One of the functions of an LLC and a JSC is the limitation of founders’ (participants’ / shareholders’) liability to the amount of their contributions to the charter capital of the company.However, in some cases, such limitation ceases to work, and the founders along with the directors and other controlling persons will be liable for the company's debts. This type of liabilityis called secondary liability1, which means the lability only if there is not enough assets of the company to pay off debts.
Secondary liability is developing in Russia by leaps and bounds: a few years ago, this tool actually did not work, but in 2018 there were hundreds ofsuch court decisions, and the total amount of secondary liability comes in crude estimate to about RUB 200 billion annually.
1.WHO IS LIABLE?
The controlling persons of the debtor (CPDs) can be brought to secondary liability. English analogue of the CPD is a concept of People with significant control (PSC). In Russia, CPD is a natural or juridical person who, directly or indirectly, influenced or determined the company's decisions during the 3 years’ term before the company's bankruptcy.2 The concept is very broad and, depending on the circumstances, may include persons who are not formally related to the company, but whose participation in the affairs of the company has been proven in court.
Controlling persons are persons who directly or indirectly affect the company or influence its solutions. They can be responsible for the company's debts with their personal property.
The following persons are presumed to be CPDs:
Directorofthe indebted company, director of the management company3, official assignee / liquidator or a member of the liquidating committee;
Participant (founder, shareholder) with participatory share (voting share) 50% and more;
The person which had the right to appoint (elect) the director of the company;
The person which benefited from the director’s illegal or unfair conduct.
- Fraudulent conveyances (subs. 1 par. 2 art. 61.11 of the Bankruptcy Act);
Loss or falsificationof accounting records (subs. 2 п. 2 art. 61.11 of the Bankruptcy Act);
Debts on tax, administrative and criminal offenses amount to more than 50% of the debts of the company4 (subs. 3 par. 2 art. 61.11 of the Bankruptcy Act);
Loss or falsification of founding documents and other documents, which storage is mandatory(subs. 4 par. 2 art. 61.11 oftheBankruptcyAct);
Failure to submit information about the company to the Unified State Register of Legal Entities (EGRUL) and Federal Resource (EFRSFDUL) (subs. 5 par. 2 art. 61.11 of the Bankruptcy Act);
Failure (late file) of a bankruptcy petition (art. 61.12 of the Bankruptcy Act).
Who is the debtor’s CPD? It can be real beneficiaries –natural persons, participants or executives of the company (both nominal/dummy and actual);;
Do they have assets that can be recovered?
Are there any grounds for imposingsecondary liabilityon these persons?
- Bankruptcy of a company with debts is not a magic cure and will not relieve the CPD from the necessity to pay off debts on account of personal property, if the CPD acted, in one word, in bad faith;
Reorganizations; renaming; changing addresses, directors and participants; mergers and other options of the so-called "alternative liquidation" of companies stop working as a method of exempting from debts and liabilities.
Even after several years, in a bankruptcy case of a company into which companies with debts were “merged”, a judgement on the secondary liability for debts can be delivered in respect of former CPDs.
For example, in the year 2018 in the case A65-13314/2016 the court brought to secondary liability for more than RUB 200 million five directors of different companies, which together with the debts were "merged" in the LLC located in Tatarstan. The employment period of directors in the companies was dated 2012-2015. The judgement has become res judicata.
- Nominal/dummy directors and (or) participants will not save from secondary liability. In the law, there are opportunities both to impose liability on persons who are not formally associated with the company (but in reality they manage the company or reap benefits), and to inspire the nominal directors and (or) participants to show such CPDs.
However, in the court it can be proved that other persons are among the controlling persons, the list is open. For example, an accountant may also be brought to secondary liability.
Special provisions are established for nominees, or dummy directors/participants of the debtor: the court may release them from liability if they did not have a decisive impact on the company and at the same time provided the court with the information about the real CPDs (beneficiaries and/or virtual managers of the company). Consequently, the law encourages the nominees to disclose real CPDs, which may have assets to pay off debts to creditors.
2. WHAT TRIGGERS LIABILITY?
The law provides for the following presumptions when the CPD is considered responsible for the company's debts:
However, it can be proved in court that secondaryliability should be applied in other cases, if discharging creditor's claims in full became impossible due to the actions of the CPD.
CPD will not be liable for the company's debts if he/she has no guilt in bankruptcy, if it complied with the requirements of the law, behaved in good faith and reasonably, in the ordinary course of businessand the company's bankruptcy was associated with the usual business risk.
3. WHAT IS THE VOLUME OF LIABILITY?
The controlling persons of the debtor bear secondary liability, in other words,they are responsible to the amount of money that wasnot enough to fully repay the claims of all creditors.
For example, if the company's debts amounted to RUB 1 billion, and the company's assets were enough to pay off only RUB 100 million, the CPD is responsible for RUB 900 million.
If the court established the guilt of several CPDs, they are secondarily and solitarily liable: it means that each CPD is obliged to pay all the debt, but then has the right to recover "someone else's share" in debt from other CPD.
For example, if the amount of secondary liability amounted to RUB 900 million, and the number of CPDs was 3, the creditor can recover money from the first CPD in full, after which the first CPD can recover from the other two CPDs RUB 600 million.
A separate rule is providedfor the case of bringing to secondary liability in connection with the failure (late file) of a bankruptcy petition: here the CPD is responsible only for obligations arising between the date when the CPD should have filed such a petition and the date of initiation of bankruptcy proceedings.
Depending on the circumstances of the case, the court may reduce or exempt the individual CPD from liability.
4. WHAT THE CREDITOR NEEDS TO KNOW
In cases where the indebted company goes bankrupt, the creditor may consider filing a claim for secondaryliability of the CPD. Although about a quarter of such claims are satisfied by the courts, this is a serious legal work that requires a lot of time and money, so with relatively small amounts of debt, it usually makes no sense for the creditor to incur additional costs. However, if the amount of debt is solid, the creditor should find out the following:
Obviously, a reasonable creditor will also ask these questions for preventive purposes – even at the beginning of any interaction with the new counterparty, and later – to monitor changes in the information about it.
5. WHAT THE DEBTOR’S CONTROLLING PERSON NEEDS TO KNOW
Any controlling persons (nominal/dummyandactualexecutives, participants, beneficiaries of the company, accountants etc.) should first of all understand that the mechanism of secondary liability really works and it is already widespread. In addition,we will note several important points:
Disclaimer: for the convenience of readers, this material describes the secondary liability in a very simplified and concise manner. The author is not responsible for the incompleteness of the provided information and the decisions based merely on this material.
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1Verbatim translation of the Russian term is “subsidiary liability”, but it has little in common with liabilities of a mother company and its subsidiary.
2The exact definition of the law: unless otherwise provided by this Federal law, for the purposes of this Federal law, the controlling person of the debtor is a natural or legal person who has or had no more than three years prior to the occurrence of signs of bankruptcy, as well as after their occurrence before the acceptance by the arbitration court of an application for recognition of the debtor bankrupt the right to give binding instructions to the debtor or the ability to otherwise determine the actions of the debtor, including making the transaction and the stipulation of term's conditions (par. 1 art. 61.10 of the Bankruptcy Act).
3Management company – a company that exercises the powers of an executive body of the company instead of a natural person (general director, president etc.).
4Only the debts of third-priority creditors are taken into account for the purposes of this clause (the largest group of creditors).