On 25 July 2016, the White & Case team obtained, at the Supreme Court of the Russian Federation (the "Supreme Court"), a declaration that a secured creditor has the right to reduce, at its discretion, the amount of a secured claim during receivership and, as a consequence, the right to vote at meetings of the debtor's creditors.
The Supreme Court handed down its Ruling No. 308-ES15-6280(3) (the "Ruling") in the cassation appeal prepared by us on behalf of our client. The Ruling addresses an important issue and sets a precedent in the practice of Russian courts.
Advantages and limitations of secured creditors in insolvency
Because of the special legal status of secured creditors in an insolvency case the Ruling is significant. Claims secured by pledge are satisfied from the proceeds of sale of the debtor's pledged assets, taking priority over the other creditors' claims, including in the insolvency proceedings. However, in exchange for such preference the Federal Law "On Insolvency (Bankruptcy)" (the "Insolvency Law") materially restricts the voting rights of secured creditors during receivership.1
At the same time, it is not unusual for the secured creditor to lose commercial interest in retaining such preferential status for its claims. This may happen if the amount of secured claims substantially exceeds the amount of the potential proceeds of sale of the pledged assets, for instance, as a result of the pledged assets losing their value or the amount of the secured obligation becoming greater on account of moratorium interest which accrues during the insolvency proceedings. In this event, the secured creditor finds itself in a situation in which it cannot actually have a part of its claims satisfied at the expense of the pledged assets and, at the same time, the specified claims do not grant the voting rights that unsecured creditors have. Moreover, sometimes the right to vote at creditors' meetings and the possibility to gain control over the insolvency proceedings, including determining the procedure for selling the debtor's unencumbered assets, may be more valuable to the pledge holder than the preferential treatment of a part of its claims.
In such situations, some secured creditors have tried to reduce the amount of the secured obligation by waiving their pledge right in relation to a part of the claims without releasing the pledged assets. Case law, however, was ambiguous in relation to this issue.
Case law before the Supreme Court handed down the Ruling
Before the Supreme Court handed down the Ruling, the case law had reflected two approaches to the waiver by a secured creditor of its pledge right. Some courts2 cited the principle of free exercise of civil rights and upheld applications of pledgeholders seeking to waive their pledge rights. At the same time, the other approach existed, whereby courts refused to amend registers of creditors' claims on the ground that a secured creditor had waived its pledge rights. To justify this decision the courts stated that such a waiver violated the rights of other creditors3 or that waiver was possible only at the financial rehabilitation or external administration stages4 or that waiver was impossible owing to the binding nature of judicial decisions (rulings on the registration of claims in the register).5
Based on such practice, secured creditors were apprehensive about applying the waiver of pledge rights in relation to a part of their clams in insolvency.
In situations in which obtaining the right to vote at meetings of the debtor's creditors was necessary, secured creditors used to resort to assigning to a company they controlled a part of the claims under the principal obligation without assigning the rights under the pledge agreements (assigning a part of the claims as unsecured). Thereafter the controlled company would replace the creditor as a procedural successor in the insolvency case. The monetary claim the assignee received would be registered in the register as a claim not secured by a pledge. As a result, the assignee would acquire a voting right.
Although case law recognized the above tool for assigning an unsecured claim as acceptable,6 it has a number of substantial drawbacks. It is inconvenient, as it requires the taking of a considerable number of actions that stretch out over time. The secured creditor needs to engage a third party with which it concludes and performs an assignment agreement (when it does this, the assignment of claims at a reduced value or with a considerable postponement of payment may be risky or otherwise be unacceptable)7, file an application for procedural succession and wait until the court upholds such application. Moreover, tax legislation contains special rules for keeping a record of assignment agreements in relation to debt obligations from credit agreements for tax purposes. A party assigning a claim against the debtor in insolvency proceedings must take these rules into account.
In view of the above, when our client, which was a secured creditor in insolvency proceedings, needed to obtain votes, a decision was taken that it should waive its pledge right based on the new Article 450.1 of the Civil Code, which has unambiguously enacted the right of a creditor to waive its rights unconditionally, and to overcome the contradictory case law. Before this rule of law came into force, the waiver of rights could be claimed on the basis of Article 9 of the Civil Code, which was worded in a more general way.
Facts of the case examined by the Supreme Court
After the register of creditors' claims closed, Commercial Bank "Uniastrum Bank" (LLC) (the "Bank"), a secured creditor in the insolvency of Gamma Holding Company LLC (the "Debtor"), filed an application to have the register amended by reflecting a part of the Bank's claims against the Debtor as unsecured by the pledge. The purpose of such application was to obtain the right to vote on all issues on the agenda at the meetings of the Debtor's creditors and to gain control over the course of the insolvency proceedings.
The first instance court supported the Bank's position and amended the Debtor's register of creditors' claims. The court of appeal disagreed with this approach and refused to allow the Bank to amend the Debtor's register of creditors' claims. The Commercial Court for the North-Caucasus Circuit upheld the resolution of the court of appeal.
The Supreme Court granted the Bank's cassation appeal, overruled the decisions of the appellate court and the cassation court and upheld the ruling of the court of first instance. In its Ruling, the Supreme Court specified that the Bank exercises its civil rights at its discretion and in its own interest. At the same time, the law does not prohibit the pledgeholder from waiving a part of its rights that arise from the pledge. However, once it declares such waiver, it cannot subsequently exercise the waived right in question. The Insolvency Law does not restrict the right of a secured creditor in an insolvency case to waive a pledge right either in full or in part, with or without the pledged assets being released, after the register of creditors' claims has closed. When the pledge is waived, the court considering the case must amend the register of creditors' claims accordingly. The courts should not assess as unlawful the creditor's intent to use voting rights after waiver of the pledge, since participation in the decision-making process at creditors' meetings is an inalienable right of an unsecured creditor.
As a result, the Bank obtained more than 50% of the votes at meetings of the debtor's creditors without reducing the amount of the pledged assets.
For the first time the Supreme Court applied the new Article 450.1 of the Civil Code in relation to a secured creditor in an insolvency case, ruling that such creditor may, at its own discretion, dispose of its rights. At the same time, the secured creditor may partially waive the pledge, with or without releasing the proportional part of the assets from pledge, by way of reducing the amount of the secured claim. The Supreme Court particularly emphasized that, if the pledge right is waived, it will be impossible to reinstate such right in future, which directly follows from Article 450.1(6) of the Civil Code.
The Ruling is in line with the trend of increasing protection for secured creditors' rights in insolvency cases. The Supreme Court's approach allows secured creditors to compare the amount of secured claims and the actual value of the pledged assets after the register of claims is closed and, if necessary, waive security in relation to the part of the claims that is in excess of the value of the pledged assets, in order to gain control over the insolvency procedure. A partial waiver of the pledge right declared in accordance with Article 450.1 of the Civil Code will considerably simplify and accelerate the process of obtaining the voting right at the creditors meeting as compared with the assignment of the claim.
The Supreme Court's approach set out in the Ruling may also apply in situations when the debtor is, at the same time, a surety and a pledgor that has provided security for a third party's obligations. In this instance, following the position of the Presidium of the Supreme Commercial Court8, the register records the claims against the debtor acting as surety as unsecured claims of third-priority less the amount included in the register as secured by the pledge. In turn, the register records the claims under a pledge based on the value of the pledged assets, but not more than the amount that the secured creditor may claim9. Consequently, the creditor obtains the voting right based only on the claims under the suretyship agreement, deducting any secured claims that are included in the register of creditors' claims. It seems that, in this situation, to obtain additional votes at meetings of the surety's creditors, the creditor may waive its pledge right in relation to a part of the claims, and may request that the court reduce the amount of the obligation secured by the pledge and increase the amount of the unsecured obligation based on the suretyship agreement.