A subsidiary (does not) bear the debts of a foreign parent company
Recently, a judicial practice has developed in which Russian plaintiffs, filing claims against foreign companies from unfriendly jurisdictions, involve their subsidiaries as joint defendants. In May, one such case reached the Supreme Court of the Russian Federation, which unexpectedly overturned the decisions of lower courts (which had ruled in favor of collecting a debt from a Russian entity) and sent the case for a new trial.
Background
Sovcombank entered into an agreement with American Citi in 2017. Under this agreement, by the spring of 2022, Citibank owed Sovcombank more than 20 million dollars but was unable to pay due to sanctions imposed by the United States. Sovcombank filed a claim against the Russian Citibank, which predictably refused to pay the debts of its parent company, stating it was not a party to the contract.
Sovcombank filed a lawsuit in arbitration against both companies: the parent and the subsidiary—as joint debtors. Courts at three instances sided with Sovcombank and ordered both defendants to jointly repay the debt. While the legal basis for the claim against the American company was the contract, the basis for the claim against the Russian company was delict, meaning the violation of non-contractual obligations, arguing that the actions of the Russian company, which refused to pay the parent company's debt, caused harm to the plaintiff. The courts concluded that Citi had a single decision-making center, hence they should bear responsibility jointly.
What did the Supreme Court of the Russian Federation say?
While overturning the decisions of the lower courts and sending the case back for reconsideration (meaning the outcome could still turn against Citi), the Supreme Court of the Russian Federation pointed out the following violations of substantive law by the lower courts:
- The courts did not check whether Sovcombank could have attempted to unblock the funds reserved by American Citi in a special "sanctioned" account for it. The Central Bank of the Russian Federation should have been involved in the case.
- Arguments regarding violations of public order required proof from the plaintiff.
- It was necessary to clarify the extent of American Citi's control over its Russian subsidiary: the volume of investments, the amount of property belonging to American Citi that is used by the Russian entity, and the ownership of the incoming funds from American Citi to the Russian entity.
Why is this important?
- Lawyers traditionally take the concept of limited liability for legal entities very seriously. This is the foundation of the modern economy, and it is enshrined in the civil (commercial) law of all countries. Cases where other individuals are liable for the debts of a company should be exceptional (such as with dishonest directors, owners, etc.). The parent company may sometimes be held liable for the debts of the subsidiary, but the reverse is already too much.
- Somehow, the courts saw a tort obligation (arising from harm) on the part of the Russian entity. It is unclear how a contractual debt of an American company could transform into a harm caused by a Russian entity. It looks more like an attempt to find at least some formal basis for a lawsuit against the Russian company.
What to pay attention to?
It cannot be said that Russian subsidiaries have always been reliably protected from claims for debts of their parent companies. Firstly, it was always possible to enforce a claim on the parent company's share in the subsidiary—and even gain control over the latter and its assets in this way. Secondly, one could enforce a claim on the property of the parent organization that is held by the subsidiary.
However, now lawyers must also consider the risk that a "foreign" debt, for example, related to an international supply, may be enforced against a Russian company in the group.
We will monitor the development of this practice. In September, the Supreme Court of the Russian Federation will review a complaint in a similar case involving Sovcombank against JP Morgan.
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