Moscow District’s Commercial Court recently adopted an unprecedented decision, ruling that the debt of an insolvent bank must be repaid by both the bank’s former executive officers and its board members (after the repayment of debts out of the assets of the bank). The resolution may have far-reaching implications, as it introduces a turning point in current court practice. In addition to shareholders and executive officers, members of the board of directors may also now be held liable for the debts of an insolvent company.
The claim against the managers of Open Joint Stock Company Agro-Industrial Construction Bank ("ASB-bank") was filed with the court by the State Deposit Insurance Agency (the "Agency"). ASB-bank was declared bankrupt in February 2005 and is being liquidated under the supervision of the Agency acting as liquidator.
At the end of May, the court came to two major conclusions. First, it found that the top managers of the bank were liable for the acquisition of illiquid bills of exchange. This is a relatively routine decision as holding top managers liable for the bankruptcy of a company is generally accepted practice – a few months ago, the Agency obtained a similar ruling from the Cheremushinsky District Court of the City of Moscow on collecting 240 million rubles in damages from the managers of the insolvent bank "Natsionalny."
The court’s second conclusion, however, became the subject of much discussion, as it was the first time a Russian court held board members liable for the resolutions they had passed which led to the bankruptcy of the company. The court imposed liability on those who approved granting loans to insolvent borrowers, which in turn resulted in the bank’s bankruptcy. Although the above case concerns a bank, its consequences may affect other businesses as well. It appears that a tendency is developing to hold liable all those directly involved in the making and promoting of decisions to carry out dubious transactions.
The arguments of the Agency representatives were based on provisions of the Law on the Insolvency of Credit Organizations (the "Bank Bankruptcy Law") and the Law on Joint Stock Companies (the "JSC Law"). Article 14 of the Bank Bankruptcy Law provides for the liability of the founders, directors and top executives of the insolvent bank. Article 69 of the JSC Law establishes that the executive bodies of a joint stock company must report to the board of directors, and Article 71 of the JSC Law permits a court to find a General Director and other directors liable for the damages they cause to the company. Nevertheless, Agency representatives say directors should only be held liable if there is evidence that such directors deliberately caused the bankruptcy of the company.
While director and officer insurance is widely practiced in other jurisdictions, it is rather undeveloped in Russia. The liability of directors is insured only in a handful of Russian companies. For example, RAO UES recently insured the liability of its directors and top executives for US$30 million.
Whether this decision is an isolated incident or a harbinger of things to come, it puts directors on notice that their decisions may also be scrutinized by courts and potentially result in personal liability.
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