Argument (#11 November 2019)

Opportunities for Piercing the Corporate Veil in Ukraine

by Ruslan YURCHENKO

The separate personality of a legal entity is one of the most significant principles of corporate law. This principle provides that a shareholder (founder) of a legal entity shall not be liable for the obligations thereof, while a legal entity shall not be liable for the obligations of its shareholder (founder) unless otherwise provided by constitutional documents or by law1. Additionally, Ukrainian law draws a sharp distinction between shareholders rights and interests and their legal entitys rights and interests, which cannot be considered identical to the simple set of its shareholders rights and interests. As a rule, shareholders may not bring an action for protecting their legal entity without special power2.

Unfortunately, shareholders sometimes use their legal entity as a device to commit wrongful actions (e.g., to deceive creditors or launder money). In addition, there could be particular circumstances (e.g., bankruptcy or liquidation) where legal entities cannot defend themselves on their own. In such cases, it is possible to ignore the separate personality of a legal entity and, consequently, hold its shareholders personally liable for its debts or allow shareholders to act in favour of their legal entity. One of the possibilities for disregarding the separate personality of a legal entity is piercing (lifting) the corporate veil.

Piercing the corporate veil means treating the rights, actions or liabilities of a legal entity as the rights, actions or liabilities of its shareholders. The doctrine of piercing the corporate veil is usually applied either for the benefit of third parties seeking damages from a shareholder for the legal entitys wrongful actions or for the benefit of a shareholder seeking to protect the legal entitys rights and interests.

Piercing the corporate veil in Ukrainian legislation

First of all, it should be noted that Ukrainian legislation does not clearly envisage the doctrine of piercing the corporate veil. Nevertheless, under Ukrainian legislation, there are some exceptions to the principle of a legal entity being a separate personality. Technically speaking, these exceptions are similar to piercing the corporate veil. For example:

A legal entity-successor established following split-up shall bear additional liability for obligations of a legal entity liquidated following such a split up, which have been transferred to another legal entity-successor established following such a split up3.

A legal entity, from which spin-off has been made, shall bear additional liability for obligations that have been transferred to another legal entity established following such a spin off, and vice versa4.

If a legal entity goes bankrupt due to the fault of its shareholders, such shareholders may be held additionally liable for the obligations of this legal entity5.

A bank-related person shall bear liability for damages caused to this bank by the actions or inactions of such a person6. For this purpose, the bank-related person means, among others, controllers (i.e., holding 50% or more shares in the bank), owners (direct/indirect) of substantial (i.e., 10% and more) shares in the bank or owners of substantial (i.e., 10% and more) shares in legal entities associated or affiliated with the bank.

A holding company may bear liability for obligations of a legal entity, in which the holding company is a major shareholder, if such a legal entity becomes insolvent and goes bankrupt due to the holding companys fault7. For this purpose, the holding company means a joint stock company having a 50%+1 shareholding in at least two other legal entities.

In case of the liquidation of a heat-supplying or heat-generating organization, a shareholder (founder) of such an organization shall ensure the repayment of the organizations debt owed to suppliers of energy products8.

Piercing of corporate veil in case law of the European Court of Human Rights

It is well known that, considering cases, Ukrainian courts shall apply the case law of the European Court of Human Rights (the ECHR) as a source of law. For this reason, the ECHRs case law is worth analysing in terms of the possibilities for piercing the corporate veil. Broadly speaking, the ECHR defines the following three instances that may justify piercing the corporate veil:

Shareholders may protect the rights and interests of their legal entity, provided that (i)the legal entity itself cannot directly do so on its own (e.g., in case of its liquidation, its bankruptcy or the appointment of an interim administration); (ii)the shareholders have made every effort to require the liquidator/official receiver/interim administration to take certain actions; and (iii)in case of failure to take such actions, the shareholders have demanded to dismiss the liquidator/official receiver/interim administration, but to no avail. In particular, this position is reflected in the case of Agrotexim and Others v. Greece, No.14807/89, Para.66, 24October 1995, the case of Camberrow MM5 AD v. Bulgaria (dec.), No.50357/99, 1April 2004, and the case of G.J. v. Luxembourg, no.21156/93, Para.23, 26October 2000.

A shareholder may challenge decisions, actions or omissions (e.g., revocation of a licence/permit, confiscation of property or imposition of penalties) taken against his/her legal entity as if such decisions, actions or omissions concerned or violated the shareholders rights and interests. In other words, the ECHR does not distinguish between the legal entitys rights and interests and its shareholders rights and interests. This identification can be made, provided that a shareholder is the sole owner of, or holds a substantial stake in, a legal entity so that the shareholder fully controls it. Consequently, there is no difference in the opinions of the legal entitys governing bodies and its shareholder. For example, this position is supported in the Gubiyev v. Russia case, no.29309/03, Para.53, 19July 2011.

Shareholders may be held liable for obligations of their legal entity, provided that (i)the legal entity is established only to hide nefarious actions and evade liability of its shareholders (e.g., borrowing without intentions to repay a loan, fraudulent activity or sham arrangements designed to hide the ownership of assets); and (ii)the shareholders fully control the legal entity. We are not aware of cases in which the ECHR has taken such a direct approach. However, the ECHR has recognised the possibility for piercing the corporate veil on this ground in the Liseytseva and Maslov v. Russia case nos.39483/05 and 40527/10, Para.129, 9October 2014, and the Khodorkovskiy and Lebedev v. Russia case, nos.11082/06 and 13772/05, Para.877, 25July 2013.

Piercing the corporate veil in Ukrainian court practice

Although Ukrainian legislation does not directly provide the doctrine of piercing the corporate veil, Ukrainian courts do pierce the corporate veil in certain circumstances. Usually, Ukrainian courts piercing the corporate veil refer to the relevant ECHR case law, especially the Agrotexim and Others v. Greece case, and the Camberrow MM5 AD v. Bulgaria and G.J. v. Luxembourg cases.

A notable example of piercing the corporate veil in Ukrainian court practice is a group of cases in which shareholders of banks bring actions against decisions of the National Bank of Ukraine (the NBU) about the revocation of bank licences and the liquidation of these banks. This group of cases includes, among others, Resolution of the Supreme Court of Ukraine (the SC) of 27June 2017 in case No.21-373916, Resolution of the SC of 1August 2017 in case No.826/2607/16, Resolution of the SC of 24October 2017 in case No.805/4956/15-, Resolution of the SC of 24October 2017 in case No.805/3464/15-, Resolution of the SC of 24October 2017 in case No.826/1162/16, Resolution of the SC of 2November 2018 in case No.826/22323/15, and Resolution of the SC of 20November 2018 in case No.805/1312/16-.

All the cases mentioned above are similar in the following: (i)the NBU took decisions on the revocation of a bank licence and the liquidation of the bank/the classification of the bank in the category of insolvent; (ii)the Deposit Guarantee Fund was a bank liquidator/interim administrator of the insolvent bank; and (iii)a shareholder of the bank challenged the relevant NBUs decisions in order to protect his/her banks rights and interests.

Considering this group of cases, the SC provided guidance summarising the principles by which courts may pierce the corporate veil:

A person taking a decision on bank liquidation/insolvency and a person being a bank liquidator/interim administrator cooperate with each other and have common interests (e.g., both of them are state bodies). Therefore, there is a conflict of interest between the bank liquidator/interim administrator and a shareholder in the bank.

Neither can a banks governing bodies act on their own nor may a banks shareholder exercise the right to run a bank because the bank liquidator/interim administrator is authorized to control and represent it.

The banks shareholder challenging the relevant decisions of the NBU shall (i)hold a substantial (i.e., 10% and more)/significant/controlling block of shares in the bank, which gives the shareholder a fundamental, significant influence on the banks activities, and/or be a sole owner of all or most of the shares in the bank; or (ii)under other similar criteria, this shareholder approaches and/or may be equated to a person whose rights were directly violated by the actions or decisions of the NBU.

Besides, there are number of other cases in which Ukrainian courts essentially pierced the corporate veil with no reference to the relevant case law of the ECHR and the doctrine. Roughly speaking, the corporate veil was pierced in the following cases:

The SC ruled that a shareholder owning a 70% stake in a business entity may challenge an agreement executed by his/her business entity only if the shareholder proves that such an agreement violates his/her corporate rights. This case regards the property management agreement under which real estate as a core asset of the business entity has been transferred to a third party (Resolution of the SC of 1July 2015 in case No.3-32715).

The SC ruled that the sole owner of a business entity might challenge tax-notification decisions aimed at increasing the monetary obligations of the business entity. The imposition of monetary obligations on the business entity materially affects the rights of the sole owner to receive dividends (Resolution of the SC of 19February 2019 in case No.810/4438/16).

The Circuit Administrative Court of Kyiv City ruled that a shareholder holding a 99.98% stake in the bank might require cancellation of a resolution of the National Securities and Stock Market Commission on the imposition of sanctions on the bank for an offense on the stock market. This case relates to a bank that has gone into liquidation and been run by a liquidator (Ruling of the Circuit Administrative Court of Kyiv City of 7June 2019 in case No.826/13759/179).

It is also worth mentioning that, as a rule, Ukrainian courts refuse to expose shareholders to liability for their legal entitys obligations except in instances provided by Ukrainian legislation. Thus, it is unlikely that the doctrine of piercing of the corporate veil can be applied as a punitive measure against shareholders in Ukraine.

Conclusion

To sum up, despite the principle of the separate personality of a legal entity, there are specific circumstances where the corporate veil may be pierced either to satisfy the legal entitys obligations by holding shareholders personally liable or to allow shareholders to protect their legal entitys rights and interests. Ukrainian legislation provides only certain possibilities for ignoring the separate personality of a legal entity, which are similar to piercing the corporate veil. Based on the ECHRs case law, Ukrainian courts agree to pierce the corporate veil at the request of a shareholder who has substantial shares to protect his/her legal entitys rights and interests. In the meantime, Ukrainian courts do not hold shareholders personally liable for their legal entitys obligations unless otherwise provided by Ukrainian legislation.

Ruslan YURCHENKO is an associate at Marchenko Partners


1 Part 3 of Article 96 of the Civil Code of Ukraine No. 435-IV dated 16 January 2003 (as amended).

2 Judgement of the Constitutional Court of Ukraine dated 1 December 2004 No. 18-/2004.

3 Part 5 of Article 107 of Civil Code of Ukraine No. 435-IV dated 16 January 2003 (as amended).

4 Part 3 of Article 109 of Civil Code of Ukraine No. 435-IV dated 16 January 2003 (as amended).

5 Part 2 of Article 61 of Bankruptcy Code of Ukraine No. 2597-VIII dated 18 October 2018.

6 Part 6 Article 58 of Law of Ukraine On Banks and Banking Activity No. 2121-III dated 7 December 2000 (as amended).

7 Part 6 Article 126 of Commercial Code of Ukraine No. 436-IV dated 16 January 2003 (as amended).

8 Part 5 Article 22 of Law of Ukraine On Heat Supply, No. 2633-IV dated 2 June 2005 (as amended).

9 At the time of preparation of this article, the Sixth Administrative Court of Appeal was reconsidering case No. 826/13759/17.

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