Bankruptcy cases can involve not only the debtor’s pledge creditors (creditors whose claims are secured by means of a pledge), but also creditors whose claims are secured by other means of securing the performance of obligations. Said means may include both those means that are explicitly defined in the Russian Civil Code and those that are not. Among the means of proprietary nature (as opposed to means of personal nature, such as suretyship), special mention goes to security deposit, retention money, security transfer of title and finance lease. These means often result in serious problems in bankruptcy cases.
Deposit rules have been provided in the Russian Civil Code from its adoption in 1994 (Articles 380-381). Security deposit, a separate institution that is particularly popular on the financial market, was incorporated into the Russian Civil Code in 2015 during its modernization. Despite the similarity between the English terms “deposit” and “security deposit”, they constitute two independent institutions under Russian Law. They have both similarities and differences, although the latter are not substantially relevant in the context of bankruptcy cases.
The list of means of securing the performance of obligations defined in the Russian Civil Code does not include retention money, security transfer of title (including repo transactions) or finance lease. However, these means are very common in practice and often result in judicial trials.
Retention money is commonly understood as a contractual right of the creditor to retain a part of the contractual price that is due to be paid to the debtor (for instance, a payment to the contractor by the commissioner) until the expiration of the warranty period for the provided goods, works and services. Should the creditor identify any defects during the warranty period, the retention money is used to rectify them.
Finance lease is increasingly frequently considered to be a form of provision of credit secured by transfer of title. This approach is supported by Russian case law, including the Russian Supreme Court’s legal position.
All of the aforementioned security means share a similarity in that the Russian Bankruptcy Act doesn’t provide any special regulation in the event of bankruptcy involving said means. The current Bankruptcy Act regulates only relations with pledge creditors. Their claims are listed in the creditor's register and satisfied as a priority concern, but subject to restrictions: a part of the pledge realization (20-30%) is not paid to the pledge creditor, but is instead allocated towards the creditors of “social” categories. Therefore, pledge creditors in the bankruptcy case might not always be able to fully satisfy of their claims.
As for the creditors whose claims are secured by other means of proprietary nature, their situation is not covered by either the special provisions of the Bankruptcy Act or the established case law. In some cases, such creditors are able to fully satisfy their claims due to being given priority over all the other creditors of the debtor; a position that is even better than that of the pledge creditors. In other cases, however, the position of creditors in question can be significantly worse than those of pledge creditors.
At the present, disputes involving security means other than pledge are settled by local and regional arbitrazh (commercial) courts. A scant few cases have been escalated to the Russian Supreme Court, but at this time, the Supreme Court has not yet established any definite legal position upon the most significant issues.
The most common question entailed by a deposit or a security deposit: is a creditor entitled to satisfy his or her claim against a debtor at the expense of the security means in the creditor’s possession? For instance, in a situation involving a tenant debtor and a landlord creditor, is the latter entitled to collect a debt for rental payment?
On the surface, it appears straightforward: the funds (deposit or security deposit) are in the creditor’s possession, the Russian Civil Code explicitly permits the use of these funds as a contractual payment, and unlike the pledge, no special levy of execution is required. The problem, however, is that satisfying a creditor’s claims in this manner resembles a set-off resulting in preferential satisfaction of one creditor’s claims before everyone else’s - and such a set-off is explicitly prohibited by the Bankruptcy Act. One exception to the above is the closeout netting procedure, which is permitted under said Act, but it is restricted to financial contracts concluded under the rules of the financial market.
Russian courts have considered some cases concerning the preferential satisfaction problem, wherein the debtors’ insolvency officials disputed the actions of the creditors who have fully satisfied their claims at the expense of deposits. The insolvency officials believed that these actions constituted a set-off prohibited by the Russian Bankruptcy Act. Local and regional arbitrazh (commercial) courts ruled that the creditors’ actions did not constitute a set-off, and were thus lawful. The Russian Supreme Court did not reverse these decisions, but also refrained from establishing a legal position on the dispute’s merits.
The primary issue identified by the judges is that, once the deposit or security is transferred to a creditor, it is no longer possible to recover and include it into the debtor’s bankruptcy estate, as the Russian bankruptcy legislation provides no legal grounds for such recovery. Counterintuitively, if the creditors were prohibited from satisfying their claims at the expense of deposits, that would only serve to make the situation worse for the debtor and other creditors. The deposit in question would remain with the creditor who obtained it originally, yet the claim of said creditor would be listed in the creditors’ register and would be satisfied at the expense of the debtor’s bankruptcy estate. This would effectively result in the debtor paying twice, thus leading to unjust enrichment of the creditor in question. In order to avoid this result, the courts opt for «the lesser evil» by allowing full satisfaction of the creditors’ claims secured by deposit with preference over all the other creditors of the debtor, including pledge creditors.
This situation is not adequate and is likely to be further regulated. Russian legal researchers increasingly point out the unfeasibility of making the creditors’ privileges contingent on their choice of security means. In particular, they stress that, in bankruptcy cases, a creditor whose claim is secured by means of transfer of the debtor’s title (for instance by sale and repurchase agreement) is in a significantly better position than any pledge creditor. The researchers believe that satisfaction of creditors’ claims in bankruptcy cases needs to be regulated uniformly regardless of the security means securing the debtor’s obligation.
The Russian Supreme Court intends to establish guidelines on the matter of security means in the near future. Among the cases recently considered by this Court, the most relevant are a lease payments dispute and a retention money case. Both cases have been considered by the Judicial Chamber on Economic Disputes of the Russian Supreme Court (hereinafter – “the Chamber”), which has laid down its legal positions.
In the finance lease case, the courts evaluated the mutual obligations of the parties to multiple lease contracts involving a leaseholder that became insolvent. The Chamber prohibited the aggregation of the lease contracts for the purpose of determining the balance of mutual obligations, and mandated the examination of each contract and contractual obligation separately. According to the Chamber, aggregate balancing would constitute a set-off, which is prohibited in bankruptcy cases.
Separate examination of finance lease contracts means that the leasing company is obliged to transfer to the leaseholder the property which has been paid for (under some of the contracts), whereas the leaseholder’s debts (under the other contracts) can only be recovered under the standard procedure pursuant to the Bankruptcy Act. This approach deprives the leasing company of any privileges and priorities connected with the title to a leasing subject, thus putting in into a worse position compared to a pledge creditor.
In the retention money case, the Chamber, in contrast with the above referenced case, supported a creditor with said security means. The creditor’s actions to have been held lawful, the Chamber didn’t identify any legal grounds to recover retention money into the debtor’s bankruptcy estate. According to the Chamber, the debtor is entitled to sell his right to demand of retention money as an accounts receivable.
- At this point, the procedure and the level of creditors’ claims satisfaction in a bankruptcy case depend largely on the security means by which the creditor’s claim is secured;
- The Russian Bankruptcy Act provides special regulation only for pledge creditors;
- The creditors whose claims are secured by other security means of proprietary nature may be either better off or worse off than the pledge creditors;
- The Russian Supreme Court intends to lay down its guidelines concerning security means in the near future, as there are no established legal positions at this stage;
- The Russian Bankruptcy Act can be amended in order to put creditors with different security means on equal footing.