The business community in Russia is going to see an increase in default claims due to the mounting credit crisis. Many companies will not survive in such an environment and a wave of insolvencies is likely to ensue. The prospect of this has forced the State Duma to focus on developing a robust response. New bills, which would transform the Russian insolvency landscape, are currently under consideration.

The Russian authorities have recently introduced a series of legislative measures to stabilise the financial system and support the economy (see our Russian Legal Update dated 8 December 2008). The next steps are to develop insolvency procedures, make them more transparent and ensure they protect creditors’ rights in the event of a debtor’s insolvency.  

  1. The Russian Government proposed changes to Russian insolvency legislation at the beginning of 2005. Bill Nr. 145263-4, submitted to the State Duma on 28 February 2005, proposed more than 150 changes in the Federal law dated 27 September 2002 Nr.127-FZ “On Insolvency (Bankruptcy)” (the Insolvency Law). The recent deterioration in the economy and financial difficulties, which a significant number of companies might suffer, has forced Russian parliamentarians to speed up the passage of this important legislation. The main changes concern:  
  • the status of the insolvency manager (requirements for the position, rights and obligations in insolvency procedures, remuneration and liability, appointment and resignation etc.);
  • self-regulated organisations of insolvency managers (legal status and functions, rights and obligations, registration of self-regulated organisations and state control over them, public disclosure and reporting etc.); and
  • procedures of insolvency and encouraging financial recovery in insolvency (parties to insolvency proceedings, abandoning an insolvency claim, securing creditors’ rights in insolvency, “sale of enterprise” and “sale of property” of the insolvent company, the financial support of an insolvent company from shareholders and third parties etc).  

The proposed changes to the Insolvency Law aim to increase transparency relating to the status, rights and liability of insolvency managers (who play a key role in the insolvency regimes) and to impose stricter controls over the choice of the insolvency manager. Some changes concern requirements of candidates to be appointed as insolvency managers, and stipulate how any state secrets in the insolvency process should be managed.  

The second part of the changes relates to professional organisations of insolvency managers, which provide for the overall supervision of the latter. The changes concern professional liability insurance and a damagessettlement fund to cover liabilities incurred by insolvency managers for their negligent actions and inactions.  

Further changes relate to (i) the regulation of some insolvency procedures (such as a supervision, external management, bankruptcy and mutual compromise agreements); and (ii) the extent of state control over insolvency proceedings.

Some amendments provide for insolvency procedures and insolvency case resolution such as court’s investigation of the basis of an insolvency claim, control over the costs of insolvency procedures, and assessments and disposal of property of an insolvent company.  

Alterations are also proposed to the regulation of possible financial support for an insolvent company from its shareholders and third parties.  

The above-mentioned changes were adopted by the Russian Parliament at the end of 2008 and submitted for the President’s approval. These changes will come into force after the official publication but some of them will take effect from 1 July 2009 or 1 January 2010 (according to the timetable proposed in the bill).1 Thus, Russian insolvency procedures may soon become more transparent and clear.  

  1. Another bill, Nr.100593-5, which was introduced to the State Duma on 19 September 2008, is devoted to the netting agreements under derivative transactions (such as transactions using ISDA documentation) when a party to such an agreement becomes insolvent. This bill proposes changes to the Insolvency Law and the Federal Law dated 18 September 1998  

Nr. 40-FZ “On insolvency (bankruptcy) of credit organisations” (the Credit Organisations Insolvency Law). Under the existing Russian insolvency legislation, set-off is not permitted on insolvency. This has a negative impact on those companies whose counterparties under derivatives netting agreements become insolvent: the insolvency manager will demand the solvent parties pay their share of any losses incurred but will not honour the equivalent obligations of the insolvent company. The solvent party is treated merely as an ordinary unsecured creditor of the insolvent company. Bill changes the approach to netting arrangements and allows parties to set-off losses and profits on deals within one netting agreement with a counterparty, which has become insolvent. Unfortunately this bill was withdrawn on 25 December 2008.

  1. Another bill, Nr. 119643-5, that has been proposed by the State Duma’s members is connected with the problem of enforcing pledges and mortgages. This bill would amend a number of laws such as the Federal Law dated 24 June 1997 Nr. 102-FZ “On mortgage” (the Mortgage Law) and the Law dated 29 May 1995 Nr. 2872-1 “On pledge” (the Pledge Law), the Civil Code of the Russian Federation (in the part on pledge), and current insolvency legislation. It introduces stricter and more coherent procedures for enforcing security and sets out the rights of secured creditors in case of a borrower’s insolvency. The proposed changes set out the maximum percentage of proceeds from enforcement of any security which may nonetheless be applied in repaying creditors having priority ahead of secured creditors on insolvency. It also allows the enforcement of the security without the creditor(s) having to file a claim to court if this is agreed between parties to a pledge or mortgage agreement. Under the current Pledge Law and Mortgage Law such agreements can only be made after the secured debt becomes due. This bill passed all parliamentary hearings in late December 2008 and was signed by the President, and it came into effect on 11 January 2009.
  2. Bill Nr. 125066-5, dated 12 November 2008, proposes changes in insolvency procedures for credit organisations. This bill introduces potential liability on insolvency for anyone (companies or individuals in their capacity as shareholders, affiliated and interested parties to an insolvent company), who had the ability to control or influence the company before it became insolvent. It encourages the company’s management and shareholders to support the company when it faces financial difficulties. The new law would also impose stricter regulation of contestation of deals of the insolvent company. It is common in Russian business practice that, when a company starts suffering financial difficulties, its management and shareholders try to transfer the assets into affiliated or related entities before formal insolvency begins, to decrease the pool of assets available to creditors on insolvency. The proposed changes will make such asset transfers more difficult and help insolvency managers to contest such deals successfully and will be an important creditor protection. The first reading of this bill took place on 19 December 2008 and the next hearing might be in January 2009.
  3. There are some other bills developing insolvency legislation waiting for parliamentary consideration:  
  • bill Nr. 146674-4 proposes changes to the Insolvency Law and the Tax Code relating to an increase from six months to one year of deferral of taxes for insolvent companies under the financial recovery or the mutual compromise agreement procedures;
  • bill Nr. 151989-4 introduces changes to the banking legislation and the Credit Organisations Insolvency Law increasing of the capital adequacy requirement for banking institutions from the current 2 per cent to 10 per cent. The inadequacy of capital is a ground for the Bank of Russia to revoke the banking licence and start an insolvency proceeding in respect of such credit organisation;
  • bill Nr. 392304-4 introduces particularities of insolvency proceeding of companies obtaining funds for residential construction to protect rights and interests of individuals who take part in financing of such construction;
  • bill Nr. 68143-5 introduces changes to the insolvency law relating to sales of agricultural land plots of insolvent agricultural companies: this bill adjusts the implementation of the preemptive rights in buying of such land by other local agricultural companies;
  • bill Nr. 100311-5 proposes changes in the Insolvency Law and some other acts adjusting the insolvency proceeding for financial companies other than banking institutions (e.g. insurance companies, managing companies for mutual investment funds and pension funds, special depositories and professional participants of security market).

To summarise, this legislative activity demonstrates the willingness of the Russian legislators and authorities in the current economic difficulties to protect interests of creditors and improve insolvency processes.