On December 21, 2017, the Plenum of the Supreme Court of the Russian Federation adopted the resolution regarding the liability of the controlling persons in the event of company bankruptcy. The resolution clarified the application of the new law No. 266-FZ dated July 29, 2017 that introduced amendments to the Russian Law on Bankruptcy, including the new chapter III.2 “Liability of the debtor’s executive and other persons in a bankruptcy case.”

The practice of holding the executives of banks and other companies liable has developed in Russia for over ten years, with the first court rulings on the liability of former top managers of insolvent banks dating back to 2006 – 2007. The practice to hold company officials liable for damages has developed in parallel. This practice was summarized by the resolution of the Plenum of Supreme Arbitration Court No. 62 dated July 30, 2013, with ratio decidendi of this resolution being actively used by the courts to this day.

Russian law differentiates liability for damages and subsidiary liability. An executive’s liability for damages exists towards the company itself, regardless of whether said company is or is not insolvent. The amount of compensation is based on the amount of real damages caused to the company by the action or inaction of the executive, as well as the loss of expected profit.

In contrast with the damages, subsidiary liability of the executive or controlling person occurs only in the event of bankruptcy of the company and constitutes liability towards said company’s creditors. Imposition of subsidiary liability stipulates recovery of the deficient amount in order to satisfy the demands of all creditors. The liability can apply even to debts that were written off for the company itself. In practice, the amounts due may be as high as billions and tens of billions of rubles (approximately – up to one billion Euros). An example can be found in the court ruling issued in 2015 in regard to imposition of subsidiary liability upon Sergey Pugachev, the owner of the insolvent Mezhprombank.

In practice, the greatest obstacle is identification of the controlling persons of the company in question and discovering the property that can be used to satisfy the creditors’ demands. In the above referenced case of Sergey Pugachev, the court “pierced the corporate veil” and determined that it was Sergey Pugachev who controlled the bank and issued instructions to undertake transactions with its property, even though the bank was nominally owned by offshore companies and trust funds.

The amendments introduced to the Law on Bankruptcy provided a more streamlined definition of the controlling persons and clarified the grounds for holding executives liable or releasing them from liability. In clarifying the new provisions, the Supreme Court emphasized that effective control over the debtor company can be established “regardless of formal and legal indications of affiliation”. Consequently, Russian law allows for recognition of a controlling person that does not formally participate in the share capital of the company and is not a part of its governing bodies. The Supreme Court further introduced the concept of the “nominal executive”: a person who ostensibly is a member of the governing bodies yet does not carry out effective governance of the company (for example, someone who merely implements the directives of the controlling person).

Pursuant to the explanatory statements of the Supreme Court, a nominal executive may be subjected to subsidiary liability together - and, as a general rule, jointly - with the controlling person. The court may reduce scope of the nominal executive’s liability if he or she discloses information about the factual company executive and the property that can be used to satisfy the creditors’ demands, provided that this information is “unavailable to independent parties”.

The new law and the Supreme Court distinguish two reasons for subsidiary liability:

  • The debtor’s failure to file the bankruptcy petition (or late filing thereof);
  • Impossibility to fully satisfy the creditors’ demands.

The debtor’s obligation to file the bankruptcy petition is a longstanding part of the Russian Law on bankruptcy, yet the practice of imposing subsidiary liability on the executives who failed to duly file said petition did not take hold for a long time.  The reason for this was both the courts and the executives found it difficult to identify the moment when objective indicators of insolvency become apparent, particularly since the Russian courts do not generally carry out economic analysis. Moreover, the prior stance of the courts was that the executives’ subjectively favorable perception of the company’s situation constituted grounds to discharge them from liability.

At the present, both the established case law of the Supreme Court on individual cases and the resolution of the Plenum call for an evaluation of the company’s position from the viewpoint of “a reasonable executive”, who, acting “within the framework of standard managerial practice” under similar circumstances, would objectively determine whether the company shows evidence of bankruptcy. The executive’s attempt to rescue the company constitutes grounds for discharge of liability only for the period when implementation of the anti-crisis plan would be reasonable.

The liability for failure to file the bankruptcy petition (or late filing thereof) is borne by all authorized executives of the company (if there are multiple executives, the liability cannot be imposed only on one of them), controlling persons, as well as liquidators (if the evidence of bankruptcy was discovered during liquidation).

In addition to controlling persons and nominal executives, the chief accountant of the company can also be subjected to subsidiary liability for the impossibility to fully satisfy the creditors’ demands. The chief accountant is held liable if he or she destroyed or misrepresented the company’s documents at the behest of an executive.

When deciding whether to impose subsidiary liability, the court needs to identify key business decisions made by the executives and determine whether said decisions went beyond the regular business risk and contributed to the company’s bankruptcy. The court needs to assess the totality of the transactions and other operations of the company undertaken at the direction of the controlling person and estimate the significance of his or her influence.

The grounds for and the scope of the subsidiary liability are broadly contingent on the relative degree of impact of the external (market) factors and the executives’ actions on the company’s bankruptcy. Should the court conclude that the controlling persons’ faults did not have a significant effect on the company’s position and could not have objectively resulted in bankruptcy, then in lieu of subsidiary liability the controlling persons can be held liable for damages.

The Supreme Court’s resolution also resolved the question whether it is necessary to invalidate the company’s transactions that resulted in bankruptcy before imposing subsidiary liability on its executives.  The answer is clear: it is not necessary to expressly annul the transaction. Moreover, the executive or controlling entity cannot be discharged from liability on the grounds that the transaction was approved by the collegial body (for example, the company’s shareholder meeting or the bank’s credit committee). This position is not novel for case law: it is established in the above referenced resolution of the Plenum of Supreme Arbitration Court No. 62 on the executive’s liability for damages.

The new law and the Supreme Court of the Russian Federation expanded the scope of entities who are entitled to demand the imposition of subsidiary liability upon the executives and the controlling persons. The claimants can be the debtor’s bankruptcy supervisors, authorized agencies (for example, tax authorities) or the debtor’s employees. Substantiation proceedings are greatly simplified: it is sufficient for the claimants to present indirect evidence that the person in question exercised control over the company and brought it to bankruptcy. The burden of disproving the allegations is on the person that was identified as the controlling one.

Creditors who succeed in holding executives and controlling persons liable under subsidiary liability may choose the method of satisfying their claims at their discretion. The law offers three options:

  • Recovery of the debt from the liable person as a part of the bankruptcy proceedings, wherein the recovered assets are entered into the insolvency estate and divided between the creditors;
  • Sale of the claim rights against the person subject to subsidiary liability, with the proceeds of the sale entered into the insolvency estate;
  • Partial cession of the claim rights against the liable person to the creditor in the amount corresponding to said creditor’s claim.

The law prioritizes the second method, wherein the claim is subject to sale and the amount is entered into the insolvency estate of the debtor.

If the bankruptcy supervisor of the company succeeds in holding said company’s executives and controlling persons liable under subsidiary liability and satisfying the creditors’ claims, he or she may claim remuneration in the amount of 30% of the sum entered into the insolvency estate. The Supreme Court made it clear that these 30% constitute a surcharge upon the persons subjected to subsidiary liability.

The conclusion of the overall analysis of the new law and the resolution of the Plenum of the Supreme Court of Russian Federation is that the options for identifying the controlling persons of the company and bringing them to subsidiary liability have greatly expanded, while the liability was made more severe. Furthermore, the courts will need to investigate issues of economical nature, which until recently was uncharacteristic for the Russian courts.