At first sight, the new rules on responsibility of top managers at LLC and ALC only expand the rights of business owners for dismissal of hired managers. However, they can also become an incentive for a more meaningful approach towards recruitment of managers and detailed coordination of terms and conditions of an employment agreement, primarily in terms of increasing labor remuneration as compensation for the risk of dismissal at the will of the owner and inserting financial responsibility in the event of a company suffering financial failure
The Law of Ukraine "On Limited and Additional Liability Companies" (the Law) provides business owners in Ukraine with many new tools for company management. Now the owners are able not only to initiate the bringing of top managers at their company to administrative and/or criminal liability, but also to discipline them for violation of corporate rules.
How it was
In the past the director of a company could be brought to administrative and/or criminal liability, in particular, for non-payment of taxes, improper bookkeeping or tax accounting, neglect of duty and willful tax evasion. The Labor Code of Ukraine (LCU) provides for full financial responsibility of the director only for salary arrears for more than one month.
The only provision imposing the obligation of compensation for damages caused to the company on the official is the general provision of the Civil Code of Ukraine on fiduciary responsibility. At the same time, as evidenced by judicial practice, compensation of damages under this provision was only possible with a final and binding court judgment on finding the director guilty of embezzlement or neglect of duty.
US courts, for example, consider that managers and other officials should be personally liable for offences in the area of their official liability, and such "corporate" responsibility is expressly provided for in laws. Thus, in the Afanasov v. VorBroker (N.D. Ill., 2002) case, the court resolved that damages should be collected directly from the manager responsible for payment of salary, who willfully violated provisions of the Fair Labor Standards Act. Therewith, the court judgment on his bringing to administrative or criminal liability is not required, since there is an express law provision stipulating the personal liability of officials for monetary damages.
There were no efficient means for bringing top managers to liability for business management in Ukraine before the Law came into force, which had negative consequences in certain cases. The Law changed this situation into a positive for business owners and provided the ability to bring company managers to joint and subsidiary liability for negligent or poor management. In particular cases the owner is also able to early terminate an employment agreement with a company manager without payment of obligatory indemnification provided for in the Labor Code of Ukraine.
It can be assumed that directors will now be more scrupulous on the issue of conclusion of the employment agreement and will detail the provisions on duties and possible liability of the manager.
Types of liability
Joint liability of officials to creditors or company members is provided for misrepresentation of the company’s members regarding financial standing of the company which resulted, in particular, in the illegal payment of dividends, in the amount of such illegal payments that are subject to return; for damages caused to the company by wrongful acts or omissions by officials within the amount of damages.
Innovation in the form of joint liability is certainly positive. However, this provision may be applied in practice only in cases when violations by top managers are proved or confirmed either documentarily or by a court decision on bringing to administrative or criminal liability. In fact, in this respect the Law only specified the general provision of the Civil Code of Ukraine on fiduciary responsibility of members of management bodies of legal entity. Therewith, the mechanism for bringing to liability remains a not entirely clear. There are hopes that either amendments to the Law or judicial practice will set out specific grounds allowing for company managers to be brought to joint liability without legal proceedings. It appears that this approach is acceptable in order to determine nonconformity financial statements resulting from the results of audits or inspections by the tax authorities.
Another important innovation is duty of the executive body to notify the members of a reduction in the net asset value of the company by more than 50% compared with the previous year. In the event of the company's bankruptcy within the next three years the director will be held vicariously liable for the company's liabilities for violation of this duty.
This provision bears a certain risk for top managers. They are now obliged to not only keep a good look-out for the company's finance indicators dynamics, but also to properly and in a timely manner notify the founders of a reduction in such indicators.
Employment agreement termination
The possibility of early termination of employment agreements (contracts) concluded with top managers without payment of compensation can, for example, in the event of violations of non-competition provisions, be a lever over them to encourage proper performance of official duties.
The Law provides that officials are now allowed to engage in business activities as entrepreneurs, be members of a general company, members of the executive body or supervisory board of another company in the area of business activities of the company without the prior consent of the general meeting (or supervisory board, if any).
It is interesting that this prior consent should be obtained not only before registration of official as an individual entrepreneur or employment in the other company, but also in the event of changes in composition of the body that provided the consent.
Furthermore, all officials are now obliged to notify the company of any conflict of interest in case of actual or possible contradictions between the interests of the company and their personal interests, and to provide a written list of all affiliates and update it when changes occur. Violation of this requirement may also be grounds for dismissal without compensation.
Despite these quite progressive innovations, the above-mentioned grounds for dismissal are provided for in corporate and not labor legislation. Due to this there is a high probability of successful judicial appeal against dismissal according to the Law under the procedure provided for resolution of labor disputes, if the judicial practice will not determine that the corporate law provisions should prevail in the event of "labor" conflicts involving persons who occupy management positions. Furthermore, the concepts of conflict of interests and competition specified in the Law remain to be evaluated, which does not allow for reliable determining of their presence (or absence) without recourse to a court of law.
In general, the provisions of this Law are aimed more at the protection of the interests on business owners rather than those of top managers. Nevertheless, new duties and liability may become grounds for managers to demand an increase in the compensation package and salary as a response to potential personal risks.