Manager’s Liability and Owner’s Risks-Publication

The newspaper "The Economy and Life" ("Ekonomika i zhizn")

The company's effectiveness, financial success, and stability in the market depend on the manager’s decisions. Owners often delegate rather broad authority to the General Manager. The ability to single-handedly control the company's assets in the course of business operations without oversight from the company's other governing bodies (the board of directors or a general meeting of the shareholders or participants) can provoke a director to abuse his or her privileges. In order to protect the interests of the company and its stakeholders, the legislations allows the owner to call the manager to account. What steps do business owners need to take in this case? Is it always possible to neutralise the negative consequences of a manager's actions? When can an organisation or an owner initiate proceedings against the manager?

The law establishes a few types of managerial liability for infractions committed by managers in the fulfilment of their professional duties.

Disciplinary liability

In the event of improper discharge of a manager's duties, Article 81 of the Labour Code of the Russian Federation establishes the following as grounds for cancellation of the labour contract at the employer’s behest:

1) making an untenable decision that involves a violation of the preservation of property, the wrongful use of property, or some other damage to the organisation's property;

2) a one-time, flagrant violation of job responsibilities;

3) cases stipulated by the manager’s labour contract with the organisation.

Article 192 of the Labour Code of the Russian Federation refers to dismissal based on the first two grounds as a disciplinary penalty. A manager can also bear disciplinary liability (right up to termination of employment) for a violation of labour laws and other legislative acts, or for a breach of the terms of the collective bargaining contract or agreement (at the request of the labour union). In this case, dismissal requires incontrovertible evidence that the manager violated the duties established by labour laws, the labour contract, or some other document defining his or her rights and obligations.

The procedure for imposing disciplinary liability must be clearly followed. In particular, before enforcing a disciplinary penalty the employer must request a written explanation from the employee and issue the appropriate order.

The law does not regulate the process for holding a manager disciplinarily liable by the company's governing bodies (the board of directors; participants or shareholders), given the special nature of his or her legal status. In practice, that is why issues arise that prevent the enforcement of labour laws on the acting manager.

Considering that the manager has judicial recourse to use any violation of the procedure for imposing disciplinary liability as the grounds for being reinstated at work, legal proceedings on these grounds are quite risky. In addition to the abovementioned, Article 277 of the Labour Code of the Russian Federation establishes grounds for terminating the manager's labour contract, e.g.

in connection with the dismissal of the manager by the organisation in accordance with insolvency law (bankruptcy).
in connection with the decision to terminate the labour contract by an authorised body of the legal entity. If the labour contract is terminated on these grounds without guilty actions (or inaction) on the part of the manager, then he or she is compensated in the amount set forth in the labour contract, but no less than triple his or her average monthly earnings;
for other reasons set forth in the labour contract. These last grounds for cancelling the labour contract make it possible to formally dismiss the manager for the violation of any provision of the labour contract — even an insignificant one. However, if the manager seeks judicial recourse, the company has to substantiate the reasons for cancelling the labour contract and prove that the violation is commensurate with its consequence (the cancellation of the labour contract).

Financial liability

According to Article 277 of the Labour Code of the Russian Federation, an organisation's manager bears full financial liability for direct, actual damages caused to the organisation. Furthermore, a demand for full repayment of damages may be submitted regardless of whether or not the labour contract contains a provision for full financial liability.

Example. A company filed a claim in a court of general jurisdiction for repayment of damages by the company's manager. During the course of the judicial proceedings it was established that the manager took a business trip for personal reasons; there was no business need or rationale to it. As a result, an inventory shortage appeared, confirmed by a check of the inventory. There was not business justification for the manager's write-off of accounts receivable. The court found that through his actions the manager had inflicted direct, actual damages on the company. The court ruled against the manager in the amount of the business trip expenses, the inventory shortage, and the accounts receivable write-off (see cassational ruling No. 33-17946, dated 17/06/2010, from the Civil Chamber of the Moscow Municipal Court).

As a general rule, an employee's financial liability excludes damages that results from normal business risk (Article 239 TK RF), i.e. when the employee properly executed his or her professional duties, demonstrated the due level of diligence and caution, and took steps to prevent the damages. Employers have the right to judicial recourse in disputes over repayment of damages incurred for one year following the discovery of the damages.

Civil liability

A number of federal laws in Russia set forth circumstances where the manager is responsible not only for the amount of actual damages (the costs of restitution for an infringed right, the cost of damaged or lost property), but also for the loss of profit (revenue that would have been received under normal business conditions).

According to Article 53 of the Civil Code of the Russian Federation, a manager is obligated to repay a company's incurred losses at the request of its participants. Similar regulations can be found in the federal laws No. 14-FZ "On limited liability companies", dated 08/02/1998, and No. 208-FZ "On joint-stock companies", dated 26/12/1995, which state that the manager is liable to the company for the losses it incurs due to his or her guilty actions (or inaction).

The demand for repayment for losses can be submitted to the court by the company itself or a participant (for joint-stock companies, a shareholder owning more than 1% of the shares). Regardless of whether the plaintiff is the company or one of its participants, losses are recovered exclusively for the benefit of the company.

Losses are recovered when the following conditions exist:

1) harm has been inflicted and the size of the incurred losses can be substantiated;

2) there have been illegal actions (or inaction) on the part of the manager;

3) there is culpability;

4) there is a causative link between the manager's illegal actions (or inaction) and the ensuing consequences (the incurred losses).

If even one of these conditions is absent, the manager cannot be brought to bear civil liability.

Thus, when resorting to court a company should present evidence that establishes not only the fact that damages were inflicted and the amount of the losses, but also the causative link between the losses and manager's illegal, culpable actions that contravened the company's interests.

Good faith and reasonableness have been defined as the legal criteria for assessing a manager's actions (Article 53 of the Civil Code of the Russian Federation, Article 71 of the law "On joint-stock companies" and Article 44 of the law "On limited liability companies").

The lack of a clear legal definition of good faith and reasonableness leaves it to the courts to determine whether the manager's actions fit the indicated criteria. The courts do not have a uniform approach to the question of holding a manager civilly liable.

Administrative liability

If an administrative violation is made in connection with a manager's fulfilment of his or her managerial or administrative roles, then, based on Article 2.4 of the Russian Federation's Code of Administrative Violations, as the executive, the manager can be held administratively liable for the non-execution or improper execution of his or her duties.

The following penalties can be applied in the case of administrative liability:

a warning (for first-time administrative offences that do not inflict property damage);
an administrative fine (from 10,000 to 50,000 roubles);
disqualification, i.e. depriving the individual of the right to fill positions in the legal entity's executive body, to be on the board of directors, to manage the legal entity's business activities, or manage the legal entity in other specific circumstances (determined by the court and imposed for a period from six months to three years).

In one such case, the manager was held administratively liable for the violation of labour laws. It was established that when employees were dismissed, their final payment was delayed and back wages were due to the employees. The court noted that seizing the company's property had not freed the manager of the obligation to pay wages in the specified time periods. In view of the fact that the manager had previously been fined 3000 roubles in a case of administrative liability, the punishment for a similar, repeated offence was disqualification for the period of one year (ruling by the Perm Krai Court on case No. 44-A-373/2011, dated 11/05/2011).

If the company had been fined as a result of the manager's administrative violation, it would have had the right to appeal to the court to demand collection of its losses in the amount of the fine (ruling No. F09-10063/08-S4, dated 30/07/2009, by the Federal Arbitration Court of the Ural Okrug).

Criminal liability

A manager whose actions have the appearance of a crime may be held criminally liable based on a court verdict.

If action (or inaction) is formal and has the appearance of a crime, but presents no public danger because of its insignificance, then it is not considered a crime.

Crimes by a manager are generally punished by a fine, the loss of the right to occupy certain positions or engage in certain activities, mandatory or correctional work, restrictions on freedom, arrest, or imprisonment.

Here are some examples of a few types of crimes for which managers may bear criminally liability:

deliberately evading the payment of large debts;
deliberately evading the disclosure or granting of securities information or presenting incomplete or fraudulent information, if doing so causes significant damages;
wrongful actions during bankruptcy (concealing property, transferring ownership of property to third parties, alienating or destroying property; non-disclosure, destruction, or falsification of accounting documents), if doing so causes significant damages;
evading the payment or collection of a large tax obligation by failing to file a tax return or provide other required documentation; or by deliberately including false information in a tax return or other document;
using his or her authority contrary to the company's legitimate interests and for the purposes of securing benefit and advantage for one's self or for others, if doing so substantially harms rights and legitimate interests;
refusing to hire a woman or dismissing a woman, without cause, because of being pregnant or having children under the age of three;
failing to pay wages or make other payments, for personal gain or other self-interests.

The main criteria for establishing criminal liability are 1) being the cause of significant damages or 2) acting for personal gain.

In one of these cases — relying on the testimony of witnesses, the findings of legal forensic and handwriting analyses, the company's financial audit reports, and other documents — the court found that due to wrongfully including VAT deductions in a number of contracts, the company was obligated to pay the tax. According to the manager, dishonest work by company employees and his lack of the necessary oversight resulted in false information being included in the tax returns and the tax base for VAT being understated. The court considered his testimony an admission of his guilt and fined him 210,000 roubles, to be paid to the state (ruling No. 4y/5-5163, dated 19/07/2010, from Moscow Municipal Court).

Summary

As has been demonstrated in practice, holding a manager criminally liable is difficult. Minimising the risks of improper management of a company is only possible by restricting the manager's authority. The company's founding documents may require, for example, that certain types of transactions (alienation of company shares, concluding a deal for more than a certain amount, etc.) can only take place with the prior written approval of the company's shareholders (participants) or board of directors.

In cases of financial and civil liability, the company itself or its shareholders (participants) must prove the correlation between the inflicted damages and the manager's actions, except when there have been administrative violations or criminal behaviour, in which case the illegality and culpability of the manager's actions are proven by the appropriate state agencies.

Considering the fact that the law does not contain a detailed list of a manager's rights and obligations nor specific instructions of the possible grounds for liability, it can be extremely difficult to hold him or her accountable for a violation of professional duties. Therefore, special attention should be given to the manager's labour contract. We recommend spelling out the professional duties as precisely as possible.

Any corroborating document can serve as evidence of inflicted damages, for example, accounting statements, property appraisals (when property has been sold at and understated price), information on similar transactions (if a transaction has been concluded on unfavourable terms), information about a contractor (if the contractor is a company under the manager's control), and previously concluded contracts.

A manager can only be held liable if he or she is culpable. It is nearly impossible to hold a manager liable for risky transactions that later prove to be unprofitable, because the outcome of such deals is considered an inherent risk of business. Evidence that the manager took every precaution in his or her power to avoid damages may also be considered grounds to clear him or her of liability.

As you can see, holding a manager liable is a long and difficult process that requires shareholders to follow formal procedures and present solid evidence.

Source: The newspaper "The Economy and Life" ("Ekonomika i zhizn"), No. 27 (9393), 15 July 2011

By Liliya Khakimova, Senior Counsel,
Outsourcing Division BDO Russia