This is a summary of the principal new provisions of recently enacted insolvency legislation applicable to businesses other than banks, insurance companies, pension funds and certain other entities. This summary is not comprehensive and does not constitute legal advice. The reader should obtain separate legal advice with respect to the issues addressed herein.
The new Law of the Republic of Kazakhstan “On Rehabilitation and Bankruptcy” came into force on 26 March 2014 (the “New Bankruptcy Law”). The New Bankruptcy Law replaced the Law of the Republic of Kazakhstan “On Bankruptcy” dated 21 January 1997 (the “Old Bankruptcy Law”). Concurrently with the New Bankruptcy Law, the Law of the Republic of Kazakhstan “On Introduction of Amendments into Certain Legislative Acts of the Republic of Kazakhstan on Questions of Rehabilitation, Bankruptcy and Taxation” (the “Bankruptcy Amendments Law”) came into force.
The new laws generally preserve the approach taken towards bankruptcy under the Old Bankruptcy Law. However, creditors of a Kazakhstan entity should assess new insolvency-related risks arising from certain changes made under the new laws, including with respect to early termination and bankruptcy set-off, acquisition of an equity stake in a bankrupt entity, enforceability of indemnity provisions and default interest payments, and extension of “claw-back” provisions.
Early termination and bankruptcy set-off
Contrary to the Old Bankruptcy Law, the New Bankruptcy Law:
- provides that initiation of bankruptcy proceedings may not serve as a basis for unilateral termination of a transaction by a counter-party of the debtor; and
- makes invalid any provision executed prior to the initiation of bankruptcy proceedings with respect to one of the parties that an agreement between the parties shall terminate if the bankruptcy proceedings have been initiated.
Further, the New Bankruptcy Law explicitly provides that a creditor and a bankrupt entity (or an entity which is under rehabilitation) may not freely set-off their liabilities after the initiation of bankruptcy/rehabilitation proceedings (i.e. after a court orders to commence a bankruptcy/rehabilitation case).
Accordingly, there is a significant risk that early termination provisions in an agreement governed by foreign law to which a Kazakhstan entity is a party will not be recognized in Kazakhstan in case of the bankruptcy of the Kazakhstan entity. As an example, ISDA Master Agreements usually contain a provision that the agreement is deemed to automatically terminate in the event of the bankruptcy or insolvency of the counterparty. Such provisions, in turn, trigger close out netting and set-off provisions. If early termination provisions are deemed not enforceable in the event of the bankruptcy of a Kazakhstan counterparty, then the application of any close out netting/set-off provisions that are to be triggered would also be questionable. Similarly, provisions in a loan agreement that provide for acceleration and cancellation of the lender’s commitment in the event of the bankruptcy or insolvency of a Kazakhstan borrower may be deemed unenforceable under the New Bankruptcy Law.
Tightening of rules regarding affiliated creditors
The New Bankruptcy Law introduces a definition of affiliated party in bankruptcy/rehabilitation proceedings. There are three important changes arising from the newly introduced definition.
- First, the creditors’ register (i.e., the list of creditors having a claim to be satisfied from bankruptcy estate) will not include claims of founders (participants) of the debtor. It is, however, not fully clear whether this provision operates to exclude (a) claims of any participant regardless of the amount of the interest it has in the debtor and (b) claims of shareholders of the a debtor that is a joint stock company (as opposed to participants of the debtor being a limited liability partnership).
- Second, in addition to the grounds set out in the Old Bankruptcy Law, the rehabilitation manager will also have the right to refuse to fulfil executory contracts entered into with an affiliated party. Note that the definition of affiliated party for that purposes expressly refers to both shareholders and participants.
- Third, an affiliated party of the debtor does not have any votes at the creditors’ meeting until satisfaction of claims of other non-affiliated creditors.
Changes in bankruptcy priorities
Most notably, the New Bankruptcy Law introduced a new (fifth) category of claims - payment of losses, penalties and fines - which comes after payments to unsecured creditors, but before distributions to shareholders. Under the Old Bankruptcy Law, payment of losses, penalties and fines were to be included in the generic category that covered claims of unsecured creditors. It is likely that amounts payable pursuant to a standard indemnity clause and, with a lesser degree of certainty, a default interest clause such as those found in English law governed finance documents would be considered as payment of losses and fines, as appropriate. As a result, it is likely that indemnity/default interest payments would be subordinated to payments due to claims of unsecured creditors.
New “claw back” provision
The New Bankruptcy Law generally preserves the list of grounds to invalidate transactions/transfers of property which were entered into by a debtor prior to initiation of bankruptcy/rehabilitation proceedings under the Old Bankruptcy Law and confirms the three year “claw back” period for most of these grounds. Notably, the New Bankruptcy Law now provides a new ground for challenging a transaction entered into by a debtor within a three year period prior to initiation of bankruptcy/rehabilitation proceedings – entering into a non-arm’s length transaction that resulted in a financial loss to the bankrupt entity.
Under the Old Bankruptcy Law, in a bankruptcy proceeding a secured creditor effectively lost the rights to the collateral. The New Bankruptcy Law introduces a new mechanism for satisfaction of claims of secured creditors where a secured creditor may take the collateral. In particular, the creditors’ meeting may decide, upon a secured creditor’s request, to transfer the collateral in-kind to the secured creditor in exchange for repayment by such secured creditor of all claims of creditors of the first level of priority (which include claims for payment of salary, compensation for damage to health, claims for payment social security and pension contributions and certain other employee-related claims). The difference between the value of the collateral and the amount of the repayment should be paid either:
- by that secured creditor to the bankruptcy estate if the collateral is worth more than the amount of the first category claims; or
- to that creditor as an unsecured debt (which will be treated as a fourth category claim) where the amount of the first category claims exceed the value of the collateral.
The New Bankruptcy Law introduced substantial changes regarding the administration of the insolvency proceeding. These changes include, among others, elimination of external supervision procedure, introduction of an interim manager who has the responsibility to control the affairs of the debtor until the court makes a decision on the bankruptcy of the debtor, increased scope of obligations of insolvency managers, debtors, debtor’s corporate bodies and controlling shareholders, and introduction of the concept of a creditors’ meeting in bankruptcy proceedings.