Criteria of Integrity of the Sole Executive Body: Problem Statement

Vronskaya Mariya Vladimirovna PhD in Law Associate Professor at the Department of Private Law of Vladivostok State University of Economics and Service  690014, Russia, Vladivostok, Primorsky Krai, 42 Balyaeva str., sq. 119 m.vronskaya@mail.ru Other publications by this author

Pavlova Anna Dmitrievna Master, Department of Civil Law Disciplines, VVGU 690014, Russia, Vladivostok krai, Vladivostok, Gogol str., 41 Pavlova.AD@vvsu.ru

 "Conscientiousness" is located at the junction of two areas and acts not only as a legal category, but also as a moral one, therefore – purely subjective. In view of this, a number of authors, addressing the issue of integrity of the sole executive body and integrity in general, adhere to different interpretations of this term. I.G. Fedin notes the multidimensional nature of integrity, which can be used by researchers as a measure, idea, beginning, presumption, evaluative concept. Due to its multidimensional nature, this category as a tool of legal technology is in demand in all branches of domestic law ^{[1, p. 7]}. According to E.N. Bychkova and K.S. Kalinichenko, good faith implies compliance with legal regulations, as well as making objective decisions ^[2].  Kuligina M.A. notes the evaluativeness of the category "good faith", even despite the attempt made by the legislator to disclose the content of this concept in the Resolution of the Plenum of the Arbitration Court of the Russian Federation dated July 30, 2013 No. 62 "On certain issues of compensation for damages by persons who are part of the bodies of a legal entity" ^[3]. On the one hand, the act of interpretation is an opportunity to highlight the main characteristics of good faith, to reduce judicial practice to uniformity, on the other hand, it is the basis for many discussions and entails a number of contradictions, especially from a theoretical point of view.

Taking into account the absence of legislative formulations that allow determining and specifying the good faith of the participants' behavior in the event of disputes, the question of the qualification of the participants' actions is established within the framework of legal proceedings. Having familiarized with the practice of applying and interpreting the bona fide behavior of participants in civil turnover by Russian courts, it becomes clear that the courts see a manifestation of good faith in the behavior of persons expected from any participant in civil turnover, taking into account the rights and legitimate interests of the other party, assisting her, including in obtaining the necessary information ^[4].

Fixing in Article 1 of the Civil Code of the Russian Federation the obligation of civil participants to act in good faith in establishing, exercising and protecting civil rights and in the performance of civil duties, the legislator points out the value and integrity of this institution in all civil relations arising between subjects ^[4].

Despite the fact that the principle of good faith is normatively fixed as a general principle of civil law in Russian legislation, in 2012 by Federal Law No. 302-FZ of December 30, 2012, its observance by participants in legal relations is not fully ensured by the requirements of the law. For almost 10 years now, there has been an urgent problem in the legal environment of the lack of criteria for conscientious behavior by participants in various civil legal relations. Judicial practice shows that the dishonesty of participants in civil legal relations is found everywhere, and corporate law is no exception. Depending on the direction of the legal entity's activity, options for possible behavior within this legal entity with its counterparties and government agencies will depend, which often manifests itself in the abuse of owned rights and violation of the rights of other persons, causing them losses.

That is why the purpose of this study is to identify criteria for conscientious behavior of the sole executive body of a legal entity, to propose ways to solve the problem of the lack of their legislative definition and consolidation.

From the point of view of the legislator, corporate law is not an independent branch, it is assigned the role of only a component of civil law ^{[5, p. 11]}. At the same time, it is subject to the norms enshrined in civil legislation, its main principles, which include conscientiousness.

Speaking about legal entities and their conscientious behavior, it is necessary to proceed from the fact that the nature of the legal relations into which this legal entity enters depends, first of all, on the decisions of the sole executive body of the company – the director or the general director. Therefore, the initiative of unscrupulous behavior, the legality of certain actions, their compliance with the fundamentals of civil legislation is the result of the strong–willed behavior of a single person, because the dishonesty of the subject is possible only if this person has the appropriate fixed right.

Paragraph 3 of Article 53 of the Civil Code of the Russian Federation stipulates that a person who, by virtue of a law, other legal act or constituent document of a legal entity is authorized to act on its behalf must act in the interests of the legal entity represented by it in good faith and reasonably ^[4]. In case of violation of this obligation, the director, at the request of the legal entity and (or) its founders (participants), who are granted the right by law to make a corresponding claim, must compensate the losses caused to the legal entity by such violation.

There are several reasons that give rise to unscrupulous behavior. The most significant of them are:

 – a low level of legal awareness of persons who have the authority to exercise the management of a legal entity, which entails the use of the rights granted to them for purposes contrary to the law;

 – the absence of formally defined and legally fixed criteria for such behavior. This is where the biggest problem manifests itself, because if the level of legal awareness is something that the person himself is able to influence, then the criteria that he would have to follow when managing a legal entity are not specified.

The improvement of the Russian legal system determines the same rapid development of corporate legal relations. There are more opportunities to cause damage to counterparties or third parties and, of course, more opportunities to avoid liability, and it is increasingly difficult for the latter to protect their rights.

This problem is aggravated, first of all, because the state, although it establishes the presumption of good faith of the behavior to be followed, the legal norms do not formalize the possible behaviors of the subjects, but only define the limits of the exercise of civil rights, assuming their non-infringement by the participants. By conscientious behavior, the legislator means compliance with the norms of law and, at the same time, awareness that their implementation will not lead to violation of the private or public interests of other participants in civil turnover. In the presence of proven guilt of a participant in legal relations, it is not possible to talk about good faith. That is, the edge when the realization of a participant's subjective rights becomes an abuse is causing harm to third parties to such an extent that dishonesty acquires a level of public danger.

In order to ensure compliance with the lawful conduct of the director (or CEO) of a legal entity, the most accurate criteria for good conduct should be determined. On July 30, 2013, the legislator made an attempt to establish the criteria of good faith of the sole executive body of a legal entity, based on the court decisions made. By Resolution of the Plenum of the Supreme Arbitration Court of the Russian Federation No. 62 dated 30.07.2013 "On certain issues of compensation for losses by persons who are part of the bodies of a Legal entity", the legislator determined that this is evidence of unfair behavior of the sole executive body of a legal entity ^[6]:

1) acts exclusively in the interests of a legal entity, without involving in its activities and without taking into account its personal interests, except in cases when information about the conflict of interests was disclosed in advance and the director's actions were approved in accordance with the procedure established by law;

2) provides reliable information for the participants of the legal entity information about the transactions of the legal entity (in particular, if the information about such a transaction in violation of the law, the charter or internal documents of the legal entity were not included in the reporting of the legal entity);

 3) does not make transactions (other legally significant actions) without the approval of the relevant bodies of the legal entity required by law or the charter;

4) after the termination of his powers, voluntarily submits to the legal entity documents relating to the circumstances that entailed adverse consequences for the legal entity;

5) in the case of a transaction on conditions that are obviously unfavorable for a legal entity or with a person who is obviously unable to fulfill an obligation (a "one-day company", etc.) did not know or should not have known that his actions (inaction) at the time of their commission did not meet the interests of the legal entity ^[6].

The said Resolution examines examples of dishonesty of the sole executive body and by the method of the reverse, it is possible to come to a conclusion in what conscientiousness is manifested in the management of the company's current activities. But how are the limits of the participation of the sole executive body of a legal entity in the implementation of management determined, and the boundary between the fair use of the rights granted and the abuse of them? How conscientious will it be considered to issue a power of attorney by the director (CEO) to a person temporarily replacing him during a period of unstable economic situation in the company, is this an attempt to evade responsibility by involving third parties? What is the degree of his conscientiousness when signing an order to issue a bonus to the director (general director), whether there is a conflict of interest in these situations – neither the law nor the acts of interpretation regulate these circumstances. These rights of the sole executive body of a legal entity are not a novelty for civil law, while to this day they are not without problems associated with their implementation. How then to regulate the new legal relations arising in modern conditions?

A.V. Neznamov and M.A. Mikheenkova touched upon the problem of criteria of integrity of the sole executive body of a legal entity in their research. They noted that the existence of such an act, the clarification of some provisions related to the implementation of the principle of good faith does not indicate uniformity in the application of existing norms. In this regard, they identified a fairly wide list of criteria by which it is possible to determine the good faith or bad faith of a legal entity and, accordingly, the sole executive body of a legal entity. Among these, the authors include the commission of transactions not for the intended purposes, the debtor's repeated appeal to the creditor with a request to defer the debt due to the inability to repay it within the originally established period; the presence of information from an unscrupulous creditor that at the time of the disputed transaction, the debtor stopped fulfilling its obligations to other creditors and other signs that may to testify about the possible dishonesty of the legal entity and, accordingly, its sole executive body.

But even these criteria cannot unambiguously characterize a person as conscientious or unscrupulous. Moreover, it is quite difficult to identify such circumstances, especially at the stage of concluding a transaction, when no contractual legal relations have yet developed. And compliance with some of the criteria named by Neznamov A.V. and Mikheenkova M.A. is almost impossible (for example, the presence of information from an unscrupulous creditor that at the time of the disputed transaction, the debtor stopped fulfilling its obligations to creditors (both unscrupulous and others), the presence of an unscrupulous creditor of the debtor's accounting data and/or the right to require the provision of such reporting, despite the fact that at the time of the disputed transaction, the insolvency or insufficiency of the debtor's property, or the existence of another possibility of access to such information, was seen from the accounting statements) ^[7]. Such information can only be obtained in court.

In other words, a person, having information about compliance with the counterparty's good faith or bad faith, can only see actions in the behavior of his sole executive body that indicate possible bad faith.

Despite the fact that the interpretation, the practice of applying the norms and, as a result, the conclusions concerning the principle of good faith are very subjective and can be criticized by various theorists, there is a statement that is quite difficult to challenge. This statement is stated in the scientific works of D.I. Stepanov and Y.S. Mikhalchuk, who believe that the integrity of the sole executive body of a legal entity is manifested, first of all, in compliance with the prohibition to the director to identify the interest of the legal entity managed by him with personal interest ^{[8, p. 33]}. Yu.G. Leskova also addresses the issue of the contradiction of personal interests and the interests of the company in her scientific works. She notes that the fact of the director's participation in a conflict of interest is a rather controversial issue, given the uncertainty of both legislation and judicial clarifications in this area. But even here a logical question arises: can actions committed by a sole executive body not in the interests of society be in good faith ^[9]

The authors of this article believe that the criteria set out in the Resolution are not sufficient for the most complete and lawful application of the existing norms by the courts. At the same time, it is impossible not to agree with Neznamov A.V. and Mikheenkova M.A. and their proposed criteria that can be accurately applied in the work of a particular company at the stage of concluding contracts. These criteria (together with the criteria from the Resolution) should be recognized as relatively sufficient to rely on the integrity of the sole executive body and the legal entity when planning contractual obligations, or the exercise of control and supervisory functions by state bodies.

Further along the text of this article, I would like to place additional aspects justifying the need to raise the issue of doctrinal and legislative establishment of criteria for the integrity of the behavior of economic entities.

The pandemic of coronavirus infection, other civilizational and political threats gave a new powerful impetus to the development of digital technologies in corporate law, which was supposed to provide maximum technological capabilities for the remote exercise of corporate rights and corporate governance. There was not only an opportunity for all participants in corporate relations to interact with each other in a "remote" mode, but also the possibility of abuse of the right of the sole executive body of a legal entity. Thus, in the conditions of partial mobilization carried out within the framework of the Decree of the President of the Russian Federation dated 09/21/2022 No. 647 "On the announcement of partial mobilization in the Russian Federation" ^[10], a number of employers introduced a "remote work mode" in the organization with the aim of not providing the opportunity to serve summons to citizens subject to conscription and hiding the location of these employees. At the same time, the Director (General Director) legally complied with the Recommendations for employers on the prevention of coronavirus infection in the workplace ^[11] and took the necessary and sufficient measures to achieve the goals of the activity for which the legal entity was created ^[6].

Legislation and legal relations are constantly evolving, digitalization of all spheres of public life, including the legal one, is a catalyst not only for improving corporate legal relations, but also for new opportunities for abuse of the existing rights of their participants, including the sole executive body of a legal entity, and the 2013 Resolution is only the first step towards regulating the institute of integrity.

Obviously, the above list of criteria is not exhaustive at the moment. This is due not only to the breadth of the powers of the director of a legal entity, but also to constantly evolving legislation, political and foreign economic circumstances. Trends in identifying criteria for unfair behavior in the current legal space can be predicted. Digitalization has not bypassed corporate legal relations. That is why unscrupulous persons have more and more opportunities for appropriate behavior within the legal framework. This means that the criteria of good faith cannot be clearly defined. The legislator and the participants in such legal relations can only have an approximate understanding of what constitutes unfair behavior, how to avoid the consequences and damage caused by such behavior. It is also possible for bona fide participants in legal relations, within the framework of the same digitalization, to promptly study judicial practice, pay attention to news sources in which evidence of unfair behavior of participants in legal relations is fixed in order to avoid and prevent a collision with such within the framework of their activities.

Failure to comply with the principle of good faith by a legal entity entails not only a violation of the interests of participants in corporate relations (within the legal entity, counterparties, public authorities) ^[6], but also the occurrence of reputational losses in the further activities of the legal entity.

The solution to the problem of the lack of criteria for the integrity of the sole executive body of a legal entity can be a systematic review of judicial practice, the publication by the higher courts of acts of interpretation summarizing the already existing precedents of such unfair behavior, highlighting their most common features. Such measures will allow to increase the legal establishment of participants in corporate relations – legal entities, in particular the sole executive body exercising direct management, and significantly reduce the number of disputes arising due to unfair behavior of participants in corporate legal relations.

 Over the past few years, Russian courts have increasingly taken into account the fact that participants in civil turnover observe the principle of good faith, which is sometimes crucial for the outcome of a case. For this reason, according to the authors, many problems related to the interpretation and implementation of the principle of good faith in corporate law have worsened, including the problem of determining the criteria of good faith of the sole executive body of a legal entity. The authors see the reason for the existence of many problems and contradictions due to the abundance of evaluative concepts in the legislation, such as morality, responsibility, and, of course, conscientiousness ^[12]. Due to the ambiguity and lack of specificity of such concepts, many problems manifest themselves.  It is almost impossible to bring about uniformity and the same understanding of such ambiguous and subjective categories for the reason that they, one way or another, relate to philosophy and understanding of their nature, influence on public relations, role in corporate law, etc. it depends on the mentality, upbringing, level of education, literacy of the individual, her standard of living and other circumstances that are constantly changing.

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