its acts and contracts are carried out by it through its representatives in accordance with the powers vested in them. This principle gives it legal personality, that is, a legal person is created that has its own assets, with responsibility totally different from the assets and individual responsibility of the members of the company. According to doctrine, legal personality can be understood as the capacity to be the subject of rights and obligations. This principle is recognized by Panamanian case law under Judgment. Civil Chamber. Supreme Court of Justice. January 31, 1995)
This separation ensures that the personal assets of shareholders are shielded from the corporation’s liabilities. The Supreme Court of Panama has consistently upheld this principle, emphasizing that the obligations of shareholders are confined to their capital contributions.
Piercing the Corporate Veil
Despite the general rule of limited liability, there are exceptional circumstances where the corporate veil can be pierced. The courts may disregard the separate legal personality of the corporation if it is used to perpetrate fraud, evade existing obligations, or conduct business in a manner that is misleading or unlawful. This legal remedy ensures that individuals cannot misuse the corporate structure to shield themselves from accountability.
Panamanian jurisprudence has addressed various scenarios where the corporate veil may be lifted.
For instance, in cases where the corporation is merely an alter ego of the shareholders, or where there is commingling of corporate and personal assets, the courts have found grounds to impose personal liability on shareholders. The Supreme Court has articulated that while the corporation acts through its representatives, any fraudulent or deceptive conduct by these individuals can lead to personal liability.
Fraud and Abuse of Corporate Structure
The misuse of the corporate form to commit fraud or avoid liabilities is a significant concern. The law recognizes that the corporate structure can be abused to shield illicit activities. Therefore, in instances where shareholders use the corporation as a façade to engage in wrongful acts, the courts are empowered to pierce the corporate veil and hold the perpetrators personally liable.
Case Law. Notable cases have illustrated the application of these principles:
Tribunal Superior de Distrito Judicial de Panamá, Sentencia de 31 de diciembre de 1946
In this case, the court held that the shareholders were personally liable because the corporation was used to perpetrate fraud. The ruling emphasized the need to look beyond the corporate structure when it is misused to achieve unlawful ends.
Supreme Court of Panama, Decision of February 10, 1947
This decision highlighted that shareholders could be held liable where there was a commingling of personal and corporate assets.
The court found that such practices indicated that the corporation was merely an alter ego of the shareholders, justifying the piercing of the corporate veil.
Supreme Court of Panama, Decision of November 6, 1963
In a significant ruling, the Supreme Court underscored that the principle of limited liability does not protect shareholders who engage in fraudulent activities. The court asserted that corporate protection cannot be extended to cover illegal or deceptive practices.
Supreme Court of Panama, Decision of April 1, 1965
This case involved shareholders who used the corporate form to evade existing obligations. The court decided to pierce the corporate veil, holding the shareholders personally liable for the corporation's debts due to their misuse of the corporate structure.
Conclusion The liability of shareholders in Panamanian corporations is primarily limited to their contributions to the corporation’s capital. However, the legal system provides mechanisms to hold shareholders personally liable in cases of fraud, abuse of the corporate form, or other exceptional circumstances. This balanced approach ensures that while the corporate structure encourages investment and economic activity, it also upholds principles of justice and accountability. Shareholders must therefore exercise their rights and responsibilities within the bounds of the law to avoid potential personal liability.
B. Board of Directors’ Liability
Board of Directors duties and responsibilities
Companies are required to have a single board of directors who generally have control over the management of the affairs of the company. The general duties of directors include the sound management of the business of the company and conduct of its accounting, and compliance with the laws, the articles of incorporation, the by-laws (if any), and resolutions of the shareholders. The board of directors may exercise all of the powers of the corporation, except such powers that are by law, the articles of incorporation or the by-laws, reserved to the shareholders.
The board of directors manages the day-to-day business of the corporation and in doing so, it represents the best interests of the corporation and its shareholders. Directors are generally considered to have received a mandate to manage the affairs and assets of the corporation. As such, directors are responsible for discharging their mandate with due care and may become personally liable not only for fraud and willful misconduct but also for negligence in the discharge of their duties.
Standard of Care and Prudence
The standard of care to which directors are generally subject is that which ‘ordinarily prudent men would usually exercise in the discharge of their own affairs’. Directors of public companies may also become personally liable for breach of a duty of loyalty and for violation of certain restrictions on self-dealing. All members of the board of directors are subject to the same standard of care, ie that which ‘ordinarily prudent men would usually exercise in the discharge of their own affairs’. Thus, generally speaking, all directors owe the same duty of care as would ordinary, careful, and prudent men in the conduct of their own personal affairs, to the company and the shareholders, regardless of their different, individual skills and experience.
Liability and Enforcement Actions
Although generally speaking, directors are not personally liable for the obligations of the corporation, they may become jointly and severally liable if they are found not to have discharged their duties as directors with the degree of care that ordinarily prudent men would exercise in the discharge of their own affairs.
Directors are in a principal/agent relationship with the corporation they serve. Directors who have voted against a resolution of the board of directors that gave rise to personal liability, as well as directors who were not present with reasonable cause at the meeting where such resolution was adopted, are not personally liable for actions or resolutions adopted by the board at said meeting. If directors are found liable for violation of the general duty of care or any other provision imposed by law, they would be held jointly and severally liable for damages arising from their breach of the duty of care. A claim may be filed by the company itself or, derivatively, by a shareholder.
Generally speaking a director of a Panama corporation may not be held personally liable either to the company, its shareholders or any other person, unless a resolution authorising such action against the director is adopted by the shareholders of the company. However, in case of fraud, for instance, declaring a dividend or authorizing a capital reduction from insufficient funds, the directors who assent to such action would be personally jointly and severally liable to the creditors of the company, with or without shareholders’ authorization of the claim. Also, certain other causes of action such as liabilities arising for violation of the directors’ duties as trustees in liquidation for example are not dependent on shareholders’ authorization.
Finally, in the case of financial, banking, or securities entities, certain criminal sanctions may apply to directors if involved in authorizing or approving improper disclosures, refusing to cooperate with an inspecting authority, or, in the case of banks, when such banks exceed statutory lending limits.
Insurance D&O - Panama companies may purchase D&O insurance to protect their directors, but such insurance would not be enforceable with respect to liabilities resulting from fraud, wilful misconduct, or gross negligence. There are no legal provisions that would prevent the company from paying the insurance premium.
We shall pay particular attention to Articles 64 and 87 of Panama’s Company Law as well as Article 444 of the Commercial Code.
Company Law
ARTICLE 64. If any dividend or distribution of assets is declared or paid that reduces the value of the corporate assets to less than the number of its liabilities, the corporate capital being included in the latter; or if the amount of the corporate capital is reduced; or if any false declaration or report is rendered on any substantial point, the directors who have given their consent to such act, knowing that in doing so the corporate capital would be affected or that the declarations or the report are false, will be jointly and solidarily liable to the creditors of the corporation for the damages resulting therefrom.
ARTICLE 87. In the case of the preceding Article, the directors shall be jointly and individually liable for the debts of the corporation, but only up to the value of the assets and funds which they may have managed or held.
Commercial Code.
ARTICLE 444. Directors shall not be personally liable for the liabilities of the corporation, but will be personally or solidarily liable (joint liability), as the case may be, to it or to third parties, for the effectiveness of payments that appear to have been made by the shareholders; for the real existence of agreed dividends; for the proper management of the accounts and, in general, for the proper or improper execution or performance of the agency or for the violation of the laws, the articles of incorporation, the by-laws or resolutions of the General Meeting. Directors who were absent with cause or who protested in due time against the resolution of the majority shall be exempted from liability. The liability can only be demanded by means of a resolution of the General Shareholders Meeting.
Before the reinstatement of Article 444 of the Commercial Code through Law 9, Article 64 was the only provision addressing the liability of directors for their actions within Panamanian corporate law. However, Article 64 does not cover all possible actions of directors and is limited in scope. It specifies that directors are liable to the company's creditors for specific acts, such as declaring or paying dividends or distributing assets that reduce the company's asset value below its liabilities, reducing the amount of capital, and making false declarations or reports on substantial points.
There is a lack of judicial pronouncements that thoroughly analyze Article 64 or confirm whether it is the sole provision applicable to directors' liability.
The text suggests that the existing framework does not fully encompass the extent of directors' responsibilities and potential liabilities. It implies that other legal provisions may also be relevant for holding directors accountable for their actions.
The term "creditors" as used in Article 64 is not explicitly defined in Panamanian legislation, and there are no court rulings clarifying whether shareholders are included as creditors with the right to claim liability from directors. Generally, a creditor is understood to be someone entitled to demand payment of a debt or fulfillment of an obligation, which means the term could encompass more than just financial claimants.
Upon examination of the statutory provisions regarding director liability, it is evident that the legal framework exhibits certain ambiguities and inconsistencies. The grounds for liability predicated on false statements or reports concerning "substantial points" lack precise definition, necessitating a broad interpretation for the purpose of director accountability. Furthermore, Article 64 presents a contradictory application of joint and several liability, creating uncertainty in the allocation of responsibility among directors.
In light of Article 221 of the Commercial Code, which establishes joint and several liability as the norm in commercial activities, and considering the commercial nature of directorial duties, it is our considered opinion that Article 64 should be construed to impose joint and several liability on directors. This interpretation would allow for any director to be held accountable for the full extent of damages while preserving their right to seek proportional reimbursement from co-directors.
The reinstatement of Article 444 of the Commercial Code has significantly expanded the scope of directors' liability. While directors are not personally liable for corporate obligations, they may be held accountable to the company and third parties for various matters, including the validity of reported payments, declared dividends, proper accounting practices, and the general execution of their duties. It is noteworthy that liability can only be imposed through a resolution of the general shareholders' meeting, and directors may be exempt from liability under specific circumstances, such as timely objection to majority decisions or justified absence from relevant proceedings.
The exemption from liability of directors for company obligations referred to in Article 444 of the Commercial Code and the requirement of authorization by the shareholders' assembly to demand said liability find an exception in Article 94 of the Commercial Code, which provides for sanctions may apply to a legal entity engaged in commerce in Panama for non-compliance with Article 95 of the Commercial Code regarding the preparation of financial statements. According to Article 95 of the Commercial Code, the sanctions attributable to the company will be imposed "in its absence, to its legal representative, its directors, managers and officers, in that order." We highlight that we have not found a precedent where the sanction in question has been applied to an officer or legal representative of a company.
Articles 444 and 94 of the Commercial Code establish a framework for director liability and its exceptions. While Article 444 generally exempts directors from personal liability for company obligations and requires shareholder authorization for liability claims, Article 94 provides an exception in cases of non-compliance with financial reporting requirements under Article 95. In such instances, sanctions may be imposed on the company or, in its absence, on its legal representatives, directors, managers, and officers, in that order.
The interpretation of "third parties" in Article 444 is crucial in determining the scope of director liability. While the term is not explicitly defined, it is generally understood to exclude shareholders, who are considered part of the corporate relationship. Consequently, individual shareholders are not deemed "third parties" and lack standing to sue directors for breaches falling under Article 444, even in cases of accounting mismanagement or violations of laws or assembly agreements.
Conclusion. Directors of Panamanian corporations face potential joint and several liability for breaches of their fiduciary duties, as outlined in the Company Law and Commercial Code. Their liability extends to issues such as improper dividend declarations, false reporting, mismanagement of accounts, and violations of laws, articles of incorporation, by-laws, or shareholder resolutions. Directors are held to the standard of "ordinarily prudent men" in discharging their duties. While they are generally not personally liable for corporate obligations, they may be held accountable to the company and third parties for various matters related to their roles. Notably, enforcement of liability typically requires authorization through a General Shareholder’s Meeting resolution, with some exceptions. Directors may be exempt from liability if they were absent with cause or protested against majority decisions in due time.