Terminating the CEO: Employer’s Discretion Shrinks in Court

Yevgeny Reyzman
Counsel
Baker & McKenzie

In 1995, the freshly introduced law on joint stock companies declared for the first time that shareholders and board members were free at any time to terminate the head of a company (referred to in this article by the synonyms CEO and executives) and also declared that the rules of corporate law supersede those of labor law in relationships with these top officers.

This was perceived by practitioners and by businesspeople as a sort of legislative minirevolution, a major step by the government in advancing the interests of private business. Indeed, the 1971 Labor Code protected CEOs, as well as all other employees, from termination. That made the owners of Russian businesses hostages to their own decisions to appoint CEOs, since their options for legitimately replacing a top officer who failed to meet the company’s needs were quite few.

The fact that the Labor Code did not support the above provision generated problems with its application, and before the 2001 Labor Code came into effect, this rule worked at half-steam. The new Labor Code set out the basic rules intended to support owners of businesses vis-a-vis top managers.

By those rules, a CEO (a) could be appointed for a fixed term, (b) could seek co-employment with another company only with the consent of the principal employer, (c) always bears full monetary liability for damages incurred to the company because of his or her fault and (d) may be terminated on grounds specifically worded in a relevant contract in addition to statutory ones — Article 278(3) — or even in the absence of any fault, simply by a decision of an authorized body of corporate governance, Article 278(2). Businesspeople hoped that at last the owners would obtain some real protection. But practice has shown these hopes to be a bit premature.

After the Labor Code came into effect in 2002 — and during the years of growth — many companies in Russia used that instrument to replace executives. Many of the latter were not ready to leave so easily and challenged their termination in the courts. The issue of the constitutionality of such wide discretion to terminate a CEO was finally brought to the Constitutional Court in 2005.

In its ruling of March 15, 2005, No. 3-P, the Constitutional Court confirmed that the discretion of shareholders or board members to make a decision to replace a CEO without reference to a specific reason does not contradict the law, since it supports the constitutional rights of business owners. The court also held that such discretion cannot be unlimited, that the owner cannot make such a decision arbitrarily, and that it is discrimination against the terminated manager and with no respect to the company’s legitimate interests.

The Supreme Court further developed the above approach, so that business owners now face difficulties when attempting to dismiss CEOs of Russian companies without reference to any faulty action or inaction on their parts. Thus, in its 2004 Decree No. 50, the Supreme Court extended the general employee protection against dismissal to heads of companies, such as the prohibition against terminating an employee during his or her absence because of vacation or sickness. Following this interpretation, lower courts of general jurisdiction started to reinstate CEOs who were terminated during such absences. However, these courts, to correct such unreasonable limitations of owners’ rights, later supported employers in several cases in which CEOs simply concealed from shareholders or board members that they were on vacation or on sick leave and made that defense only in court.

It is now obvious that lower courts became materially more attentive to arguments of terminated executives who sought reinstatement. Although upon termination under Article 278(2) shareholders or boards are not required to refer to any specific reason, in cases when terminated managers allege discrimination or arbitrary decisions on the part of employers, courts require that defendant companies prove the objective necessity of such termination for their enjoyment of the legitimate rights or benefits of company owners. In some cases, the courts reinstated company heads who managed to prove that they were treated unjustly despite their successful performance, or that they were terminated after declining to comply with owners’ instructions that were illegitimate or economically detrimental to the companies.

In other cases, courts supported employees when they established that, in spite of Article 278(2), executives had in fact been terminated “for cause.” Since in that event employers did not follow the rules of disciplinary termination, did not perform an internal investigation and did not request written explanations from the executives, the courts recognized those cases as a violation of an employee’s rights to protect himself against employer allegations.

Regarding the termination of CEOs, one more risk for employers appears. The current Labor Code explicitly sets out the rules for employers when it comes to termination: By the day of termination, the employer must issue a staff order on termination, pay the employee all amounts due by statute, make the relevant entry in the work log and hand it to the employee with a signed receipt. When terminating an executive that procedure becomes problematic. In the majority of cases, companies were unable to comply with the statutory deadline when terminating executives. The courts do not view that fact as grounds for reinstatement but often consider it to be evidence that the manager was treated unfairly.

Most experts, and even many judiciaries, realize that the current developments in practice related to CEO termination may exceed the reasonable level necessary to protect the employee rights of executives and thus infringe on business owners’ legitimate interests. Unfortunately, the experts see no other way to reach any reliable balance in this practice without making relevant amendments to the Labor Code, which hardly will happen soon. Meanwhile, in each specific case, practitioners work out technical recommendations to employers that may, to a certain extent, mitigate the main risks.