The Russian Supreme Court has determined new criteria of secondary liability FAO owners, heads and employees of legal, corporate and financial departments

Pepeliaev Group advises that the Russian Supreme Court has significantly changed the approach to assessing the good faith of controlling persons in disputes over secondary liability, and has developed new criteria for assessing the connection between their actions and the bankruptcy of the debtor[1].

Facts of the dispute and the position of the lower courts

In the bankruptcy case of PJSC JSCB Baltika, claims to have secondary liability imposed were raised by DIA against five defendants, including a member of the Board of Directors and a member of the bank’s Management Board who had the authority to consummate transactions under a power of attorney.

The court of first instance refused to impose liability on the members of the collective management bodies, but the court of appeal and cassation court did not agree with this. By imposing liability on members of the Board of Directors and the bank’s Management Board, senior courts considered that the transactions they consummated under a power of attorney resulted in bankruptcy, as they formed the assets of the credit institution by increasing bad loan debt and acquiring illiquid shares. In addition, promissory notes of the bank were contributed to the issued capital of the company, which conducted no real economic activities.

The Supreme Court’s position and the new criteria for assessing the good faith of the defendants and the connection between their actions and the bankruptcy of the debtor

1. The need to take into account the debtor’s corporate structure

The Supreme Court noted that credit institutions differ by the following:

• they carry out large-scale financial activities;
• they have a complex and numerous composition of their management bodies;
• owing to special legislative regulation, a significant number of requirements are imposed on the management bodies of a credit institution, including the personnel of their members.

Given the large number of persons who control the bank's activities, only those of them whose actions directly led to the bankruptcy of the credit institution can have secondary liability imposed.

2. Criteria for assessing the relationship between the actions of controlling persons and the bankruptcy of the debtor

At the same time, the Supreme Court has confirmed the three criteria (that were previously worded in the definition of the secondary liability of members of the Board of Directors[2]) for a connection between the actions of the controlling person and the bankruptcy that occurred, and has given them an additional explanation.
The first criterion is the ability to directly have a significant impact on the debtor's activities. 
The 2nd criterion is that the defendant's exercise of the relevant powers resulted in adverse consequences for the debtor and its creditors, comparable to the scale of the debtor's activities. The comparability entails such consequences radically changing the structure of the debtor's property, pushing it into a state of bankruptcy. Accordingly, these consequences cannot serve as a ground for secondary liability for actions in consummating transactions, albeit not beneficial, but insignificant in size and consequences for the debtor.

The 3rd criterion is that the defendant is the initiator of or an accomplice in such behaviour and/or a potential beneficiary.

3. Protection of a business decision

If the transaction or approval or other decision or action of the controlling person was performed on the basis of a positive opinion or recommendation of the company’s relevant division, it is assumed that the actions of the defendant did not deviate from the standards of reasonableness and good faith usually applied in this area of activity (the rule on the protection of a business decision).

The burden of refuting this presumption lies with the plaintiff. The latter must prove that, based on the essence of the transaction, its extreme disadvantage for creditors was obvious to the defendant, or that the defendant was conclusively aware of a violation of the principles of objectivity in the preparation by the relevant division of an opinion or of the insufficiency of information regarding the relevant counterparty.

The Supreme Court gave an example of circumstances that testify to the reasonableness of a business decision and the good faith of the senior management or managers of a credit institution:

• credit files confirm the prior verification of information about borrowers and their financial condition by the relevant structural divisions of the bank;
• the application for the loan was agreed and approved in the structural divisions of the bank: lending directorate, economic security department, project financing department;
• there is no evidence that loan agreements have been signed which are contrary to the conclusions of the relevant committees or in the absence of their approval or with incomplete (inaccurate) information on the relevant borrower obvious to the senior manager / line manager.

What to think about and what to do

The best protection against secondary liability is preventing it and forming a personal business archive that confirms the basis of decisions taken and transactions consummated (including recommendations of specialised departments), as well as the circumstances that influenced their implementation.

Since the approach developed by the Supreme Court is applicable to any company with a complex management structure, it is necessary to think about improving the company’s structure, its corporate documents in order to record in detail how functions are allocated between divisions and the job responsibilities of managers.

Persons in control should be precluded from circumventing or violating corporate and legislative rules.

Help from your adviser

Pepeliaev Group’s specialists have considerable experience in supporting the current activities of financial and other organisations from the point of view of anti-bankruptcy compliance (restructuring the business, corporate decision-making, transactional support, acquisition of assets, the protection of transactions contested in bankruptcy cases).

We successfully implement legal protection of controlling persons in disputes over secondary liability and are ready to provide comprehensive legal support in order to eliminate or mitigate such risks.

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[1] The Ruling of the Supreme Court's Panel of Judges for Economic Disputes dated 7 October 2021 (2) in case No. А40-252160/2015 on the bankruptcy of PJSC JSCB Baltika (the “Ruling”).
[2] The Ruling of the Supreme Court’s Judicial Board for Economic Disputes dated 22 June 2020 in case No. А56-26451/2016.