Subsidiary liability. Grounds for attraction. The order and nuances of legislation.

Aug, 08 2022

Contents:

Subsidiary liability (CO) is one of the types of liability that occurs in the event of bankruptcy of the company and the formation of debt. In this case, the head of the legal entity will be obliged to repay the debt from his own funds. 

The peculiarity of subsidiary liability is that it is an additional way to force the debtor to fulfill its obligations to counterparties, customers, the bank, the tax service and other entities in the bankruptcy process. Thus, two conclusions can be drawn: the measure will be applied to the entity that actually controlled the company, and in addition to subsidiary, other types of liability, such as administrative or criminal, may be applied to the defaulter. In the latter cases, everything depends on the circumstances of the transactions and the insolvency procedure. 

Grounds for subsidiary liability

The grounds for bringing to subsidiary liability in bankruptcy are almost always connected, to one degree or another, with non-fulfillment of their financial and credit obligations, as well as violation of the law. 

It is important to know here that one desire or demand of creditors for the occurrence of subsidiary liability is not enough. To assess the grounds, interested persons should file a lawsuit with the court, which will decide on the occurrence of subsidiary liability for a particular person. 

The legislation of the Russian Federation defines the following grounds for bringing a senior person to this type of responsibility. 

1. Lack of money or assets to close debts to creditors based on the results of bankruptcy proceedings.

According to paragraph 1 of Article 57 of the Federal Law “On Insolvency (Bankruptcy)”, creditors have the right to demand full repayment of debts despite the difficulties with repayment of debts from LLC. It should be noted that at the very beginning of the bankruptcy procedure, the head of the enterprise retains independence in conducting financial procedures and has the right to decide whether to attract additional funds or initiate a financial recovery procedure. After the arbitration manager is involved in the bankruptcy proceedings, the director loses the ability to control the fate of the company. Thus, if the bankruptcy trustee is unable to find the necessary amount of money to close the debt obligations, subsidiary liability may occur against the head of the organization.   

2. The presence of conditions under which the insolvency occurred due to the fault of the management.

As a rule, the ability to bear subsidiary responsibility for the payment of debt obligations of the company stops the management from conducting illegal schemes that are likely to cause irreparable financial damage to the enterprise. However, cases of business collapse for this reason are not uncommon. What can managers do wrong? 

Usually we are talking about dubious transactions that undermine the production and economic activities and the economic position of the company. Such actions may be expressed in the conclusion of dubious contracts for the alienation of assets and the withdrawal of money from a legal entity. It is important to know that the court will also take into account the management’s inaction, for example, in a situation when a partner did not dissuade another partner from making a suspicious decision. 

3. Significant errors in accounting statements.  

The presence of facts of concealment of the taxable base or fixed assets will be perceived by the court as a malicious act and intentional concealment of funds. Thus, we advise you not to hide the primary and other documentation, and if it is lost or damaged, immediately take care of restoring or obtaining copies. 

4. Deliberate disruption of the deadlines for applying to the court with an application for insolvency in a situation where it was necessary. 

Entrepreneurs often forget or do not take into account that when financial problems and unaffordable debt to a bank or counterparties are discovered, going to court is not a choice, but a necessity. The law sets different deadlines for each business entity. 

  • The head or a group of LLC participants must file a claim no later than one month from the date of the last financial report reflecting the insolvency of the company.
  • Founders or shareholders submit a corresponding application within 10 days from the date when the same period for the head has expired, provided that the founder /shareholder is one person. Or within 20 days if there are several founders/shareholders.

It is important to know that a deviation from the deadlines for filing an insolvency claim may be regarded by the court as a special concealment of data on the difficult economic situation of a legal entity. 

5. Fictitious insolvency. 

Here we are talking about situations where bankruptcy is only in the documents, which does not reflect the real state of affairs in the LLC. In fact, a company may be able to pay off creditors, but not to do so to conceal the value or quantity of assets.  

6. Deliberate bankruptcy. 

It is worth noting here, first of all, the deliberate assumption of a large credit burden, inaction in matters of debt repayment or conducting obviously unprofitable transactions. 

Procedure for bringing to subsidiary liability

As we have already noted earlier, it is only the court that forces such a type of responsibility. Thus, the plaintiff needs not only to submit an application, but also to collect an evidence base confirming the existence of grounds for bringing to subsidiary liability.  

Further, the court must take into account the financial condition of the legal entity and the amount of debt. If the credit burden is unbearable for the company, then according to paragraph 1 of Article 339 of the Civil Code of the Russian Federation, an additional subsidiary may be applied to an official who bears managerial responsibility. 

As a rule, it is necessary to go through several stages to attract this type of responsibility.  

Stage 1. Filing a claim to arbitration to attract a senior or managing link to subsidiary liability. 

Such an application can be submitted by: an arbitration manager, a creditor (bank, counterparty, partner and other entities), state organizations, for example, the Federal Tax Service or extra-budgetary funds.

Stage 2. Consideration of the case in court.

The judge always listens to the arguments of both sides in order to make the right decision. Sometimes directors refer to the lack of real official authority to make serious decisions or to the lack of links between his work and the bankruptcy of the enterprise. 

Stage 3. The court issues a decision on bringing to subsidiary liability or refusal.

In the first case, the decision can be executed with the involvement of bailiffs. However, the loser can file an appeal within the time limits established by law. 

Stage 4. The court determines the level of debt burden for each creditor.

Stage 5. The executive authorities describe all the property and other assets for the purpose of selling them at auction. 

Stage 6. If it turns out that the official does not have enough own funds to repay the debt, then the circle of persons controlling the debtor (CDL) is determined.

Here it is important to know that four categories of subjects fall under CDL. 

1. Members of LLC. 

If the partner has a share of 50% +1 vote or more, then he can share the subsidiary responsibility of the official. The court and the executive bodies proceed from the fact that with such a size of the share, the participant can influence financial decision-making. However, this fact can be disputed by providing a number of proofs. 

2. Part-timers of positions.  

Often, the directors or founders of an enterprise can work in the organization part-time, for example, as a deputy director or chief financial officer. In this case, the chances of becoming a CDL increase. 

3. A subject with broad powers according to the charter. 

Here you need to understand that although the director solves certain issues, but his powers are still limited by the charter of the LLC. However, if, according to the charter, the director will bear broad responsibility, then it is likely that he will also bear subsidiary responsibility. 

4. Beneficiaries. 

Subject to proof of profit from the operation of the enterprise. 

Nevertheless, it should be borne in mind that most often company directors, financial employees, founders and beneficiaries are involved in subsidiary liability. At the same time, Law No. 127-FZ “On Insolvency (Bankruptcy)” makes this list practically unlimited.  

Grounds for bringing the debtor’s manager to subsidiary responsibility

According to Article 56 of the Civil Code of the Russian Federation, the founders are not responsible for the result of the work of a legal entity. However, in practice, the courts appeal to other legal norms that establish the procedure for bringing the director to subsidiary liability for LLC debts. And if we turn to judicial practice, we can see that over the past 10 years the number of such cases has increased significantly.  

However, not only the head, but also other persons can be brought to subsidiary responsibility:

  • The general director of the company. 
  • The actual owner of the business. 
  • Chief Accountant. 
  • An entity that has actually managed the business for the last 36 months – a director, a top manager. 
  • Other beneficiaries, including close relatives of the head or owner, provided there is evidence of the use of the assets of the bankrupt company. 

Thus, any entity related to the company can be held vicariously liable if it is possible to prove in court its detrimental effect on the financial situation of the company. This can be expressed in the issuance of malicious orders or orders, concealment of accounting information, negative influence on management. 

The procedure for bringing the debtor’s manager to subsidiary responsibility

Bringing the company’s management to subsidiary responsibility is standard in its essence for any lender. To do this, the one whose financial interests have been violated must:

  1. Get a court verdict on the recognition of the LLC as bankrupt, as well as order an extract from the Unified State Register of Legal Entities on the termination of the company’s accounting. 
  2. Collect financial documents justifying the amount of debt. 
  3. Find and submit to the court evidence of the firm’s inability to repay the debt with its own assets. 
  4. File a claim to the arbitration court for the involvement of the company’s management or employees related to its financial affairs or who made specific decisions. To do this, it is necessary to collect concrete evidence and provide it to the court. It is on their basis that a decision will be made on the involvement of a specific entity in the SO. 

Is it possible to protect yourself from the occurrence of subsidiary liability? 

Legal practice shows that it is possible to protect yourself from paying the company’s debts. To do this, you just need to follow some simple rules: 

  • File for bankruptcy on time. 
  • Perform due duties in accordance with the company’s charter. 
  • Monitor the possibility of questionable transactions on the part of other employees or partners. 
  • Seek legal assistance in case of a difficult situation.
Author of the article
Subsidiary liability. Grounds for attraction. The order and nuances of legislation.
Valentina Khlavich
Managing Partner
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