In the presence of a complex economic situation, the tendency to escape payment of debts can be observed. Such avoidance is exercised by using illegal means, for instance by establishing new companies and transferring activities, assets and funds, in order to leave the primary entity holding the outstanding debts. Article 2.50 (3) of the Civil Code of the Republic of Lithuania states: where a legal person fails to perform his obligations due to acts in bad faith of a member of the legal person, the member of the legal person shall, in a subsidiary manner, be liable for the obligations of the legal person by his property.
It follows that this rule establishes an opportunity to apply a civil liability to a member of a legal person acting in bad faith, and protects the creditors of the company from both unlawful acts or omission of the company's members and the abuse of the concept of limited liability.
In order to establish civil liability under this Article, the following preconditions must be met: i) inability of the legal entity to perform its' obligations; ii) bad faith acts; iii) causation between the inability to fulfil the entity's duties and bad faith actions.
Due to the presumption of good faith, one of the most complicated issues which arise in practice is that actions of bad faith need to be proven. A member of the legal entity is considered to be acting in good faith if he was not aware and was not able to be aware of the negative effects of his acts, which influence the ability of the entity to perform its' obligations. It is worth mentioning that the concept of bad faith as a base of the liability was formed by the courts' practice, which defines bad faith actions as:
The establishment of a new entity and the transfer of activities, assets from a primary company to the new one, not including the outstanding debts. In this case several criteria should be assessed, e.g. relations between the legal entities, which can be held being connected through the same person acting in both positions as a member and a director of the company (this person is considered as the only executor of the entity's will, having unrestrained influence towards the company), similar titles of both entities, the same address of the head office, control over the companies, etc.
The breach of a legal order of the entity, for instance, an omission of the general meeting of the members, a failure to approve annual financial results of the company, or to elect its managing bodies or not being able to solve the question of profit (losses) distribution, etc.
The decision of the members to pay amounts of cash to members of the legal entity and its employees when payments do not conform to financial results of the legal entity and are not included into financial statements of the company, and the members are aware of outstanding liabilities to creditors.
The omission of the members to perform their duties, which involves such situations as a failure to initiate bankruptcy procedures if the company is insolvent; noncompliance with the duty to summon a general shareholder's meeting in order to appoint a new director, when such failure could cause the loss of assets and documents.
The conclusion of onerous and null and void contracts, as, for example, a member who is the only shareholder of the company and its director transfers the property of an entity to his relatives or other related persons, setting an unreasonably low price, thus causing the company to be insolvent.
The "write-off" of the debts, when both legal entities (debtor and creditor) are controlled by related persons, who are members of these entities.
The previously presented norm is considered to be an additional opportunity for creditors to protect their interests from acts of bad faith or omissions performed by members of the entity, therefore, it might be expected that in case the number of cases, based on the reasons mentioned above, increases, the number of businessmen seeking to fraudulently avoid liabilities to creditors would gradually decrease.
Zydrune Stuglyte is an associate advocate at Jurevicius, Bartkus & Partners, a member of Baltic Legal Solutions, a pan-Baltic integrated legal network of law firms including Glikman & Partnerid in Estonia and Kronbergs & Cukste in Latvia, dedicated to providing a quality "one-stop shop" approach to clients' needs in the Baltics.