The Russian parliament is processing a bill concerning a number of amendments to the Russian Civil Code (30.11.1994 51-FZ), which contains the most important provisions concerning corporate governance in Russian companies. The proposed amendment is expected to enter into force during 2013.

The amendment of the Civil Code was initiated in 2008 by President Dimitry Medvedev, who expressed the need to make Russian civil law more business-friendly and Russia a more comfortable business environment. According to Pavel Krashannikov, Head of the Parliament Committee, the purpose of the reform is to unify the Russian civil legislation with international standards, as well as to establish an international business center in Moscow.

When drafting the legislation, much emphasis was placed on the need to ensure that persons behaving deceitfully could be held accountable for their actions. For this purpose, the amendments concern, inter alia, the liabilities of the managing bodies and the shareholders in a Russian company, liabilities which would be strengthened and clarified by the amendment.

It is clear that Russian legislators are generally attempting to make the Russian business environment more stable by reforming the legislation on corporate governance. In this series of three articles, the current status and development of corporate governance in Russian limited liability companies (OOO) will be analysed in comparison with Finnish limited liability companies. The first article concerns the role and liability of the general director, which is the executive body in a Russian company. The second article deals with shareholders’ liability. The third article concerns the role of the board of directors, which in a Russian company is an optional supervisory body.

Part 1/3: General Director - Too Broad Powers, Too Little Liability?

Part 2/3: Shareholders’ Liability for Company Debts

Part 3/3: Board Members in a Russian Company

Part 1/3: General Director - Too Broad Powers, Too Little Liability?

The duties of the general director of a Russian company consist of the day-to-day management of the company’s operations. The general director thus carries out similar tasks as the managing director in a Finnish company. The general director of a Russian company has, however, much broader authority to represent the company and to decide on company matters in comparison to the managing director of a Finnish company. This is the main difference between the Russian and Finnish systems of corporate governance.

General Director Signs

The general director represents the company and signs on its behalf alone, without proxy. The general director is the only person whose name can be entered into the Trade Register as representative of the company. It is important that the Russian company has at all times a general director who is available for signing various documents on behalf of the company and to represent the company with authorities.

Unlike in a Finnish company, board members or other persons cannot represent the company and have no signatory powers on behalf of the company without power of attorney. The general director represents the company always alone. This makes it impossible for Finnish corporations to implementing in their Russian subsidiaries their corporate policy of having two persons represent the company jointly.

General Director Decides

The general director has the competence to decide on all company matters not falling within the authority of the general meeting. Thus, these general powers of the general director to decide on all company matters can be compared to the powers of the board of directors in a Finnish company, with certain limitations relating to major transactions exceeding 25% of the company’s assets and transactions with affiliated persons. This is the case in particular in companies that do not have a board of directors. Even if the company has a board of directors, it has only a supervisory function in relation to the general director. The board of directors of a Russian company is not intended to take an equally active role in making business decisions in comparison with the board of directors of a Finnish company.

Dual Role as Management Body and Employee of the Company

The general director is appointed and dismissed either by the shareholders’ meeting or the board of directors depending on whether, according to the company’s articles of association, it has a board of directors. The general director signs an employment contract with the company, and thus has a dual role as both a managing body and employee of the company. Even if the general director of a Russian company has much broader powers than the managing director of a Finnish company, such powers being comparable to those of the board of directors in a Finnish company, the general director enjoys the considerable protection provided to employees by employment law.

The provisions regarding the liability of the general director are generally in line with those applicable to the board members of a Russian company. It is, however, quite obvious that this dual normative basis (civil law and employment law) influences the actual liability of the general director.

Limiting the General Director’s Powers

Given that the general director has such broad powers, the shareholders may wish to remove certain actions from the scope of the general director’s authority as provided by company law. This can be done by entering limitations into the company’s articles of association, and via the general director’s employment agreement, requiring the general director to seek the consent of the shareholders’ meeting or the board of directors for certain transactions. Typically, such actions include taking out and giving loans, as well as transactions involving real estate or exceeding certain monetary amounts.

However, limitations on the general director’s powers must not be too strict, in order to avoid possible stoppages in the operations of the company, due to the inability of the general director to run the company.

No Effective Limitations without Effective Remedies

Third parties do not, however, have any obligation to familiarise themselves with the articles of association of their contracting parties. This means that limitations to the general director’s powers in the company’s articles of association might not be effective with respect to third parties concluding transactions with the company. Thus, it is possible that the validity of such transactions could not be disputed in court. Potentially, the remedy for the company might be to demand damages from a general director who has exceeded his powers.

Taking into account that it might not be possible to cancel transactions with third parties, the effectiveness of the limitations on the powers of the general director depend largely on whether the general director can be held liable for damage and losses caused to the company. There must be consequences for breaching the limitations set forth in the general director’s employment agreement and the articles of association. If the liability of management is strengthened, the powers of the general director can more effectively be limited.

Liability of the General Director to the Company

In accordance with current Russian legislation, the general director is liable to the company for losses caused to the company through his or her faulty actions (omissions) (article 44 of the Law on Limited Liability Companies 08.02.1998 14-FZ).When assessing the liability of the general director, general business practice should be taken into consideration. The general director has the obligation to act honestly and reasonably. A lawsuit against the general director can be filed by the company or by a shareholder.

Proposed Changes to Legislation for Strengthening Management’s Liability

There have been discussions in Russia on the need to make the liability of management more effective. This is due to the lack of case law where the management of Russian companies would have been held responsible for losses caused to the company by its actions. According to some, the provisions in company legislation concerning management’s liability are written in a way that is too general, and therefore difficult to implement in practice. As a response to this, the President of Russia introduced in 2010 a bill that was intended to amend and clarify in more detail the general concepts of management’s liability, such as the obligation of the management to act “honestly” and “reasonably”. For instance, according to the bill, if the director makes decisions without taking into account available information, he will not be acting reasonably.

The bill strengthening management’s liability is currently being reviewed by the Russian Parliament. It will, however, have to wait for some time, until the major amendment to the Civil Code has been processed by the Duma, as the amendment to the Civil Code contains changes to, e.g. company forms.

The amendment of the Civil Code, which is currently being reviewed by the Duma, contains a further criterion for assessing whether the director has acted honestly and reasonably: the director should not take actions exceeding “normal business risk”. Thus, business failures causing losses to the company that are within the scope of normal business risk would not lead to liability for the director, but excessive risk-taking would.

Future Trends

Both the 2010 bill on management’s liability and the proposed amendments to the Civil Code demonstrate the desire of the politicians to make management’s liability more effective. As relevant case law does not seem to be emerging as quickly as the politicians would like, so that Russia would become more attractive to foreign investors, the politicians are attempting to add more detailed criteria for defining when management has acted dishonestly or unreasonably, and can therefore be held liable. Such amendments to the legislation will, however, not compensate for the lack of case law. They will also not change the culture of corporate governance which is required to effectively implement management’s liability. In comparison, the Finnish Companies Act contains provisions on the liability of directors on a more general level than in current Russian legislation, being based on the general concept of the duty of care.

The lack of case law may be due to Ja kaiRussian businesses having little need to implement management’s liability, as the management of Russian companies has often been elected from among their owners – at least in the SME sector. As more directors who are independent from the company’s owners are hired into Russian companies, the likelier it becomes that new court cases will emerge on management’s liability.

Part 2/3: Shareholders' Liability for Company Debts

As a general rule, the shareholders of a Russian limited liability company are not liable for the company’s obligations. However, in certain limited cases, the corporate parent or other shareholder could be held liable for the debts or other liabilities of a subsidiary. Unlike in Finnish legislation, the Russian Civil Code and company legislation contain specific provisions on piercing the corporate veil.

Liability of Corporate Parent

In accordance with current legislation, a company that is the corporate parent of a Russian limited liability company is jointly and severally liable for transactions made by said company pursuant to the parent company’s orders, if following such orders is mandatory for the subsidiary. The applicable legislation does not contain a definition of mandatory orders. There is also little case law relating to this provision. Thus, the risk of foreign companies being held responsible for the debt of their Russian subsidiaries has been minor.

Proposed Strengthening of Legislation on Liability

According to current legislation, the parent company is liable for the transactions of the subsidiary which have been undertaken on the basis of orders from the parent company. In the course of preparing the amendment to the Civil Code, the issue of strengthening the liability of the shareholders was first included in the proposed amendments aiming to improve Russian corporate governance. In the proposed amendments, more criteria were set forth in respect of the liability of a parent company for the debts of its subsidiary. After the first reading of the bill in the Duma, those provisions were, however, removed during the processing of the bill by Duma.

Despite the fact that the amended Civil Code will most likely not include more specific provisions on piercing of the corporate veil, there is a trend visible among the decisions of the Supreme Arbitration Court of the Russian Federation in respect of applying the principle of piercing the corporate veil. In an interview published on the webpage of the Supreme Arbitration Court, the president of the court Anton Ivanov commented that it will take less than two years to have court practice on holding owners liable for debts of Russian companies. According to Ivanov the courts will have to develop practice in this respect if more claims relating to piercing of corporate veil will be brought to them.

Application of Russian Law on Foreign Entities

The proposed amendment to the Civil Code also introduces provisions on choice of law with respect to shareholders’ liability as applicable to foreign companies engaged in business activities mostly in Russia. Russian law would apply to the liability of said foreign entity’s shareholders for that entity’s debts. This would apply to the shareholders with control over the foreign entity in question. Russian law would we applied depending on the creditors’ choice.

In practice, the proposed amendment would mean that the shareholders of a Finnish limited liability company engaged in business in Russia could be held responsible for the company’s debts in accordance with Russian law. Finnish law restricting the shareholders’ liability would not apply, even if the company were registered in Finland.

Parent Company’s Liability in the Event of Bankruptcy

The parent company bears secondary liability for the bankruptcy of its subsidiary in the event that the subsidiary’s bankruptcy was due to the culpable actions of the parent company. This liability concerns shareholders that are entitled, during a period of two years prior to the acceptance of a bankruptcy claim, to give the subsidiary mandatory orders or to determine the subsidiary's actions in some other manner.

Furthermore, a shareholder can be held liable for losses resulting from the shareholder’s failure to comply with the requirements of bankruptcy legislation pertaining to the shareholder. Specifically, the shareholder is liable for failure to file a bankruptcy claim if, after a resolution on liquidation has been passed but prior to the appointment of the liquidation committee, it became clear that the value of the subsidiary’s assets was not sufficient to satisfy the claims of all of its creditors.

Strengthening of the Shareholders’ Liability - Risk or Opportunity for Foreign Investors?

The management of a Russian company often consists of its owners, at least in the SME sector. The company is identified with the individuals owning and managing it. This might be why strengthening owners’ liability is seen to be so important and why there is so little case law relating to management’s liability.

As stated by Russian politicians, the purpose of the Civil Code reform and other amendments to company legislation is to make Moscow an international business centre and Russia more attractive to foreign investors. Yet, from the perspective of a foreign private equity investor or an industrial actor investing in Russia, strengthening shareholders’ liability for Russian entities’ debt is not likely to attract investments to Russia. The risks incurred by foreign parent companies would at least in theory increase. On the other hand, if strengthening shareholders’ liability would prevent the abuse of corporate structures and the limited liability of shareholders, it might stabilise the business environment.

Part 3/3: Board Members in a Russian Company

In a Russian limited liability company, the board of directors is an optional management body. The establishment of such a body is left to the discretion of the shareholders’ meeting. Even when a company has a board of directors, the board has relatively limited powers and functions compared to the board of directors of a Finnish limited liability company.

Supervising the General Director

In a Russian company, the board of directors is not an executive management body making actual business decisions like the Finnish board of directors, but has more of a supervisory function. Neither the board nor its individual members have signatory powers on behalf of the company.

The powers of the board of directors are defined in the company’s articles of association. The company legislation only provides general guidelines on the powers of the board. Most of the duties and powers of the board set forth in company law are related to supervision of the general director. The main purpose of setting up the board is to limit the authority of the general director.

Approval for Important Decisions

The board of directors usually appoints and dismisses the general director. The board also approves certain decisions made by the general director. According to mandatory law, transactions with a value exceeding 25% of the company’s assets are to be approved by the board of directors, unless they, according to the company’s articles of association, require the approval of the shareholders’ meeting. The same also applies to related-party transactions. In addition, the powers of the general director can be limited by provisions in the articles of association, requiring the approval of the board for certain transactions such as taking out or giving loans or creating encumbrances on the company’s property.

Avoiding Unnecessary Paperwork

In the event that the company does not have a board of directors, supervision of the general director is exercised by the shareholders’ meeting or by the sole shareholder. If the company has only one shareholder, the board of directors is usually unnecessary and increases the administrative burden of the company, as the supervisory function can be more effectively exercised by the parent company. Thus, in Russian companies owned by a foreign holding company, a board of directors is usually not established. A board of directors could be useful in Russian joint ventures where there is no foreign holding company.

How the Board Works

The number of board members can be freely determined. The board is headed by the chairman of the board, who is elected by the members of the board and may be reelected at any time. The general director may not be elected as the chairman of the board.

A meeting of the board may be called by the chairman of the board at his/her own initiative, at the request of a member of the board, the general director or the auditor of the company. Decisions at the meetings of the board are passed by a simple majority of board members present, unless otherwise stipulated in the articles of association. At a board meeting, members of the board decide through voting on matters within the scope of competence of the board. Each board member has one vote.

Foreigners as Board Members

Russian law does not contain any significant limitations on foreigners being board members; no work permit is required. There are no limits on the number of consecutive re-appointments of an individual board member or the board as a whole.

Liability Issues

In company legislation, the same provisions on management’s liability apply both to the general director and to the members of the board of directors. Board members are liable to the company for losses caused to the company by their faulty actions (omissions) (article 44 of the Law on Limited Liability Companies). Like the general director, the members of the board have the obligation to act honestly and reasonably.

The liability to compensate the company for losses is vested in the board members who had voted for the resolution that caused the losses. It means that Board members who had voted against such a decision or had not taken part in voting are not liable. Both the company (through its general director) and a shareholder of the company may file a lawsuit for compensation of losses caused by a board member. The board members who passed the resolution which resulted in losses bear joint and several liability to the company, i.e. the company (the shareholder) is entitled to demand compensation from all of them jointly or by any of them separately, both fully and in part.

In practice it is not likely that members of the board will be held liable for losses caused to the company. The board does not usually make independent business decisions like a board in a Finnish company, but instead supervises the general director and approves certain decisions of the general director. As the powers of the board are relatively limited compared to a Finnish company, the members of the board can seldom be held responsible for losses caused to the company.

Future Development

There have been discussions in Russia regarding the need to make the liability of management more effective both with respect to the general director and to the board of directors. Amendments to legislation that would strengthen management's liability have been proposed and are currently being processed by the Duma. These amendments are intended to specify in more detail the criteria according to which management will be held liable for losses caused to the company.

Furthermore, board members' liability may during the next few years develop through case law. As is the case with the liability of the general director, the lack of case law may be due to the fact that there has not been much need among Russian businesses to implement management’s liability, as the management of a Russian company has been elected from among its owners. As more directors who are independent from the company’s owners are hired into Russian companies, the likelier it becomes that new court cases will emerge on management’s liability.