Greater Liability in Bankruptcy Cases for Debtor Controlling Parties


Legal update No 612

Goltsblat BLP advises of radical changes to the way liability borne by the CEO and other persons controlling a debtor in insolvency (bankruptcy) cases is regulated. The purpose was to improve the secondary liability mechanism in relation to such entities. Previously, their liability was effectively regulated by just Article 10 of the Federal Law “On Insolvency (Bankruptcy)”. Federal Law No. 266-FZ dated 29 July 2017 added Chapter III.2, Liability Borne by the Debtor’s CEO and Other Persons in a Bankruptcy Case, consisting of 22 Articles clarifying the procedure and grounds for bringing debtor’s controlling parties to secondary liability. The new legislative provisions govern any applications filed after 1 July 2017 seeking secondary liability for a controlling person.

Provisions of particular interest and importance:

1. The concept of a “debtor’s controlling party” has been extended considerably to preclude potential evasion of liability by actual beneficiaries of the debtor, should they be found culpable of inflicting damage on creditors. The court now has discretion to recognise a person as controlling the bankrupt debtor for reasons beyond those expressly listed in the law1. The following wording is of particular interest here: a person is also recognised as being in control if it has “derived benefits from illegal or bad faith conduct by the bankrupt company’s management team2.”

2. The concept of a “nominal CEO” is used by the law-makers for the first time and grounds are listed for releasing a nominal officer from secondary liability or reducing the scope thereof. For instance, a nominal officer will not be subject to secondary liability if it manages to prove that it exerted no determining influence on decisions made by the bankrupt company and helps identify the true controlling party and/or track its concealed assets or those of the bankrupt company3.

3. Existing presumptions of a causal link between the debtor’s bankruptcy and actions by its controlling party4 are now supplemented by new ones5. According to the revised law, a causal link is presumed to exist if:

  • by the time supervision is introduced, the controlling person has failed to arrange storage of documents that must be kept by law or has distorted them;
  • on the date the bankruptcy case is initiated, no mandatorily registrable data are registered in the Companies Register or the Federal Register of Information on Facts in Activities by Legal Entities.

4. The law now establishes that a debtor’s controlling party may not be released from secondary liability even if6:

  • the debtor meets the insolvency criteria not as a result of the controlling person’s actions, if the court establishes that said person’s actions and/or omissions after the bankruptcy indicia became apparent considerably aggravated the debtor’s position;
  • bankruptcy proceedings are terminated because the debtor’s funds do not cover legal fees associated with the relevant procedures or a bankruptcy petition filed by a competent body is turned down.

5. Persons entitled to file an application seeking to bring controlling parties to secondary liability may do so at any stage in the bankruptcy proceedings7. Previously, this was possible only at the final stage of receivership proceedings, possibly after a wait of several years, meaning the beneficiary had time to siphon off the assets.

6. An application to hold a person secondarily liable may also be filed outside of bankruptcy proceedings and even if the court has terminated such a bankruptcy case for insufficiency of the debtor’s funds. The creditors may also seek secondary liability for controlling parties after receivership proceedings have been completed8.

7. The new law expressly entitles the court to re-distribute the burden of proof and require the persons being held liable to prove their own innocence and/or absence of grounds for imposing secondary liability whenever they do not submit a statement of defence for reasons the arbitrazh (commercial) court deems inadequate or they provide apparently trivial objections to the claims brought against them9.

8. A new mechanism is introduced to safeguard assets of the debtor’s controlling parties. The court is now allowed to attach property owned by the party being held secondarily liable or by its controlled parties10. Also, in contrast to common provisional remedies granted outside a court session, if the arbitrazh (commercial) court believes it necessary to hear the applicant and/or other parties involved, it may schedule a hearing to examine the application for provisional remedies within three business days of receiving the application.

9. The law details how claims filed against the debtor’s controlling party should be distributed between its creditors. The creditors may now choose how to handle their rights of claims with respect to secondary liability11:

  • recover debt under the claims as part of bankruptcy proceedings, or
  • sell the rights of claims by tender, or
  • assign part of the rights of claims to a creditor to the extent of its receivables.

10. Previously, even if the debtor’s controlling party was successfully brought to secondary liability, the rights of claims were commonly sold by tender, the participants often being the debtor’s affiliates, which then acquired the receivables for a song. The persons guilty of the debtor’s bankruptcy thus virtually evaded enforcement of a court ruling on compensating for the damage inflicted on the debtor and its creditors.

A receivership creditor is now entitled to assume a portion of the liability due from the debtor’s controlling party in consideration of its claims against the bankrupt debtor or demand that the insolvency officer seek complete enforcement of the judicial act on bringing the controlling party to secondary liability through court bailiffs12.

11. The law also makes it possible to bring a controlling party to secondary liability for failing or refusing to contest questionable (ungrounded) creditor claims13.

1Article 61.10 of the Federal Law “On Insolvency (Bankruptcy)”
2Clause 1, Article 53.1 of the Russian Civil Code
3Clause 9, Article 61.11 of the Federal Law “On Insolvency (Bankruptcy)”
4Ibid., Paras 1–3, Clause 2, Article 61.11
5Ibid., Paras 4–5, Clause 2, Article 61.11 and Para. 2, Clause 2, Article 61.12
6Ibid., Clause 12, Article 61.11
7Ibid., Article 61.14
8Ibid., Articles 61.14 and 61.19
9Ibid., Clause 4, Article 61.16
10Ibid., Clause 5, Article 61.15
11Ibid., Article 61.17
12Ibid., Article 61.17
13Ibid., Article 61.13

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