Ukraine: Civil Liability for Causing Bankruptcy – Myth or Reality?
23 November 2020
The article is published in International Corporate Rescue
This article aims at shedding light on the topic of civil liability for causing bankruptcy that is much discussed and in demand nowadays in Ukraine. The application of the legal rules on civil liability is relatively new in this jurisdiction. It started developing only since 2018, when courts began to ‘re-shape’ their approach in deciding such cases.
Previous court practice associated the possibility of holding a person liable for causing bankruptcy with the existence of a criminal conviction in a separate criminal proceeding. As such, a formal judgement of guilty was a ‘pre-requisite’ for civil liability. Given that the proof of all elements of a criminal offence would pose a problem in practice, the prospect of imposing civil liability on the persons at fault for causing bankruptcy within a bankruptcy proceeding was more of a myth than a reality.
Recent court practice in Ukraine signals a change to the former approach in deciding such cases, by underlining the need to ‘differentiate’ civil and criminal liability cases by contrasting the standards of proof and presumptions for each type of case. In this article we therefore re-open the debate as to the possibility of imposing civil liability for causing bankruptcy on the persons at fault for causing bankruptcy (such as the director, shareholders or other persons in position to influence decision-making processes) outside of any criminal proceedings, and provide insight into the current court approaches in considering such cases.
Banks and other financial institutions are excluded from the scope of this paper, only debtors that are ordinary legal entities and are non-financial institutions are considered.
In Ukraine the level of repayment of debt is quite low. Regrettably it is quite a widespread for non-bona-fide debtors to take out loans and instead of repaying them, intentionally go bankrupt. All this would typically be accompanied by the dissipation of the debtor’s assets, putting them out of reach of creditors prior to the commencement of a bankruptcy case.
While most bankruptcy laws have a good legal instrument to ‘refill the liquidation estate’ by way of avoiding ‘suspicious’ transactions that were entered into in the twilight zone before the opening of a bankruptcy case, this tool may not always be a lifeline in all bankruptcy cases. Limitations of domestic legislation, like a short ‘claw-back period’, can impede the prospect of successful transaction avoidance actions, etc.
In this instance, when the defrauded creditors fail in their Plan A when setting the transactions aside, they are bound to have a Plan B available. The possibility of holding persons at fault personally liable for causing bankruptcy is believed to be that necessary option that would enable creditors to get a remedy in the circumstances when direct recovery of the debt via bankruptcy procedures proves to be unsuccessful.
‘Piercing the corporate veil’ for the purposes of identifying the real persons at fault for causing bankruptcy would be a good ‘must-do’ exercise in such cases. That would help define the persons with real managerial influence (e.g. shareholders, directors and other persons, such as UBOs), responsible for causing an adverse effect on the creditors and the debtor company itself, either by their direct wrongful decision-making or intentional failure to take proper action to avoid bankruptcy, etc.
In contrast to the UK, which is a popular hub for civil tort claims by defrauded creditors, Ukraine is only learning how to do it in practice.
In autumn 2019, with the bankruptcy law reform that replaced the law in Ukraine On Restoring Solvency of the Debtor or Declaring it Bankrupt by a first-ever Ukrainian Code on Bankruptcy Procedures (‘BCU’),1 we observe some positive shift towards wider application of civil (subsidiary) liability for causing bankruptcy. This is largely due to the re-visited court approach to the pre-requisites needed for the application of the legal rules on civil liability within a bankruptcy proceeding.
- Civil liability for causing bankruptcy – what’s on paper?
1.1 Civil liability and its elements
Civil liability is the legal responsibility for damages caused to the claimant. A general legal basis for civil liability is a civil tort as a legal fact. A civil tort is unlawful conduct or failure to act that violates the law or the contract that gives rise to civil liability.
To hold a person liable for civil tort, all elements of civil liability have to be in place, i.e.: unlawful conduct of the tortfeasor, occurrence of damage, a causal link between the unlawful conduct and the damage, and the fault of the tortfeasor.
1.2 Subsidiary liability as a type of civil liability
Subsidiary liability is a type of civil liability where the unpaid (part of) debt of the main debtor is vested with other persons.
Before claiming anything against the person who is subsidiarily liable for the debt, the creditor is to first claim it against the main debtor. Should the main debtor fail to satisfy the creditor’s demand, the creditor may claim it in full against the person who is subsidiarily liable (Article 619(2) of the Civil Code of Ukraine).
In other words, it is the non-main debtor who, in case of failure to satisfy the demand of the creditor by the main debtor, becomes personally liable for the debt by its money and assets.
Such personal liability is subsidiary only in terms that it applies after the creditor has addressed the main debtor and was unsuccessful.
1.3 Civil (subsidiary) liability for causing bankruptcy
Under the BCU, in case of bankruptcy due to the fault of shareholders or other persons, including the director of the debtor company, who are entitled to instruct/give mandatory instructions to the debtor or are in positionto define its actions, such persons may be held personally liable for the debt of the debtor, should there be insufficient assets to satisfy the creditors’ claims4 (Article 61(2) of the BCU).
Only a liquidator can bring a civil (subsidiary) liability claim against the respective persons for causing bankruptcy (Article 61(2) of the BCU), and the extent (amount) of the liability is defined as the difference between the total amount of debt owed to creditors and the liquidation estate.
In other words, in bankruptcy cases a civil (subsidiary) liability claim can be said to be the last resort available to a liquidator in the face of (partial or full) non-recovery of debt. This means that the liquidator should be able to address the persons at fault for causing bankruptcy only after the debtor has undergone a liquidation procedure, realisation of assets that form the liquidation estate, and distribution of proceeds to the creditors, which proved to be insufficient to satisfy creditors’ claims in full or partially.
- Civil liability for causing bankruptcy – what it is in practice
A legislative possibility of holding a person at fault liable for causing bankruptcy is not a new one for Ukraine. Such legal rules existed in the former Law of Ukraine On Restoring Solvency of the Debtor or Declaring It Bankrupt that regulated bankruptcy relations until autumn 2019. With the bankruptcy law reform enacted fully on 21 October 2019, the rules on civil (subsidiary) liability for causing bankruptcy were largely ‘cut and pasted’ into the new Code of Ukraine on Bankruptcy Procedures (‘BCU’).
Regardless of the formal ‘transmission’ of these rules to the new BCU, a very promising shift in the approach of courts when further applying these legal rules is being observed in Ukraine, which is the subject of our further analysis.
2.1 Revisiting standards of proof and presumptions – general
Previously, the courts used to construe and associate the possibility of imposing civil (subsidiary) liability on the persons at fault for causing bankruptcy largely with a criminal conviction, in which guilt was formally established in a criminal proceeding.
As such, courts tended to use the established element of ‘guilt’ in a criminal case as a proof of ‘fault’ in a civil liability case, when considering whether all elements of civil liability were met. Such approach was questionably justified due to the different standards of proof required for different types of liabilities.
The burden of proof for criminal offences is that of beyond reasonable doubt, in which both the mental element and physical element of the offence have to be proved, accompanied by the presumption of innocence, until guilt is duly proved.
In contrast, for civil liability cases, the standard of proof is much lower – preponderance of the evidence is usually enough. No presumption of innocence of the tortfeasor exists in such cases, rather there is a presumption of fault that has to be rebutted.
A person who inflicts damage shall be exempt from liability for its reimbursement, should he/she prove that the damage was caused not due to his/her ‘fault’ (Article 1166(2) of Civil Code of Ukraine). Therefore, the burden of proving the opposite vests with the defendant, who has to prove the absence of his/her fault in the respective civil tort.
This legal position was reinforced in a decision of the domestic Supreme Court9 in Case No. 907/327/18 dd. 15 November 2019, where the Court held that the claimant is released from the obligation to prove the fault of the defendant in causing damages due to the presumption of fault of the tortfeasor.
Moreover, this court decision is important for further forming court practice and arguments when litigating cases in part of the existence of such an element of civil liability as unlawful conduct. In the decision of the same court in Case No. 907/327/18 dd. 15 November 2019 it was held that there should exist a presumption of unlawful conduct.Meaning that the conduct that caused the damage shall be deemed unlawful unless the tortfeasor can demonstrate that the conduct was authorized or was otherwise in accordance with law.
A breach of specific duties imposed upon particular individuals or entities to act, or refrain from acting, shall also amount to unlawful conduct, which should be a persuasive argument in holding a person liable for causing bankruptcy.
2.2. Revisiting a civil liability case for causing bankruptcy
Some years ago, the idea of bringing of a civil subsidiary liability claim for causing bankruptcy in Ukraine would not have been taken seriously. Therefore, escaping civil liability was a real possibility due to the difficulty in proving guilt in a criminal proceeding, which previously proved to be a pre-requisite for the factual meeting of such element of civil liability as a ‘fault’.
In contrast, the bankruptcy Case No. 911/3513/16 dd. 30 January 2017 against Nova Liniya-Pivnich LLC (‘the Case’) signals how Ukrainian court practice is gradually transforming and developing towards facilitating imposition of civil (subsidiary) liability on directors and shareholders of the bankrupt company for causing bankruptcy in a bankruptcy case.
In the Case, the liquidator filed a claim holding a director and three shareholders subsidiarily liable for causing bankruptcy, once the insufficiency of assets to satisfy creditors’ claims in a liquidation procedure was established. The liquidator alleged that the director and three shareholders were at fault for causing bankruptcy of the debtor company and requested the court to award recovery of debt in the uncovered amount.
By the decision of the Northern Appeal Commercial Court dd. 20 February 2020 the ruling of the Commercial Court of Kyiv Region dd. 07 October 2019 on dismissal of the liquidator’s claim was upheld.
However, the Supreme Court comprising a panel of judges of the Cassation Commercial Court in its decision dd. 10 June 2020 cancelled the court decisions of previous instances14 and held to revisit the case in the cancelled part by the court of first instance.
The Supreme Court pointed out that the courts of previous instances when dismissing the liquidator’s civil liability claim for causing bankruptcy falsely relied on the absence of grounds for imposing civil liability on the director and shareholders of Nova Liniya-Pivnich LLC, which it deemed inconsistent with the material and procedural rules of Ukraine and is upfront (premature).
The Supreme Court further guided the court of first instance as to the need to properly assess and analyse the conduct or failure to act to prevent bankruptcy by the director and shareholders so as to come to a lawful and justified conclusion regarding their (in)action. Moreover, the Court rejected the previous courts’ conclusion on the failure of the liquidator to prove the unlawfulness of actions of the persons concerned, it further reiterated that the burden of proof of absence of ‘fault’ for causing bankruptcy vests with the defendants.
In its decision the Supreme Court made the following legal conclusions that are of vital importance for further practical application of the civil liability for causing bankruptcy:
– Subsidiary liability in bankruptcy cases is an independent type of civil liability imposed on the founders (participants, shareholders) or other persons, including the director of the debtor company, provided the fault for causing bankruptcy of the debtor is in place.
– To hold a person subsidiarily liable for causing bankruptcy there is no requirement to obtain a criminal conviction against such persons that would establisha criminal offence by their actions. This is possible due to special rules of the BCU regarding the possibility of imposing civil liability on the respective persons – such a position was earlier reinforced in the decision of Supreme Court dd. 12 February 2020 in Case No. 922/2391/16 and in Case No. 907/327/18 dd. 15 November 2019.
– A qualifying feature of civil liability is that the person who is a defendant (tortfeasor) to the case is to prove the absence of his/her fault.
– If upon declaring a debtor bankrupt, there are signs of causing bankruptcy, and it is impossible to repay the debt due to the (in)action of shareholders or other persons, including the director, or persons who are in position to give mandatory instructions to the debtor, such persons may be held subsidiarily liable for causing bankruptcy, unless they prove the absence of their fault.
– The BCU does not stipulate what actions may constitute ‘signs of causing bankruptcy’. Therefore, a detailed analysis by a liquidator of the financial standing of the debtor in conjunction with detection of the cause of actions for the incurred debt before the creditors, may allow the liquidator to identify the (in)action of the persons involved in causing
bankruptcy. Should this be the case, such persons at fault for causing bankruptcy shall be held personally liable for the debt in the unpaid amount.
– A claim imposing subsidiary liability must be filed by a liquidator in case there are insufficient assets to recover the debt in full or partially before the creditors in a bankruptcy case.
– Should the liquidator find signs of causing bankruptcy and identify the persons at fault, the liquidator must file a claim holding such persons liable, which will signal observance by him/her of the principle of undoubtful full performance of his/her actions in a liquidation procedure. Such application is possible only after the full realisation of the assets that constitute a liquidation estate, and distribution of the proceeds to the creditors, where the insufficiency of assets to cover all of the claims is established.
– The amounts due to creditors shall be the difference between the total debt as per the register of creditors’claims and the amount of the realised liquidation estate.
The above Supreme Court legal conclusion demonstrates that the previous approach which led to a common misconception of the need to obtain a criminal conviction for the purposes of civil liability for causing bankruptcy, is now legally proved to be false. Current Ukraine court practice underlines the absence of need to establish guilt in a criminal proceeding for the purpose of proving civil liability to award damages to the creditors.
In Ukraine, court practice imposing civil liability for causing bankruptcy is gradually developing as of late.
The direction it is going in is very promising. If a couple of years ago the idea of bringing a civil subsidiary liability claim for causing bankruptcy in Ukraine would not have been taken seriously, this prospect now doesn’t seem that illusory.
The positive shift is largely due to revisited court practice in civil cases that reinforce the need to strike the right balance and differentiate between the standards of proof and presumptions in civil and criminal liability cases.
Let’s wait to see how it develops further.
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