Moscow
The new Law “On Insolvency (Bankruptcy)” (hereinafter referred to as the ‘Bankruptcy Law’) which came into effect on March 1, 1998 is a significant advance in the development of this branch of Russian legislation. Some of the specific differences between the Bankruptcy Law and the Law “On Insolvency (Bankruptcy) of Enterprises”, which was enacted by the Russian Parliament in 1992 and which the former replaces, will be discussed in more detail below1. However, even at a quick glance, the very fact that the Bankruptcy Law is significantly larger than its predecessor provides an indication that this is a more detailed approach to legislating the problems connected to bankruptcy in Russia.
Significant changes were introduced, not only to the existing procedures on bankruptcy, but to the very understanding of the concept of ‘bankruptcy’. The Insolvency Law defined the bankruptcy of a legal entity as ‘the inability to satisfy the demands of its creditors for the payment of goods (work, services), including the inability to make obligatory payments to the state and budgetary funds, if the debt owed is higher than the value of its property or if the structure of the balance is not satisfied’2. As a result of this definition, in order for a court to declare a legal entity bankrupt it was necessary to determine the value of the property of the debtor, compare it with the amount of the debt, and then evaluate the structure of its balance. Only after this lengthy process of investigation and evaluation had been completed could a court make a judgement about the solvency of the debtor.
Furthermore, before a creditor could even make an application to the court to have a legal entity declared bankrupt for reasons of non-payment of a debt, three months had to have passed from the date of such non-payment. Thus, creditors were forced to wait a long time before they could recover on a debt. In addition, the bankruptcy procedure could not be initiated if the value of the debtor’s property exceeded the value of the debt, even if only by a small amount and the structure of its balance was satisfactory. For creditors, this state of affairs meant a significant delay in regaining the sum it was owed by a debtor.
Although the Bankruptcy Law also stipulates the three month period, it does not require any analysis of the comparative size of assets to debts in order for a legal entity to be declared bankrupt. It sets out two main criteria, which are necessary and sufficient for bankruptcy:
three months must have passed since the date the legal entity failed to fulfill a debt; and,
The size of the debt must exceed 500 times the minimum monthly wage (which is established by law).
Of particular significance, the Bankruptcy Law requires the manager of a debtor-company to return to the arbitration court within a month of the non-payment of a debt with a statement about the insolvency, should the fulfillment of a creditor’s or creditors’ demands lead to a situation in which the company would be unable to fulfil completely its financial obligations towards other creditors. By introducing this principle the Bankruptcy Law specifically provides for the liability of the manager of such company for non-fulfillment. In other words, a company is now required to take care of its own debts, otherwise the manager has subsidiary liability for the obligations, but only inasmuch as such obligations arise after the aforementioned term expires3. In addition, the manager of the company may be prohibited from carrying out any entrepreneurial activities (in the company or otherwise) and in some cases he may be held criminally liable for the non-fulfillment.
One of the mechanisms guaranteeing the interests of creditors during the period between the filing of a claim with the court to have a debtor declared bankrupt and the establishment of an external manager or the company being declared bankrupt by the court, is the introduction into the Bankruptcy Law of external supervision. Such supervision comes into play immediately after the court has received an application for bankruptcy. Concurrently with the appointment of external supervision, the court appoints a temporary supervisor. The governing bodies of the debtor-company continue to carry out their functions, but with a severely limited competence. As a rule, they may not take any decisions which would result in the financial position of the debtor-company worsening (such as on the payment of dividends, establishing branches or representative offices or issuing additional shares). All such decisions can be taken only with the prior consent of the temporary supervisor. The temporary supervisor also has the right to apply to the arbitration court for the dismissal of certain individuals from the governing body of the debtor-company if he believes that the actions of such individuals are causing material damage to the company.
The main objective of the temporary supervisor is to safeguard the property of the debtor-company until the court has reached a decision about the insolvency of the debtor-company. The temporary supervisor also informs creditors about impending hearings concerning the bankruptcy of the company, prepares a register of creditors, and organizes the initial meeting of creditors. During this meeting the creditors must analyze the financial status of the debtor and take one of the following decisions:
to apply to the arbitration court for the establishment of external management;
to conclude an amicable agreement with the debtor company or;
to apply to the arbitration court for the debtor company to be declared bankrupt and its property sold.
Whatever the decision of the creditors, only the court can actually make a determination that a debtor company is bankrupt. In certain cases the court may also deem it reasonable to establish external management, regardless of the fact that the meeting of creditors decided to apply to the court for the debtor company to be declared bankrupt. The court must also take into consideration the report written by the temporary supervisor. This report analyses the financial status of the company and the possibility that it will be able to restore its liquidity.
The Bankruptcy Law has also introduced certain changes introduced regarding the external management procedure. During this period the court dismisses the managing bodies of the company and appoints an external manager who has full authority to take any decision he deems to be reasonable to restore the liquidity of the company. The external manager drafts an external management plan and proposes it to the meeting of creditors for adoption. The creditors, for their part, have the right not to adopt such proposal and to apply to the arbitration court for the company to be declared bankrupt. The external manager has the right to conclude all transactions on behalf of the debtor company as long as no transaction exceeds 20% of the value of the company's assets. Provided the value of a transaction does exceed the aforementioned amount, the meeting of creditors must only approve such transaction. If a transaction, which is in accordance with the plan of the external manager and approved by the meeting of creditors, is concluded, the external manager has the right to sign such transaction, regardless of its value.
An important addition to the Bankruptcy Law is the concept of a moratorium with regard to satisfying the claims of creditors during the period of external management. Although the Insolvency Law also provided for the concept of such moratorium, its effectiveness in helping to restore the liquidity of the debtor was significantly reduced by the fact that during the moratorium the debtor was supposed to pay fines and penalties for non-payment of the debt. Thus, while trying to resolve the financial crisis the debtor found that his efforts were futile, as his debt continued to increase at the same time. The Bankruptcy Law provides that for the duration of external management no fines or penalties with regard to debts, including tax debts, may be set at a level other than that provided for in Article 395 of the Civil Code of the Russian Federation (which sets this level at the rate of interest of the Central Bank of the Russian Federation). When the external management of a company ends, a creditor may claim fines and penalties only at the level, which existed before the period of external management.
Another important development in the Bankruptcy Law is its individualized approach to the bankruptcy procedures applicable to different types of companies. For example, the Bankruptcy Law provides for a special bankruptcy procedure for a ‘core-company of a city’. This term designates those industries, the employees of which (along with their families) make up more than 50 percent of the population of a defined area. This term also refers to companies, which have more than 5000 employees. The Insolvency Law did not distinguish between the bankruptcy procedure applicable to big industrial companies and that for small businesses. Therefore, a number of social problems, such as unemployment, arose during the bankruptcy of big companies. The Bankruptcy Law stipulates a range of specific points with regard to the bankruptcy procedure for a ‘core-company of a city’. For instance, even if the committee of creditors applied to the court to file a bankruptcy claim, the court has the right to establish external management, provided that the government of the Russian Federation, a government of a constituent entity of the Russian Federation or local government will guarantee the repayment of the debts of the company within a certain period of time. Also, in agreement with such governing bodies, a court has the right to extend the period of external management up to ten years.
Specific requirements are prescribed for the sale of an enterprise (for example, if an enterprise is being sold as a ‘whole property complex’4). The buyer in such case must reserve at least 70% of the job positions for the existing employees of the debtor company. Even if the company restructures its production, the buyer must retrain and re-employ these employees. Another specific requirement is that the representatives of employees of a ‘core-company of a city’ have the right to participate in the meeting of creditors.
The Bankruptcy Law further provides for the application of specific bankruptcy procedures with regard to professional participates in the securities market, insurance organizations, credit institutions, agricultural plants and individual entrepreneurs. New to the Bankruptcy Law is the provision for bankruptcy of physical persons who are not engaged in individual businesses. The criterion for declaring such person bankrupt is whether the debts of this person are greater than his or her assets. If that is the case, both the creditor and the debtor have the right to apply to the court with a bankruptcy claim. If the debtor presents the claim, he may also present to the court a plan for satisfying creditors, which action will postpone the court procedures against him for a period of three months. The debtor may also apply to postpone the case for one month in order to satisfy creditors and reach an amicable agreement with them. After the property of the bankrupt person has been sold and the relevant amounts are distributed among the appropriate creditors in the order established by law, the individual is freed from having to satisfy any further claims by creditors. In this way, the debtor has the opportunity to start afresh financially. It is interesting to note that transactions involving the alienation of property concluded with the immediate family of the debtor less than one year prior to the declaration of bankruptcy are declared void and the property in question must be included in the property for auction. These provisions regulating the bankruptcy of individuals have not yet come into effect. They will enter into force as soon as the corresponding changes are made to the Civil Code of the Russian Federation.
The new approach of the Bankruptcy Law is also evident in the creation of a special, easier procedure, to be applied during the bankruptcy of a debtor undergoing liquidation or of an absent debtor. As there was no comparable provision in the Law “On Insolvency (Bankruptcy) of Enterprises” it will be interesting to see how this introduction works in practice.
The arbitration manager plays an extremely important role in all the procedures provided for in the Bankruptcy Law. The term "arbitration manager" implies an external manager, temporary supervisor and receiver. The Bankruptcy Law provides that the court may appoint to the position of arbitration manager a private person who has been registered as an individual entrepreneur and who has a special license for such activities. The Bankruptcy Law also requires all arbitration managers to pass a special training course and receive a special license before March 1, 1999. It is clear that the increased qualification and licensing requirements for arbitration managers are intended to increase their professional level and thus their efficiency.
In conclusion, the Bankruptcy Law is a significant contribution to the development of Russian bankruptcy legislation. Obviously it will not be possible to judge its merits and demerits properly before it has been tested in practice. However, at this stage its progressive nature is encouraging.
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1 The Bankruptcy Law is not a retroactive law. However, it is recognized that due to the fact of there being a grace period during which a debtor may satisfy its creditors, it is possible that situations will arise in which it is unclear by which law an infringement should be judged. The Bankruptcy Law contains specific details regarding these sorts of problems. See also Note 3.
2 It is unclear in Russian exactly what ‘неудовлетворительная структура баланса’ means and therefore the English translation is also unsatisfactory. Under the Law “On Insolvency (Bankruptcy) of Enterprises” this was one of the criteria by which the bankruptcy of a legal entity was decided. The vagueness of the phrase left it open to interpretation. One of the changes introduced by the Bankruptcy Law is to remove this phrase and thus, hopefully, the confusion that arose from it.
3 The fact that a manager must return within one month means, in effect, that this specific provision of the Bankruptcy Law cannot come into effect before April 1, 1998 as this Law does not govern any non-payments prior to the date on which it came into effect.. Under the Bankruptcy Law, a manager may become liable for a non-payment that occurred on March 1, 1998 only after one month has passed.
4 The concept of a ‘whole property complex’ is defined in Chapter 30 (paragraph 8) of the Second Part of the Civil Code of the Russian Federation.
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