New Bankruptcy Rules. What a CEO Needs to Know?

This legal alert discusses the liability of the management, the shareholders and controlling persons of a debtor organization under the new bankruptcy rules.

As noted in the Legal Alert on Bankruptcy Law Changes to Protect Creditors' Rights, since June 5, 2009 the legal liability of a debtor's CEO and shareholders have been seriously tightened. Now, besides administrative and criminal liability, a debtor's management and owners may be open to unlimited subsidiary civil liability.

 

Issues to consider

The main risks for a company's management and the owners of a business are related to non-fulfillment of the following obligations:

1. The CEO of a debtor is obliged to initiate bankruptcy proceedings if the debtor shows signs of inability to pay or it lacks the assets to settle its obligations. Violation of this requirement leads to the CEO's subsidiary liability for all new obligations of the debtor that arose after the requirement was violated.

Although the previous wording of the law also obliged a debtor's CEO to monitor bankruptcy criteria and file an application with an arbitrazh court within one month of said criteria being met, now the situation has changed radically.

Since June 5, 2009 new bankruptcy criteria operate; notably inability to pay and asset insufficiency.

Inability to pay means a debtor's non-payment of its monetary liabilities (including compulsory payments) caused by lack of money.

Asset insufficiency means a debtor's monetary liabilities exceed its asset value.

Uncertainty over these criteria may trigger the liability of a CEO or head of a collegial executive body, or a person acting in the name of the debtor without a power of attorney, for the debtor's obligations in the case of the debtor's bankruptcy.

Currently a number of companies meet the criteria of inability to pay, for example due to cash flow issues or non-payment by customers.

Moreover, it is quite common for asset insufficiency to arise due to changes in the market value of a debtor's assets or increased liabilities, or even methodological mistakes in bookkeeping.

Taking into account the legal possibility of retrospective claims by creditors (e.g. in relation to the existence of bankruptcy criteria before the initiation of bankruptcy proceedings) a CEO should evaluate these risks and take measures sufficiently early.

 

2. The CEO of a debtor is responsible for complete and accurate bookkeeping and reporting. Violation of this obligation causes the subsidiary liability of the CEO for all the debtor's obligations.

Despite the fact that formally Article 6 of the Federal Law "On Accountancy" stipulates a CEO's obligation to organize book keeping and reporting, to date there has been no federal law creating unlimited subsidiary liability for all the debtor's obligations for the CEO.

Taking into consideration the continuing changes in Russian accounting standards, as well as the common practice of rather formal adherence to accounting rules on collection and storage of documents and keeping proper accounts of the debtor's assets and liabilities at the present time it may be presumed that a CEO is exposed to a high risk of unlimited subsidiary liability for all a debtor's obligations.

Considering this and taking into account the possibility of retrospective claims from creditors about deficient accountancy and reporting, it is recommended that companies' management pay serious attention to the bookkeeping for the past three years.

 

3. Controlling persons are obliged to act honestly and reasonably in the debtor's interests. Controlling persons jointly bear subsidiary liability for all debtor's obligations as regards compensation for damage caused to the creditors' property rights as a result of their dishonest or unreasonable actions or instructions.

According to the law a controlling person means any person who had a right to give a debtor obligatory instructions or otherwise determine debtor's actions within the two years before the bankruptcy application was accepted by an arbitrazh court.

Based on the above the actual owners of businesses, who were previously hidden behind multilevel holding structures, including offshore companies, may be held liable for actions, which caused pecuniary damage to creditors and led to the debtor's bankruptcy.

Thus, the legislator imposed an obligation to act in all creditors' interests, not only those of the company's management and nominal owners but also the de-facto owners of the debtor's business. The mechanism of applying subsidiary liability to controlling persons may be considered additional to the mechanism set forth in Article 56 of the RF Civil Code.

Thereby, the new law considerably discourages potential debtor's misconduct aiming to decrease of a debtor's property value or increase of property claims' for a debtor.

The other important result is recognition of the fact that insolvency (bankruptcy) of a company may be caused by the mistakes and dishonest actions of a controlling person a long time in the past (up to two years).

To summarize the above, it is necessary to point out that the legislator substantially increased the liability of a debtor's management for illegal actions committed before or during bankruptcy proceedings. In particular, in addition to the existing administrative (including disqualification for up to 3 years) and criminal (up to 6 years) liabilities, civil liability for the debtor's obligations was newly introduced.

 

Experience and advantages of Baker & McKenzie

We fully understand that during any financial crisis it is important not only to identify possible risks, but also to be able to identify prospects for future development. Our approach to bankruptcy is to protect the debtor's interests and use the bankruptcy procedure for the financial rehabilitation of the business. Our specialists possess the legal and business knowledge, as well as considerable experience, to let them work in a fast and coordinated manner in order to help you to save time and seize opportunities.