Disputes Insights #1: New Supreme Court Decision - To Litigate or Not to Litigate?

Under Swiss law, boards of directors are entrusted with significant fiduciary duties and responsibilities. One key responsibility is determining when and how to engage in litigation. While directors are not expected to predict the outcome of legal proceedings, they must exercise sound judgment in deciding whether to initiate or defend a lawsuit. Recent case law from the Swiss Federal Supreme Court underscores that failing to make these decisions carefully can lead to substantial personal liability for directors (see: decision 4A_506/2024 of 18 March 2025).

The Risk of Misguided Litigation

The principle that a director may be liable for damages caused by engaging the company in a hopeless litigation is not new: In the leading decision BGE 139 III 24, the Federal Supreme Court ruled that a director could be held personally liable if they initiate or continue litigation on behalf of the company without reasonable prospects of success. If such actions lead to a financial loss for the company, directors may be held accountable for breaching their fiduciary duties.

This case underlined that directors must exercise due diligence before pursuing legal action. Litigation decisions must be based on a realistic assessment of the risks, potential costs, and probable outcomes.

The Flip Side: Failing to Litigate

More recently, in its decision 4A_506/2024 of 18 March 2025, the Federal Supreme Court addressed the reverse scenario: Can a director be held liable for failing to litigate appropriately? The answer is yes.

In this case, a company was engaged for a construction project and was later sued for damages allegedly caused during its execution. The company lost the lawsuit, resulting in significant liability. In the litigation, the board of directors had failed to properly defend the company. In the subsequent liability claim against a director (who was also the sole member of the company's executive management), the Supreme Court upheld the lower court's decision, finding that a diligent and properly conducted litigation defence would likely have avoided the company's loss. As a result, the director was held personally liable pursuant to Article 754 of the Swiss Code of Obligations.

In this case, it was a failure to effectively contest a claim: Directors who do not defend a claim against the company may expose themselves to liability.

The Business Judgment Rule: Shield or Sword?

Directors are not accountable for ensuring success, neither in business decisions nor in litigations. Swiss law recognises the business judgment rule, which provides some protection for directors who make decisions in good faith, based on sufficient information, and free from conflicts of interest. Courts will not second-guess such decisions simply because they turn out to be wrong in hindsight.

However, the business judgement protection only applies if the directors' decision-making process itself was sound. As the Supreme Court emphasised again in its decision 4A_506/2024 of 18 March 2025, it is not merely the decision that matters but how the decision was made. In that case, the director failed to demonstrate that a proper internal decision-making process had taken place. There was no evidence of careful deliberation, no record of internal discussions, and no documentation of the rationale behind the passive litigation strategy. As a result, the court focused on the process behind the decision and found it insufficient.

Key Takeaways: Sound Process, Clear Records – Protecting Directors in Litigation Decisions

Directors must ensure that any decision to litigate, defend, or abstain from legal action is grounded in a careful, well-structured, and informed process, and therefore:

• gather relevant and sufficient information;

• evaluate the legal merits and commercial risks;

• consult legal counsel and obtain a written opinion where appropriate;

• identify and avoid any conflicts of interest;

• thoroughly document all deliberations and decisions.

Proper documentation is especially critical. A sound decision-making process is only as strong as its traceability. Without records of internal discussions and the rationale behind a decision, courts may presume that no proper process occurred at all.

Conclusion: Litigation as a Corporate Duty

In an era of heightened scrutiny, both in Switzerland and abroad, the decision to initiate or defend legal proceedings is not merely a tactical one; it is a fiduciary responsibility. Directors who fail to act when the company's interests call for legal action, or who pursue clearly unwinnable claims without due care, risk personal liability.

Litigation should neither be entered into lightly nor avoided out of hesitation or fear. Directors must carefully evaluate their options, base their decisions on sound judgment, and ensure that their reasoning is clearly documented. Ultimately, they must trust the process – provided that the process is both robust and transparent.

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