On 17 February 2011, the Plenum of the Supreme Arbitrazh Court of the Russian Federation passed Resolution No. 10 "On some questions of the application of pledge legislation" (the Resolution). The Resolution aims to eliminate existing ambiguities concerning the interpretation and application of pledge legislation and to enhance the position of lenders taking Russian law pledges. From 11 March 2011 (the Resolution’s official publication date), the Russian courts will follow the position of the Supreme Arbitrazh Court (set out in the Resolution) when passing their judgments.

This client update does not examine the Resolution in detail, but provides an overview of the major changes that may affect finance transactions secured by Russian law pledges and mortgages.

Amendment of principal obligation does not invalidate pledge agreement

Russian law prescribes certain mandatory terms that must be included in Russian law pledge agreements, such as the subject of the pledge agreement, the value of pledged property and a description of the secured obligations (including loan amount, interest rate, final maturity date, etc.). A pledge agreement may be held unexecuted in absence of any of these mandatory terms.

The Resolution clarifies that amendments to the secured obligations (being a material term of the Russian law pledge agreement) will not invalidate the pledge agreement itself even if it is not amended accordingly (unless the parties agree to the contrary). The non-amended pledge agreement will continue to secure performance of the principal obligations on the initially agreed terms.

Out-of-court enforcement options

In January 2009, certain amendments to Russian legislation relating to pledges and mortgages came into force. These amendments introduced the possibility of out-of-court enforcement of movable and immovable property. During the last two years, market practice has been to include all possible out-of-court enforcement options in Russian law pledge and mortgage agreements for the benefit of secured creditors. The Resolution, however, clarifies the view of the Supreme Arbitrazh Court on the use of these multiple out-of-court enforcement provisions.

According to the Resolution, if the parties to a mortgage agreement agree to more than one out-of-court enforcement option, the out-of-court enforcement agreement will be deemed not executed. The out-of-court enforcement clause (with multiple options) does not invalidate the mortgage agreement itself, but limits the mortgagee’s enforcement options to court enforcement only. The application of the Resolution by Russian courts will affect mortgage agreements, including those that have been executed prior to its publication. Therefore, if secured creditors still want out-of-court enforcement to be available under such mortgage agreements, they should consider the most suitable option and amend existing mortgage agreements accordingly. The above restriction, however, does not apply to pledges of movable property.

Minimum initial selling price of the pledged property at out-of-court public auction

To ensure a prompt sale, secured creditors commonly insist on a low initial selling price when realising pledged assets at an out-of-court public auction. The Supreme Arbitrazh Court has confirmed that the initial selling price of the pledged property in such circumstances must not be lower than 80 per cent of the value of the pledged property stipulated in the report of an independent appraiser.

Mortgage survival

The Resolution also resolves a problem relating to the survival of a mortgage over a land plot or a building in cases of separation, allocation or consolidation of the land plots or premises in the building. The Resolution expressly states that the original mortgage extends to newly created objects and must be registered in the state immovables register together with the state registration of such new immovable objects.

Levy execution on the part of pledged/mortgaged property

According to the Resolution, if one pledge/mortgage agreement encumbers several immovable objects, the mortgagee will have to levy execution on all such pledged/mortgaged objects unless the value of each object is stipulated in the pledge/mortgage agreement. Therefore it is advisable to expressly provide for the value of each object of a pledge/mortgage in addition to the total value of the pledged/mortgaged property in Russian law security documents.

Mortgage of premises without underlying land plot

The Resolution confirms that the mortgage of premises in a non-residential building or a block of flats does not require mortgage of ownership or lease rights to the underlying land plot.

No notarisation of mortgages

The Resolution also resolves the inconsistencies in Russian legislation on the notarisation requirements of certain mortgages. It clearly states that mortgages over aircraft, sea and river vessels, railway vehicles and space objects are not subject to notarisation.

Protection for good faith purchasers

The Resolution prohibits levy execution on the pledged movable property acquired for consideration by a good faith purchaser who did not know, and would not be expected to know, that the acquired property is subject to a pledge