Subsidiary liability: what the crisis will lead to

In assessing the changes in the mechanisms for holding the beneficiaries of a business, and the persons who influence management decisions, liable, it is worth noting how contradictory those changes are.

On the one hand, the possibility of holding a beneficiary subsidiarily liable for the company's obligations stands in direct conflict with the foundations of corporate legislation. Identifying the company and its participants, and setting them apart in civil dealings as independent persons, is achieved in part by a direct rule that the company is not liable for a participant's obligations and, conversely, that a participant is not liable for the company's obligations.

On the other hand, that regulation of corporate relations ruled out any liability of the beneficiary for the activity of the business he had created. Everything was limited to the amount of the charter capital. The charter capital of the overwhelming majority of companies was limited to the statutory minimum, for example 10,000 roubles for a limited liability company. In a bankruptcy, that minimum cannot, of course, secure performance of the company's obligations.

That state of affairs created the ground for abuse by unscrupulous entrepreneurs.

In construction, for example, there has been a huge number of bankruptcies of developers, general contractors and corporate structures that served as a transit platform for the misuse of funds received under contracts, or for moving those funds to foreign jurisdictions. The result: hundreds and thousands of bankruptcy proceedings, whose participants will at best receive a partial repayment of the debt. The prospect of the beneficiaries themselves going bankrupt did not frighten them in the least. At worst they lost a business that had, by that point, already served its purpose, while the cash flows had by then been moved on to the next line of business,

- notes Sergei Pivovarchik, managing partner.

Before the reform, holding a beneficiary subsidiarily liable was practically impossible. For a fair assessment of the position before the reform, it also has to be borne in mind that a bankruptcy procedure, in most cases, did not achieve the aim of protecting creditors' interests. That is because of the way bankruptcy is financed: by law, it is paid for out of the debtor's funds. If those funds were insufficient, the difference had to be made up by the creditor who had initiated the bankruptcy. That is, if the bankrupt turned out to be an empty shell, the creditor risked receiving not a single rouble from the bankruptcy, while still paying the insolvency practitioner's salary, the current costs of tracing assets, valuation, analysis of the financial statements and the other procedures needed to assess the debtor's position. That is what accounted for the relatively small number of bankruptcies.

Often, where the debtor was not a large business with its assets in plain sight, honest entrepreneurs declined to start bankruptcy proceedings against a counterparty, for fear of incurring further expense instead of recovering the debt. The position has now changed fundamentally, because it is possible to hold subsidiarily liable a beneficiary or a manager who, aware that the business model was loss-making, did not commence bankruptcy on his own initiative and, by carrying on the activity, increased the debt.

On the negative side of the reform, it is worth noting that a beneficiary may suffer adverse consequences because the courts apply the current tax legislation flexibly. Unfortunately, it is not uncommon for a "new reading", or a creative application of the law by the courts, to leave a business owing the budget tens, or even hundreds, of millions of roubles. Practice shows that even where a taxpayer succeeds in proving his case before the prosecutor's office and in court, the budget returns the money only with difficulty.

For example, in case A40-232515/2017 an arrears of corporate property tax was imputed to the taxpayer and he was held liable, and only after he, in a separate case, had the application of a regulatory legal act to the disputed tax relations held unlawful was the inspectorate's decision set aside. But even though the regulatory legal act had been held unlawful, the Supreme Court directed that the tax and the fines still be assessed against the taxpayer, only on the basis of a different mechanism. There are many such examples.

In the context of bankruptcy, this peculiar view taken by the courts of the provisions of the law (and sometimes a reconsideration of them), set against the reform that has been carried out, is capable not only of putting an end to a business but also of depriving its beneficiary of his personal property. I believe that this particular approach to applying the law follows from an internal instruction to the authorities to maximise the collection of money for the budget, regardless of whether that collection accords with the law. From that point of view, it is impossible to judge what would justify treating one or another mechanism laid down by the law as excessively harsh, or as a restraint on business activity. What restrains it is the absence of effective means of defence in court.

If, however, one sets aside the negative aspects, which come down to the way the law is applied in this country, the reform can be said to have had a clearly positive effect on the business environment. Above all, through the greater accountability of unscrupulous entrepreneurs, and through a bankruptcy procedure that is more effective in protecting the interests of creditors.

Sergei Pivovarchik, managing partner, Consul Group

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