This article provides an overview of cases of personal civil liability of banks’ shareholders for the banks’ debts towards their creditors and liability for damages caused to banks by personal wrongful acts of their shareholders. This article describes an approach that Ukrainian courts have taken to the matter and the relevant legal principles together with mechanisms that make the liability of substantial shareholders a possibility.
On May 31, 2016 the ratings agency Moody’s announced that the outlook for Ukraine’s banking system had changed to stable from negative (1). In line with the announcement of Moody’s, the expectation is that the Ukrainian economy will begin to emerge from recession in the coming one to two years and that will help stop the decline in the solvency of Ukrainian banks.
Unfortunately, as of mid-2016 over 84 commercial banks are subject to the procedure for removal from the banking market of Ukraine. However, more than 100 of commercial banks are still operating, of which 43 banks have foreign capital in their ownership structure, and 17 of them were established with foreign capital only. The total amount of foreign capital in the ownership structure of Ukrainian banks exceeds 48% (2).
Holding a bank’s shareholders personally liable becomes a truly important issue after the bank has been recognized as insolvent. However, the personal liability of a bank’s shareholders for damage caused to the bank may also arise when the bank is still fully operating. Hence, shareholders of banks “are under the gun” all the time starting from the bank’s establishment and until its full liquidation.
Substantial shareholders liable
In general, the personal liability of a bank’s shareholders is in line with one of the fundamental principles enshrined in the Constitution of Ukraine which says that “Property obliges its owner”. That means that owners of any property should not only benefit from their property, but also be liable for damages caused by such property and other negative consequences resulting from wrongful dealings with the property.
The applicable Ukrainian legislation stipulates that not every shareholder could be liable for damage caused to a bank and its creditors. Only the bank’s substantial shareholders are determined as the potentially liable party.
The Law of Ukraine “On Banks and Banking” (the “Banking Law”) defines a substantial shareholding as the direct and/or indirect ownership of 10 percent or more of a bank’s registered capital by one person separately or jointly with other person(s) or the opportunity, irrespective of formal ownership, to exercise significant influence on the management or activities of the bank. Furthermore, the applicable Ukrainian legislation prescribes that a legal entity or an individual is required to be recognized by the National Bank of Ukraine (the “NBU”) as a substantial shareholder of the bank.
Claims on shareholders after a bank is recognized insolvent
The bank’s removal from the banking market after it has been recognized as insolvent is a highly challenging issue which entails a wide range of legal relations between the insolvent bank and the state authorities, between the state authorities and the insolvent bank’s owners, and even between the insolvent bank’s owners and the creditors of such bank.
After a bank is recognized insolvent by the NBU, the Deposit Guarantee Fund of Ukraine (3) (the “Fund”) introduces a provisional administration to the bank, which means that:
- all power and authority of the bank’s governing bodies (general shareholders meeting, supervisory board, executive board, internal audit commission, etc.) are suspended and will be transferred to the Fund and its officials; and
- the bank ceases to satisfy its creditors’ claims.
If the provisional administration is not successful and a bank has not become solvent during a one-month period, the bank will be liquidated by the Fund.
The most crucial consequence from among those listed above is that potentially hundreds of thousands of the insolvent bank’s creditors become unable to get their money back. Consequently, such creditors are forced to seek ways to recover their money.
One of the available options for such creditors is to take their problem to court by filing claims for damages to be recovered from substantial shareholders of the insolvent bank. In practice, after a bank has been recognized insolvent, its substantial shareholders could be sued with claims seeking, for example, the recovery of the amount of deposit that exceeds the amount paid by the Fund (4). Such claims may also seek to recover damages caused by any unlawful acts of the substantial shareholders that led to the insolvency of the bank.
Legal reasoning of claims to shareholders of an insolvent bank
Notwithstanding that the liability of a legal entity and its shareholders should be divided, the applicable Ukrainian legislation stipulates that an insolvent bank’s liability towards creditors may be transferred to the bank’s shareholders.
Article 58 of the Banking Law provides that the bank’s shareholders are liable for the bank’s obligations in cases and pursuant to the procedure prescribed by the applicable legislation and by the bank’s charter. This article also stipulates that substantial shareholders could be liable for damages caused to the bank by their unlawful acts. If as a result of the mentioned unlawful acts or omissions any other substantial shareholder of the bank has received the benefits of any property, such persons should be jointly liable for any damage caused to the bank.
Civil liability for damages is indeed possible if all the elements of a civil injury are proved, namely:
- unlawful acts;
- damages in an exact amount;
- causal link between unlawful acts and damage; and
- personal guilt.
Where at least one of the listed elements is missing, the civil liability does not occur. The court practice relating to claims for damages caused by bringing a bank to insolvency requires that each of the elements above must be proved with reasonable evidence in each case.
As to the substantiation of the exact amount of damages (losses), it is important to mention that it is practically impossible to establish directly the existence of damages until the completion of the liquidation process.
As to the proof of guilt, plaintiffs often support their position by reference to the provisions of Article 58 of the Banking Law, pursuant to which “the substantial shareholders are obliged to take timely measures intended to prevent the bank’s insolvency”. Hence, if there is no evidence of additional capitalization or other active operations of the substantial shareholders, plaintiffs draw a conclusion on the existence of personal guilt. Such legal reasoning is not totally sufficient for the purposes of making good this allegation in court due to the lack of any specialized legislative acts containing a detailed list of measures to be taken by the substantial shareholders. Furthermore, causing a bank to become insolvent is classified by the applicable Ukrainian legislation as a crime, hence only verdicts in criminal cases should be considered by the civil courts as conclusive evidence of the element of personal guilt.
In addition to the above mentioned conclusion, one of the general weaknesses of civil claims filed by creditors of a bank against the bank’s substantial shareholders is that the satisfaction of any one of the creditors’ claims by the court would lead to the rules on priority in the satisfaction of creditors’ claims being violated, which is unacceptable in terms of justice and the general principles of the Law of Ukraine "On Deposit Guarantee System” (the “Law on Guarantee System”). The Supreme Court of Ukraine highlighted in its legal opinion that: 1) the satisfaction of all creditors’ claims after a bank has been recognized insolvent must be performed exclusively pursuant to the ranks of priority determined in the Law on Guarantee System; 2) the satisfaction of claims of each next rank of priority is possible only after the full satisfaction of the creditors’ claims of the previous rank. Consequently, a court’s decision in favor of one of the bank’s creditors will lead to the violation of the rules concerning the ranking of priority of creditors’ claims.
The Fund as a plaintiff in relation to claims for damages
Pursuant to the Law on Guarantee System, if the bank’s property is not enough to satisfy the claims of all of the bank’s creditors in liquidation proceedings, the Fund may go to court with the claim against the bank’s substantial shareholders. In order to win the litigation, the Fund needs to prove with adequate evidence the following circumstances: 1) damages caused to the bank by unlawful acts of shareholders; and 2) lack of bank’s assets to satisfy all creditors’ claims.
The Court's practice in such a category of cases indicates that imposing an obligation to compensate for damages may not be possible if personal guilt for bringing a bank to insolvency is not established. Accordingly, absent relevant evidence of personal guilt, the Ukrainian courts refuse to satisfy such claims. It is also quite difficult to establish the lack of the bank’s assets as the bank will have property which is unsold until the completion of the bank’s liquidation procedure.
Liability of shareholders when bank is solvent
Considering that Article 58 of the Banking Law says that substantial shareholders could be liable for damage caused to the bank as a result of their unlawful acts, liability of the substantial shareholders could be possible even in cases where the bank has not been recognized insolvent and is still operating. In such a case the bank, on its own initiative, can bring an action against such shareholders. All the grounds needed to establish liability, and facts to be supported with evidence in such litigation, are still the same as those mentioned above namely damage, unlawful acts, a causal link between the unlawful acts and the damage, and personal guilt.
The applicable Ukrainian laws make it possible to impose civil liability on substantial shareholders of a bank in cases where damages are caused to the bank or its creditors by unlawful acts of such shareholders. Such liability is to be determined by the court. In the mentioned category of court cases all elements of a civil injury must be proved, namely damage, unlawful acts, a causal link between the unlawful acts and damage, and personal guilt. Nevertheless, to prevent such claims and to be protected against them, substantial shareholders of banks need to act in line with the requirements of the applicable Ukrainian legislation while exercising management of the bank and have to be careful when appointing the bank’s governing bodies.
Published by International Litigation News, IBA, September 2016