CEO and directors’ liability in Russia: drift in direction of compensatory remedies

October 2014 | EXPERT BRIEFING | BOARDROOM INTELLIGENCE

financierworldwide.com

Russian law and court practice provide companies and their shareholders with a range of possible remedies for a failure by a CEO or company director to comply with their obligations.

Until recently, punitive remedies were more commonly used than compensatory remedies. The main punitive remedies include termination of the CEO’s employment, fines and disqualification or even imprisonment of the CEO in the case of the most socially harmful corporate offences. The preference for punitive remedies was largely due to the fact that the rules of civil liability for breach of a director’s duty of care to a company and its shareholders were not fully developed, and the Russian courts tended not to accept such cases. However, there was a breakthrough last year, when the Russian Supreme Commercial Court (the highest Russian commercial, or ‘Arbitrazh’, court) published new rules on the civil liability of CEOs and directors for unfair or unreasonable acts which resulted in negative consequences for the company (Resolution of the Supreme Commercial Court No. 62 of 30 July 2014, the ‘SCC decision’). The main principles expressed in the SCC decision have been reflected in an amendment to the Russian Civil Code which came into force on 1 September this year, and as a result both commercial and civil courts in Russia are bound by them.

Although CEOs and directors were already under a duty to act in a fair and reasonable manner, the new rules have significantly developed this duty and interpreted it in greater detail. Under the new rules the CEO and directors of a legal entity are obliged to act in the interests of the legal entity in good faith and reasonably; and if they fail to comply with this duty they must compensate the legal entity for any losses which it incurs as a result of such failure.

The new rules establish two categories of breaches of duty for directors: unfair dealing (dealing in bad faith) and unreasonable dealing. The SCC decision gave several examples of dealing in bad faith: entering into a transaction in which there is a conflict of interests (this includes interested party transactions, if the director has failed to declare his interest and obtain the required approval); concealing a transaction from, or misrepresenting it to, the company; entering into a transaction without the required corporate approval; failing to carry out the required actions after termination of powers (e.g., not returning company documents); and intentionally or negligently acting against the interest of the company (e.g., entering into a transaction with obviously unfavourable conditions for the company or with a party that is clearly unable to fulfil its obligations). Examples of unreasonable dealing include entering into transactions without taking in account all the information available, without making an effort to obtain the information commonly available in business practice under similar circumstances, or without going through the company’s established internal compliance procedures (e.g., without obtaining the approval of the internal services of the company responsible for taking decisions).

It is worth noting that in certain cases the new rules permit the company to claim damages not only from the CEO or directors but also from the company’s shareholders and beneficial owners, if it is demonstrated that the CEO and directors were acting in accordance with their instructions. In certain cases, similar liability rules may also be applied to receivers and trustees. In each case, the party with effective control will be jointly responsible, together with the CEO and directors of the company, for the actions of the CEO and directors. It seems fair that a party who is in a position to give instructions to the CEO or directors should not be able to avoid responsibility for actions carried out by the latter in accordance with such instructions.

In the SCC decision, it is specifically stated that if the CEO and directors are responsible for the company’s non-fulfilment or improper fulfilment of its public duties, then they should compensate the company for any losses that arise from such non-fulfilment or improper fulfilment (including any tax or administrative liability incurred). For example, a CEO will be obliged to compensate the company for any administrative fine it incurs, if the administrative offence is related to the unfair or unreasonable conduct of the CEO. The CEO of a company is responsible for its proper and sound management, and is therefore liable for losses incurred by the company as a result of poor management, for example a failure to establish a proper security system or ensure proper bookkeeping.

Under the new rules, the CEO and directors are responsible not only for their own violations but also for those committed by their representatives, contractors and employees, if such persons have been selected or monitored by the CEO or directors. For example, the CEO or directors may be held liable for a failure to fulfil their duty to monitor employees and contractors of the company if the employees or contractors hire personnel without reasonable justification, and as a result the company incurs losses (e.g., the salary, bonuses, etc., paid to such personnel; termination of employment expenses). The CEO or directors may also be liable for losses caused by actions (or non-actions) of employees or contractors if the losses can be attributed to the CEO’s or a responsible director’s failure to supervise such persons. In such cases the court will also investigate whether the CEO engaged the persons in question with a view to evading his duty of care to the company. Given that the scale of the CEO’s and directors’ involvement in the selection and monitoring of personnel and contractors may be different from entity to entity, and given that the law and court practice do not provide any criteria for judging what level of involvement in the recruitment process by a CEO or director will result in liability, the best approach would be for the company to specify such criteria in its internal documents. When assessing the scale of involvement of a CEO and directors, Russian courts will take into account the normal business practice in the relevant industry, the nature of the company’s business and the usual scope of the CEO’s and directors’ duties. If the CEO or directors deviate from the company’s standard procedures for the involvement of third parties and the supervision of their actions, then such deviation may serve as prima facie evidence of unfair and unreasonable conduct by the CEO or directors.

Although, as demonstrated above, the Russian courts and legislators have adopted stringent requirements as to the honesty and fair dealing of CEOs and directors, they also recognise that entrepreneurial flair can be inhibited if excessively onerous duties of care are imposed on CEOs and directors. Both the law and court practice have therefore introduced certain immunities and defences for CEOs and directors against claims for breach of duty of care which may be brought against them.

Firstly, the CEOs and directors may be liable only if their behaviour is qualified as negligence or wilful misconduct. If a CEO or a director cooperates with a court in good faith and gives all necessary explanations, the burden of proving that the behaviour was intentional or negligent will be borne by the claimant. Secondly, the Russian courts and legislators acknowledge that economic risk is an inherent factor in any business activity, and that the CEO and directors should therefore not be liable for negative consequences caused by their decisions if such decisions were taken reasonably and in good faith. The SCC decision explicitly states that a CEO or director may not be liable if the loss was caused by a general deterioration of the economic situation, the misconduct of third parties or an Act of God. Similarly, if the acts of the CEO and directors are, taken as a whole, successful, and the company derives an economic benefit from them, then the CEO and directors should not be held liable for losses caused by an unfavourable transaction if such losses are outweighed by the benefits of other transactions.

The liability of a CEO or directors may also be minimised if well-developed internal policies and corporate documents define the areas of the CEO’s and directors’ responsibilities. A company officer is less likely to be held liable if he can demonstrate to the court that he acted in compliance with the law, the company’s charter and internal policies, and the directions of supervisory bodies. For example, it follows from the SCC decision that a CEO may not be liable for negligence if the negative consequences for the company were caused by circumstances which, under the company’s internal rules, or by custom, are outside the scope of the CEOs responsibility. On the other hand the fact that a CEO acted in accordance with the directions of a supervising body (for example, a shareholders’ resolution) does not provide the CEO with an absolute defence, and the CEO may still be held liable if a claimant manages to demonstrate that such directions were unreasonable or unfair.

Law and court practice provide for several other defences. For example, the SCC decision contemplates that a CEO or a director may be relieved from liability for acting in a transaction in which there was a conflict of interests, if such conflict was disclosed to the company in good time, and was waived by it. In addition, a director who voted against an unfair or unfeasible resolution or who, in good faith, abstained from voting may not be liable for the negative consequences that result from such decision. By contrast, directors or shareholders who support the unreasonable or unfair conduct of a CEO may be liable to the company jointly with the CEO.

Russian law prohibits a CEO or directors from entering into agreements with the company that purport to limit the CEO’s or directors’ liability for unfair dealing, or that guarantee to indemnify them in respect of such liability. In addition, public companies, unlike private companies, may not indemnify their CEOs and directors against liability for unreasonable dealings. In this context, professional liability insurance might provide CEOs and directors with additional protection from liability, although this would be quite expensive.

Alexey Kukharev is of counsel and Tatiana Miteva is an associate at Orrick. Mr Kukharev can be contacted on +7 495 775 4805 or by email: akukharev@orrick.com. Mr Miteva can be contacted on +7 495 604 4052 or by email: tmiteva@orrick.com.

Alexey Kukharev and Tatiana Miteva

Orrick