In late December 2014, Russia adopted major changes to its insolvency (bankruptcy) law. Critically, the changes introduced the long-awaited regulation of individual insolvency (personal bankruptcy), with the aim of closing the regulatory gap and supporting individual debtors struggling during Russia's economic downturn.1 Some time has passed since the initial draft law on individual insolvency (personal bankruptcy) was first delivered to the Russian Parliament back in 2012. However, recent developments have prompted Russian lawmakers to dust off and adopt the law in an exceptionally short time period. The most notable of these developments was the combination of Western sanctions and the slump in world oil prices which caused the first contraction in Russia's GDP since 2009. The value of the ruble has literally plummeted compared to the euro – the ruble lost half its value in 2014. This has hit some borrowers hard, particularly those who had opted for forex-denominated mortgages (which traditionally offered more attractive interest rates) over ruble mortgages. At the same time, Russians' overall consumption level did not drop in real terms in 2014. And inflation is predicted to soar in 2015. The cost of borrowing has also climbed, as Russia's Central Bank took steps to shore up the ruble by increasing the refinancing rate to 17% at year-end 2014. It is likely therefore that 2015 will witness an explosive growth of retail default. To support Russia's citizens, the government intensified its work on developing a legal framework for individual bankruptcies.2 1 In addition to the changes described herein, there were also revisions to Russia's bankruptcy legislation as regards insolvent financial institutions. Those revisions will be the subject of a separate newsletter. 2 It will be recalled that until now, Russia’s insolvency regime has only applied to commercial legal entities and individuals doing business as registered entrepreneurs. Federal Law No. 476-FZ, On Amendments to the Federal Law on Insolvency (Bankruptcy)3 and Separate Legislative Acts of the Russian Federation with Respect to Rehabilitation Procedures Applicable to an IndividualDebtor dated 29 December 2014 (the Amendments Law), introduces special tools to enable individual debtors to effectuate an orderly discharge their debts through bankruptcy under one of three basic procedures. These include (1) restructuring, (2) sale of assets, and (3) amicable settlement. Upon the court order implementing the relevant procedure, the individual debtor's debts will generally be deemed discharged in full, so that (s)he may continue life with a clean slate. We outline below the new rules introduced to the Insolvency Law by the Amendments Law (the Amended Insolvency Law). When may an individual be declared bankrupt? The Amendments Law establishes the following entry criteria for involuntary and voluntary bankruptcy petitions: (a) A creditor may file a bankruptcy petition in court against an individual if the claims against that individual: (i) are at least RUB 500,000; and (ii) have been overdue for at least three (3) months (unless otherwise provided in the Amended Insolvency Law).4 (b) An individual: (i) must file a bankruptcy petition in court if: (A) satisfaction of the claims of one or more of his/her creditors will result in non-performance of 3 Federal Law No. 127-FZ On Insolvency (Bankruptcy) dated 26 October 2002 (the Insolvency Law). 4 Paragraph 2 of article 213.3. of the Amended Insolvency Law. New Insolvency Regime for Russian Individuals to Launch in July 2015 January 20152 Moscow 2298722.2 the individual’s obligations and/or in full performance of obligations under mandatory payments (e.g., tax obligations) before other creditors; and (B) the amount of those obligations is at least RUB 500,000;5 and (ii) may file a bankruptcy petition in court if circumstances demonstrate that the individual is unable to perform his/her obligations (and/or obligations on mandatory payments (e.g., tax obligations)) on time, provided (s)he satisfies the criteria for bankruptcy and/or insufficiency of property.6 An individual cannot be declared bankrupt if there are sufficient grounds to consider (in view of forthcoming expected cash flow, including his/her income and repayment of claims of the individual by third parties) that such individual within a short period will be able to fully perform his/her overdue monetary obligations and/or mandatory obligations.7 The Amended Insolvency Law treats an individual's bankruptcy as the inability to perform obligations where at least one of the following conditions is satisfied:8 (a) suspension of payments due to creditors; or (b) more than 10% of the total amount of overdue monetary obligations and/or mandatory payments have remained unpaid for over one (1) month; or (c) the individual's total indebtedness exceeds his/her total property (including his/her claims against third parties); or (d) there is a court order on termination of executory court process due to insufficiency of the individual's property. What is the procedure for filing a bankruptcy petition? A bankruptcy procedure against an individual may generally be initiated in a court of general jurisdiction at the place of his/her residence.9 If the individual is an entrepreneur (including one who has de-registered, but claims against whom arose during his/her business) then the petition must be filed in the relevant state (arbitrazh) commercial court.10 To file a bankruptcy petition, a creditor must attach inter alia an effective court ruling justifying the claim, save for 5 Paragraph 1 of article 213.4 of the Amended Insolvency Law. 6 Paragraph 2 of article 213.4 of the Amended Insolvency Law. 7 Paragraph 3 of article 213.6 of the Amended Insolvency Law. 8 Ibid. 9 Paragraph 1 of article 6 and paragraph 1 of article 33 of the Amended Insolvency Law. 10 Paragraph 1 of article 6 of the Amended Insolvency Law. cases where the claim, inter alia: 11 (a) is confirmed by a notary's executory note; (b) is admitted, but not performed by the individual; (c) is based on a notarized transaction; or (d) arose out of a loan agreement executed between the individual as debtor and a credit organization as lender. The court must consider the petition within no less than fifteen (15) days and no more than three (3) months from the date the petition is accepted.12 Information on commencement of a bankruptcy procedure against an individual (including certain personal data of such individual) as well as information on the termination and extension of such procedure must be officially published.13 Note especially that creditors must submit their claims for registration within two (2) months from the date of publication. 14 In particular, even if a creditor does not file its claim by the two (2) month deadline it may still do so later on in the bankruptcy proceedings, within the timeframe set out for the completion of debt restructuring. However, such late creditors will lose the right to participate in the first meeting of creditors. Should all creditors (including retail bank lenders) give up their claims filed against the individual within the bankruptcy proceedings, the court is obliged to dismiss the bankruptcy case. At the same time, the dismissal of a bankruptcy case does not deprive a creditor from using its right to initiate a future bankruptcy proceeding against an individual debtor. What are applicable bankruptcy procedures? Under the Amended Insolvency Law there will be three (3) types of procedures in individual bankruptcies: restructuring of debts; realization (sale) of property; and conclusion of a settlement agreement. A so-called 'financial manager' is charged with administration of each bankruptcy procedure. The manager's remuneration is paid at the end of the proceeding in a lump sum of RUB 10,000 plus 2% of the aggregate value of the individual's property.15 Restructuring of debts In line with well-established international practice, the Amendments Law introduces the concept of debt restructuring based on a plan agreed between the debtor and his/her creditors. Restructuring is designed as an 11 Article 213.5 of the Amended Insolvency Law. 12 Paragraph 5 of article 213.6 of the Amended Insolvency Law. 13 Article 213.7 of the Amended Insolvency Law. 14 Paragraph 2 of article 213.8 of the Amended Insolvency Law. 15 Paragraphs 3 and 17 of article 206 of the Amended Insolvency Law.3 Moscow 2298722.2 interim measure to be taken before the individual is actually declared bankrupt, for the purpose of effectuating a solvent recovery. The agreed restructuring term must not exceed three (3) years. 16 Within the restructuring procedure, an individual or any of his/her creditors may prepare and file a draft restructuring plan with the financial manager. The plan may be prepared only for an individual who:17 (a) has income to satisfy creditor's claims; (b) has not been charged with certain administrative or criminal offences (in the economic domain) or records on any such charges have been terminated; and (c) has not been declared bankrupt within five (5) years preceding the date of presentation of the plan provided that such a plan has not been approved within eight (8) years preceding the date of its presentation. The plan must be approved at the creditors' meeting by a simple majority of all of registered creditors. Failure to agree on the plan entitles a court to extend the term for its preparation, but not for more than two (2) months.18 Eventually, the plan must be adopted or rejected by the court. In the latter case (plan rejection), the individual is declared bankrupt and the procedure for realization (sale) of his/her assets must be initiated. If the plan is approved, creditors may satisfy their claims strictly in accordance with the terms and conditions of such plan.19 The plan may be further amended at the individual's or the creditors' request. After the plan's adoption, the individual is not precluded from entering into further transactions (e.g., attracting financing or granting security), but such transactions are always subject to the preliminary consent of the financial manager. 20 The Amended Insolvency Law is silent with respect to the duration of the period during which such consent must be sought. It is advisable therefore to seek such consent before any such transaction. A transaction concluded with respect to an individual's property (including one concluded by his/her spouse regarding joint property) may be challenged on the basis of articles 61.2 and 61.3 of the Amended Insolvency Law (i.e., preference and suspect-transaction rules) only after adoption of the plan. Such a transaction may be challenged by the financial manager, by a creditor whose claims exceed 10% of the total amount of claims (excluding the claims of such creditor and its affiliated 16 Paragraphs1 and 2 of article 213.14 of the Amended Insolvency Law. 17 Paragraph 1 of article 213.13 of the Amended Insolvency Law. 18 Paragraph 2 of article 213.17 of the Amended Insolvency Law. 19 Paragraph 1 of article 213.19 of the Amended Insolvency Law. 20 It would appear that the financial manager's consent should be no longer required once the court terminates the manager's powers and authorities upon completion of the bankruptcy procedure. persons) or by an authorized government authority (e.g., the tax service). Realization (sale) of property If for any reason a restructuring plan is not adopted by creditors, or if a court finds there are grounds to reject such a plan, the individual is declared bankrupt, and the specific procedure of realization (sale) of his/her property is initiated.21 From this moment on, the court may also order a restriction on the individual's travel abroad. All of the individual's property, including any which is mortgaged or any which is owned jointly with a spouse, may be realized (sold) except for certain types of property which may not be sold under specific procedural rules. A homestead exemption is meant to be granted for, among other things, a debtor's residential property (if this is the only place for him/her to live on a permanent basis and is not subject to a mortgage), personal belongings, household furniture and food.22 It will be recalled, in 2012 the RF Constitutional Court confirmed23 the constitutional right of a debtor and his/her family members to living premises which, by their characteristics, are 'reasonably adequate' for the exercise of the constitutional right to a home, under article 40 of the RF Constitution. Since the RF Constitutional Court's decision, legislators have never developed a legislative framework for determining what constitutes 'reasonably adequate' for the purposes of enforcing civil-law claims against individual debtors' property. Unfortunately, the new rules on personal bankruptcy do not clarify exactly which premises will be deemed adequate, so this remains an open question. It is hoped that legislators will accelerate their work to flesh this out. A rational homestead law (balancing debtors' constitutional rights with creditors' interests) is a critical element of a working personal bankruptcy system. Notably, the individual's bankruptcy estate does not include his/her future income unless that income could be treated as currently owed receivables. From the moment of declaration of bankruptcy: (a) certain of the individual's ordinary civil rights may be exercised solely by the financial manager;24 and (b) all transactions entered into by the individual with respect to his/her property (apart from those entered into with the financial manager's consent) are deemed void. 25 21 Paragraph 2 of article 213.24 of the Amended Insolvency Law. 22 Paragraph 3 of article 213.25 and article 446 of the RF Civil Procedure Code. 23 Decision of the RF Constitutional Court No. 11-P dated 14 May 2012. 24 Paragraphs 6 and 7 of article 213.25 of the Amended Insolvency Law. 25 Paragraph 5 of article 213.25 of the Amended Insolvency Law.4 Moscow 2298722.2 The above procedure for realization (sale) of property as well as the restructuring procedure may not apply to the bankruptcy of farmers' households.26 As under the restructuring procedure, the financial manager's consent must be obtained in advance of certain types of transactions. Conclusion of a settlement agreement A settlement agreement is an alternative to a restructuring plan. It may be entered into by an individual and the registered bankruptcy creditors subject to specific rules set forth in the Amended Insolvency Law. A settlement agreement may be concluded only after satisfaction of claims of the creditors of first and second priority (e.g., health-related tort claims, employee severance pay and employee payroll and claims of authors' right holders).27 Are all of the debtor's debts discharged? As a general rule, the bankrupt individual will be deemed released from all payment obligations towards his/her creditors upon completion of settlements within the relevant bankruptcy proceedings.28 However, as with many other countries' bankruptcy systems, not all debts are discharged. The Amendments Law expands the list of debts exempted from the general discharge (largely for public policy reasons, based either on the nature of debts or where debts were incurred due to a debtor's own culpable behavior). The general discharge will not extend in the following cases:29 (a) where an individual is sentenced to criminal or administrative liability for wrongful actions or premeditated or fraudulent bankruptcy in the bankruptcy proceedings at hand; (b) where the individual has not presented information to the financial manager and/or the court required for the proceedings (or has made deliberate misrepresentations), as evidenced by a court ruling; (c) where it is proven that in the creation or performance of the relevant payment obligation the individual acted illegally (e.g., committed a fraud), or (s)he has deliberately avoided payment of debts, taxes and/or duties, or (s)he has made misrepresentations or (s)he has hidden or deliberately destroyed his/her property; or (d) where debts of an individual relate to current payments (i.e., payment obligations arising after the court's acceptance of the bankruptcy petition), health-related tort claims, severance pay or 26 Paragraph 2 of article 213.1 of the Amended Insolvency Law. 27 Paragraph 1 of article 158 of the Amended Insolvency Law. 28 Paragraph 3 of article 213.28 of the Amended Insolvency Law. 29 Paragraphs 3 – 5 of article 213.28 of the Amended Insolvency Law. payroll for employees, compensation for nonpecuniary damage, alimony payments or other claims closely related to the creditor's identity. Therefore, a debtor will still be obliged to repay these types of debt following a bankruptcy. Whose claims shall have priority against other creditors? The Amended Bankruptcy Law establishes the following order of priority for claims settlement:30 super-priority claims – claims for current payments arising after the court accepted the petition. They must be discharged in the following order: (i) alimony payments, court costs, remuneration of the financial manager and other individuals/legal entities engaged by such financial manager for the purpose of the bankruptcy proceedings; (ii) severance pay and payroll for employees engaged by the bankrupt individual during the bankruptcy proceeding under an employment contract (e.g., domestic staff or other employees); (iii) utility payments, including payments for capital repairs to communal elements of a multi-unit dwelling; and (iv) other current payments;31 first-priority claims – tort claims for injury or death, and/or for compensation of punitive damages, claims for payment of alimony; second-priority claims – employee severance pay and employee payroll claims which arose prior to the court's acceptance of the petition; and third-priority claims – payments to other creditors, including payment of taxes and other mandatory payments.32 Are there any specific rules related to secured creditors? Note that the claims of secured creditors (i.e., creditors whose claims are secured by pledge (in Russian, 'zalog')) are included in the third-priority ranking but are generally to be paid from the sale of collateral covered by their respective security. Both contractual and statutory 30 Article 213.27 of the Amended Insolvency Law. 31 Similar claims of different creditors falling into a particular category of current payments must be satisfied in the order of calendar priority. 32 Unlike in many other jurisdictions, taxes enjoy no special priority in Russia.5 Moscow 2298722.2 pledgees33 benefit from this rule.34 The satisfaction of secured creditors' claims is subject to special rules, including, inter alia: (a) from the date of the court's acceptance of a petition until the adoption of the restructuring plan or the date of the court's award of bankruptcy: (i) the enforcement of a pledge (including extra-judicial enforcement) is prohibited; and (ii) the disposal of pledged assets is subject to the consent of the pledgee (secured creditor); (b) allocation of collateral sale proceeds is subject to the following rules: (i) a secured creditor is entitled to receive 80% of proceeds from the sale of its collateral to satisfy its claims secured by such collateral; (ii) the remainder is to be transferred to a special bank account of the debtor and allocated as follows: (A) 10% of the proceeds are be transferred to discharge firstand second-priority claims; (B) the balance is be used to discharge super-priority claims due to the court, the financial manager and the latter's advisers and collateral enforcement costs; and (iii) any funds remaining in the debtor's special bank account after discharge of the first- and second-priority claims under items (i) or (ii) above (as the case may be) are to be used for settlement of the respective secured creditor's claims, and any excess is to be included in the bankruptcy estate generally for the benefit of unsecured creditors; (c) if a mortgage creditor has decided to retain residential property in settlement of its claim in the context of an enforcement procedure before the court accepts the bankruptcy petition, any executory award issued in this respect must not be suspended. Accordingly, residential mortgage lenders are likely to want to act more quickly in foreclosing than commercial mortgage lenders. 33 According to paragraph 5 of article 488 of the RF Civil Code a seller may become a statutory pledgee in relation to goods purchased by the buyer on credit. 34 A secured creditor must bear in mind that the relevant security interest may be challenged by the financial manager or other creditors based on the general defenses established by the RF Civil Code. Can creditors defend against debtor abuse? Bankruptcy proceedings are supposed to serve as a fair solution for responsible citizens overwhelmed by debt as a result of unemployment, divorce, disability or other legitimate reasons. Unfortunately, bankruptcy can also sometimes be abused by unscrupulous debtors to avoid paying debts, even where they have the financial wherewithal to do so. The most common type of bankruptcy fraud in countries with developed regulation of personal bankruptcy involves hiding assets or income. The failure to disclose such information clearly harms creditors and constitutes an abuse of the system. Under the Amended Insolvency Law,35 should an individual conceal or illegally transfer assets to a third party, a registered creditor may apply to court for the reconsideration of the results of the bankruptcy procedure and levy execution over hidden assets, within one (1) month upon discovery of such facts. There are at least three key takeaways here. Firstly, creditors must weigh the risks of failing to file and register a claim in an individual's personal bankruptcy – an unregistered creditor is ineligible to exercise this right. Secondly, creditors will need to prove they were not aware and should not have been aware of newly-discovered facts – so a failure to challenge known abuse during a bankruptcy procedure can prejudice the creditor. Thirdly, creditors much ensure they act immediately upon learning of any abuse – the one (1) month statute of limitations is extremely short. Provided the registered creditor takes action timely and proves it did not know (and should not have known) of the abuse, the court will be obliged to recall its ruling (on completion of restructuring or sale of assets) and reopen the bankruptcy case. The discharge of the abusive debtor's payment obligations will accordingly be cancelled. Bankruptcy fraudsters can also be criminally prosecuted and fined up to RUB 500,000 or even spend up to three (3) years in prison for abuse in bankruptcy proceedings (e.g., hiding, destroying or transferring assets, satisfying certain creditor's claims in preference of others).36 Criminal liability of the individual may even be more severe where a bankruptcy procedure is found to be premeditated or fraudulent. What next? The Amendments Law marks a new challenge for retail creditors. Given that the Amendments Law becomes effective on 1 July 2015, bankers and counsel will still have time for a more thorough study of the new rules and their implications. Undoubtedly, creditors will also want to adjust their internal procedures for monitoring loan portfolios and debt collection, to take account of the new rules.