Expanded Liability of Officers in Russian Companies

by Orrick, Herrington & Sutcliffe LLP
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In Resolution No. 62 “on Liability of Members of a Company’s Governing Bodies” dated July 30, 2013 (the “Resolution”) the Russian Supreme Arbitrazh Court provided new interpretations of the  Russian statutory rule that the chief executive officer and members of the management board, the board of directors  and certain other management personnel of a Russian company (collectively the “Directors”) must act “reasonably, in a good faith and in the interests of the company”, potentially creating additional liabilities for such Directors. The Resolution placed Directors in precarious position where their actions might be later second-guessed, thus exposing them to liability, with not immediately clear safeguards.

Perhaps the most concerning impact of the Resolution is a rebuttable presumption of bad faith and unreasonableness on the part of Directors in specific circumstances.  The Resolution gives several examples where unreasonableness and bad faith are presumed, unless the Director can prove otherwise.  The Director’s bad faith and unreasonableness are presumed, thus creating heightened exposure to potential liability, if the Director knew or should have know that his actions or inactions were not in the interests of the company (for example, if the Director entered into or approved a transaction knowing at the time that it would be unfavorable to the company or that the counterparty would not be able to fulfill its obligations).  The above would arguably cover any transaction on non arms-length terms (including transactions with related entities) and could be interpreted to require Directors to perform financial due diligence on contractual counterparties prior to entering into commercial agreements with such counterparties. Also, transactions with special purpose entities and restructuring debtors could expose Directors to liability because these are arguably counterparties known to be unable to fulfill their obligations.

Further pursuant to the Resolution, in determining whether a Director acted “in good faith and in the interests of the company”, courts are required to view the Director’s actions in light of his duty to generate profits and to achieve other objectives stated in the charter or other internal regulations of the company.  This leaves a Director open to the courts’ second-guessing his business judgment after a transaction results in losses.  This being said, the Resolution does specify that courts are required to disregard regular business risks and to consider the scope of duties of the relevant Director in making such assessment.

A Director’s bad faith and unreasonableness are also presumed if he: (i) acts without considering relevant information or without obtaining sufficient and necessary information, (ii) fails to comply with the company’s internal procedures prior to approving or entering into the transaction (e.g., approval of the legal, accounting and human resource departments), (iii) approves or enters into the transaction without an approval required by law or the company’s charter (for example, by the board of directors or the shareholders), or (iv) fails to return the company’s documents after the Director’s authority expires or is terminated.  This underscores the importance of maintaining documents to confirm that transactions are concluded subject to due diligence of the counterparty and observance of all corporate formalities.

If bad faith and unreasonableness are presumed when corporate formalities are disregarded, following the corporate formalities is not an automatic safeguard.  The Resolution explicitly states that approval of a transaction by the company’s board or shareholders does not absolve a Director from liability for bad-faith and/or unreasonable actions that caused damages to the company.  Moreover, members of the collective corporate bodies (i.e. the board of directors or management board) of a company who vote for approval of any such transaction may also be subject to joint and several liability.

In addition, the Resolution expands the scope of individuals who might be subject to liability and the scope of persons who can bring claims beyond those stated in the statute.  The Resolution extends the potential liability to (i) former Directors (for transactions approved by such persons when they were Directors), (ii) managers or managing companies, (iii) liquidators and (iv) external managers.

Pursuant to the Resolution, the persons entitled to claim damages from a Director include the relevant company and/or its shareholders, including persons who were not shareholders of the relevant company on the date of the action that caused damages to the company or on the date when the company incurred such damages.  This could include the situation in which a purchaser of a company would bring an action against former Directors of the company for transactions approved by such Directors prior to such purchase, including any non arms-length transactions with affiliated persons.

At the same time, the Resolution specifies that a Director should not be liable for damages caused to the relevant company that have already been recovered in any other way (insurance, recovery from other parties etc.).

Also, a Director will not be liable if he proves that an unfavorable transaction (i) was part of several related transactions that were collectively intended to be profitable, (ii) was intended to prevent an even greater loss to the company or (iii) was not obviously illegal at the time of conclusion (for example, if the relevant applicable law at the time was uncertain or its application by governmental authorities was not uniform).

Finally, the Resolution confirms that a board member will not be liable if he voted against, or in good faith did not vote with respect to, an action that was nevertheless approved by the board and caused damages to the company.

Based upon the Resolution, Directors of Russian companies should take further precautions to confirm that any transactions entered into by their companies are entered into in good faith with reputable counterparties, subject to due diligence and on arms-length terms, in accordance with applicable law, sound business practices and subject to all necessary corporate  approvals.

Although the exact application of the principles announced in the Resolutions remains to be seen, the Directors would be well advised to take appropriate precautions.  These risks for Directors may be reduced by obtaining D&O insurance or by indemnification by the company, however these too may face risks of non-enforceability under Russian law and therefore require further analysis on a case by case basis.?

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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