Subsidiary liability of lawyers in bankruptcy cases
By Roman Makarov, Nektorov, Saveliev & Partners
Subsidiary liability in a bankruptcy is an institution, which pierces the corporate veil and makes it possible to hold the ultimate beneficial owner (UBO), top management and other controlling persons liable for the debts of the bankrupt if it is proven that their actions contributed to the bankruptcy.
The standards of proof in these types of cases are relatively low – bankruptcy has already occurred, and it probably has been caused not only by objective reasons, but also by abuse. Therefore, the insolvency manager and creditors take action to expand the circle of persons who can be brought to subsidiary liability. There are increasing attempts in bankruptcy cases to hold liable lawyers – both in-house and consultants. There are many examples of practice on the matter.
If a lawyer’s power of attorney contains broad enable authority over the company's entire business scope, then creditors and the insolvency manager can prove the lawyer managed the company and that the lawyer’s actions brought it to bankruptcy. In particular, they can demonstrate the lawyer was making transactions that changed the legal status and economic performance of the debtor.
Consultants may raise the following objections: the POA alone does not confirm that the lawyer has the status of a controlling person. In order to do so, creditors must prove that the lawyer gave binding instructions to the UBO/debtor, or otherwise determine the lawyer’s actions – for example, if the lawyer chose the counterparty and the substantial terms of the deal.
Lawyers should remember that going above and beyond their labour duty and providing business management services to the employer may be better compensated, but it can also lead to liability.
It is common practice in Russia for lawyers to become nominee directors of the daughter companies of holdings. Foreign companies often ask Russian lawyers to become a nominee directors or founders of a subsidiary company. It is more convenient to work with counterparties and public authorities, and solve business problems that require knowledge of Russian law. Lawyers are strongly encouraged to keep a record of correspondence with the principal, and demand written instructions for transactions. It is also recommended they not dispose of the money of the principal independently, nor use bank keys for electronic signatures.
Finally, if the UBO asks the lawyer to develop models and schemes on how to move assets off before bankruptcy, there is a high risk that the lawyer will then be held liable. The lawyers who devise and implement the pre-bankruptcy withdrawal model will certainly be on the insolvency manager’s radar.
In one example, the insolvency manager tried to hold the debtor’s in-house lawyer liable. The lawyer designed agreements to move assets and harmed creditors. The lawyer's argument helped him avoid responsibility – he had no authority to sign documents or make final decisions. In another case, the court explicitly stated that a lawyer could be held liable for drafting documents that were intended to harm creditors.
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Nektorov, Saveliev & Partners is a law firm established in 2006 in Moscow, Russia, and focuses on providing comprehensive legal solutions to corporate and private clients under Russian and English law. Their main practice areas are tax, corporate and M&A, arbitration and litigation, banking and finance, investments, public-private partnership, and real estate. They provide legal support to clients in Russia, CIS countries and worldwide.
Roman Makarov is a Partner of Nektorov, Saveliev & Partners, specialising in dispute settlement and complex bankruptcy cases. Roman develops strategies and tactics of legal defence in court.
Published: Debt Collection, Restructuring & Insolvency Newsletter, No. 14, Autumn 2022 l Photo: R.M. Nunes - stock.adobe.com