On 30 July 2013 the Supreme Commercial Court of the Russian Federation (hereinafter – the “SCC”) published the Resolution of the Plenary Session No. 62 "On certain issues of recovery of damages by members of the company’s management bodies" (hereinafter - the "Resolution"). The Resolution contains mandatory clarifications for the lower instances courts regarding practical issues of recovery of damages caused by actions (omission to act) of members (former members) of the company’s management bodies.
The Resolution, particularly, explains the following issues:
- The list of persons to whom the Resolution’s explanations are applicable
Explanations of the Resolution shall be applicable to cases over recovery of damages from director, general director, temporary sole executive body, managing organization or manager of the legal entity, the head of a unitary enterprise, the chairman of the cooperative, members of the Board of Directors, members of executive board, directorate, board members of the cooperative and etc. (hereinafter jointly referred to as – "directors" and separately - the "director").
The Resolution stipulates application of damages recovery rules also to the liquidator, members of the liquidation committee, insolvency administrator, unless otherwise is provided by the law and does not arise from the nature of relations.
- Fiduciary duties of directors
According to para 3 Art. 53 of the Civil Code of the Russian Federation (hereinafter - the "Civil Code"), Art. 71 of the Federal Law on Joint Stock Companies , Art. 44 of the Federal Law on Limited Liability Companies directors shall act in interests of the company in a reasonable manner and in good faith, in case of breach of these fiduciary duties directors shall be liable for damages caused by their actions.
The Resolution defines the criteria of good faith and reasonableness previously lacking in law enforcement practice.
Good faith and reasonableness of actions are present, when the director takes necessary and sufficient measures to achieve the objectives of company’s activities. In this regard, in case of bringing the company to tax, administrative or other liability due to unfair and/or unreasonable behavior of the director, damages of company may be recovered from the director.
- Bad faith of directors’ actions (omission to act)
The Resolution contains a non-exhaustive list of grounds to recognize directors’ actions (omission to act) as mala fide:
- The director acted in situation of conflict between his personal interests (interests of director’s affiliated persons) and the company’s interests, including actual director’s interest in execution of a transaction by the company;
- The director withheld the information about the transaction executed by him from company’s members or provided them with incorrect information about the transaction, for example, the relevant information was not included in the reporting of the company;
- The director made the transaction without the approval of the company’s competent bodies that was required by the law or the charter, for example, approval of major transactions or interested-party transactions;
- Following termination of director’s powers the director keeps and restrains from transferring to the company the documents about the circumstances resulted in adverse effects to the company’s interests;
- The director knew or should have known that his actions did not meet the interests of the company (transactions executed on unprofitable terms and concluded with the person obviously unable to fulfill his/her contractual obligations).
Pursuant to the Resolution transaction executed on unprofitable terms is a transaction with price and terms which are significantly lower and worse than the price and terms of similar transactions made in comparable circumstances. Moreover, the unprofitable character of the transaction shall be established at the moment of its execution. If the consequences of unprofitable transaction were discovered ex post facto, the director would be liable for any damages in the presence of evidence that the transaction was initially executed to not fulfill its conditions or to fulfill improperly.
- Unreasonableness of actions (or omission to act) of directors
The Resolution contains a non-exhaustive list of grounds for recognition of director’s actions (or omission to act) as unreasonable:
- The Director made the decision intra vires without known information relevant to the situation;
- Before making the controversial decision the director did not take actions to obtain sufficient and necessary information to make the decision;
- The director executed the transaction in breach of company’s internal procedures, for example, without approval of director’s actions by legal and accountant departments etc.
- The applicant in cases on bringing directors to liability
Company’s founder (participant) or the company itself are entitled to submit the statement of claim to bring the director to liability. SCC has also stipulated that the court can not refuse in sustaining the claim, if the applicant was not the company’s participant at the moment of actions caused the damages or at the moment of actual occurrence of damages. Potentially, this measure may become the effective mean of protection of minority shareholders’ rights.
- Burden of proof in cases on bringing directors to liability
As a general rule, the applicant bears the burden of proof of bad-faith and unreasonableness of director’s actions (omission to act). The applicant shall prove the loss occurrence and causal connection between director’s actions (omission to act) and loss occurrence.
The Resolution introduced the exception from the rule on burden of proof apportionment. The court may impose the burden of proof on the director, when the director refuses to provide the court with any clarifications or in case of insufficiency of such clarifications.
- Time limit for claims on recovery of damages
Time limit shall be calculated not from the moment of discovery of director’s violation, but from the moment:
- When predecessor of the company’s participant knew or should have known about the director’s violation (when the statement of claim was submitted by the company’s participant who was not the participant at the moment of violation committed by the director);
- When the company (for instance, in the person of new director) got an opportunity to know about the violation made by the previous management (in case the statement of claim is submitted by the company);
- When the controlling participant of the company, who had an opportunity to terminate the director’s powers, knew or should have known about the director’s violation (in case the statement of claim is submitted by the company).
- Release of director’s liability
- Director’s actions caused the losses are within the scope of reasonable business (commercial) risk which corresponds to the character of business activity. Thus, the SCC has concluded that negative consequences of the director’s actions do not mean the bad-faith and unreasonableness of director’s actions. This clarification of the SCC corresponds to the concept “business judgment rule” existing in common law countries, under which the possibility to bring the director to liability only due to ineffective business decisions is restricted;
- The director proves that though the executed transaction was predeterminedly unprofitable, but it was the part of mutually interrelate transactions connected by the common commercial purpose to obtaining the profit by the company.
- The director proves that the transaction executed by him/her was aimed at prevention of a greater loss of the company;
- Information about conflict of interests between the director and the company was previously disclosed and the director’s actions were approved pursuant to the law procedure, for instance, by the general meeting of the company’s founders.
- Interrelation between claim for damages and other remedies
Granting the relief to the claim for damages is absolute and does not depend on recovery of damages using other remedies (applying the consequences of invalidity of transaction, vindication of property, claim for unjust enrichment etc.), and also on recognition of the transaction caused the damages as invalid. However, the claim to the director shall be dismissed, when the company has obtained the recovery of damages by other remedies including recovery of damages directly from the party who caused the damage (for example, the employee or the counterparty).
The new Resolution of the Plenum of the Russian SCC contains important and long awaited clarifications regarding procedure and grounds of bringing the directors to the civil liability. In particular, grounds for recovery of damages have been specified, definitions of certain evaluative concepts have been given, that could be met earlier only in doctrine and in some court decisions (transaction executed on unprofitable terms, reasonableness, good faith). We assume that the practical application of SCC clarifications potentially would help to increase the number of cases bringing directors to civil liability, that would lead to reduction of wide spread practice of recognizing the transaction as invalid.
Maria Bobrovnikova and Anna Klimuk