Fictitious and Deliberate Bankruptcy

Fictitious and deliberate bankruptcy. Bankruptcy legislation can be understood broadly. On such an approach, the rules defining the signs, conditions, procedure, and scope of liability for fictitious or deliberate bankruptcy are drawn not only from civil and administrative law, but also from criminal law. Although many participants in bankruptcy cases believe fictitious or deliberate bankruptcy is common, in practice matters are far from simple.

Deliberate bankruptcy

Under article 196 of the Criminal Code, deliberate bankruptcy is the commission, by a director or founder (participant) of a legal entity, or by a citizen (including an individual entrepreneur), of actions or inaction knowingly leading to the inability to satisfy creditors' monetary claims in full or to perform the duty to pay mandatory payments — where those actions caused major damage.

Thus, two elements are required: intent, and major damage (which, under the note to article 169 of the Criminal Code, means an amount exceeding 1.5 million roubles).

In practice, law-enforcement agencies dislike this provision, and insolvency managers, when analysing a bankrupt, tend to assess the factual circumstances formally. Creditors and managers are not always interested in pursuing criminal proceedings other than as a means of pressure on the debtor or its controlling persons. As a result, the rule exists on paper but works in practice only when someone strongly needs it; the number of criminal convictions is small.

By way of a contrary example, the Armavir City Court (Krasnodar Region) judgment of 13 April 2012 in case No. 1-114/2012 convicted a director of deliberate bankruptcy: he had knowingly entered into and recorded plainly fictitious assignment-of-claim contracts, transferring the debts of solvent enterprises to sham organisations lacking the features of genuine commercial entities.

Why liability is hard to establish

A key difficulty is that unreasonable and bad-faith actions of a director or participant may stem from errors in managing legal and other risks — hiring poor financial specialists, mis-assessing a market, or misjudging commercial deals with counterparties. Distinguishing culpable, intentional conduct from ordinary business misjudgement is genuinely hard, and the requirement of proven intent sets a high bar.

A further complication arises where the debtor's director does not delay but voluntarily initiates the bankruptcy filing — conduct that cuts against an inference of concealment or bad faith.

Fictitious bankruptcy

Fictitious bankruptcy is the knowingly false public announcement of insolvency, made to mislead creditors — for example, to obtain a deferral or instalment plan, a discount on debts, or non-payment. Here too, intent and major damage must be shown, and the same practical obstacles to proof apply.

What this means for creditors and managers

For creditors, the criminal provisions are a real but limited lever: convictions are rare and require proof of intent and major damage, so in most cases the practical route runs through civil remedies — challenging suspicious transactions and pursuing subsidiary liability — rather than criminal prosecution. Where genuine intentional asset destruction can be shown, however, the criminal track adds significant pressure. For directors and owners, the lesson is to document the commercial rationale of decisions, so that ordinary business risk is not mistaken for deliberate bankruptcy.

Related materials

• Bankruptcy of legal entities

• Suspicious transactions in bankruptcy