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Russian bankruptcy law proposal seeks to limit related party influence, but measures may yet be diluted

The Ministry of Economic Development of the Russian Federation has submitted a draft law to its parliament, which is considered a reform of its existing bankruptcy legislation, introducing, amongst others, efficient debt restructuring tools.  

The existing Russian Bankruptcy Law has been in place since 2002, and has matured from its establishment, said Konstantin Kroll, partner at law firm Dentons LLP. On paper at least, the principles of the existing law are comparable to bankruptcy laws in other jurisdictions. However, problems occur during implementation, Kroll continued.

Theoretically, creditors are supposed to be treated fairly. But in practice, the chances of securing a return for bona fide creditors is very slim and the system is often abused by company owners or shareholders and also by strong creditors with an upper hand, Kroll noted.

The involvement of the beneficiaries of businesses in the bankruptcy proceedings is currently a double-edged sword, said Fedor Belykh, associate at Latham & Watkins LLP. On one hand, owners can be held liable for a company’s debts. On the other hand, owners can oversee the bankruptcy proceedings whilst also acting as a creditor of an offshore company, he added.

The draft proposal is vast and contains significant changes, said Belykh. Historically, the bankruptcy proceedings included several procedures, and creditors often had to go through several complex stages, Belykh added. 

“The proposed amendment to the bankruptcy law is complex […] the changes are debtor-friendly in a sense that they are aimed at giving the debtor more chances to survive and also creditor-friendly as they give bona fide third-party creditors more chances of recovery,” according to Kroll.

The proposed draft bill contains some effective initiatives, but it is also dependent on practical application in the judicial system, Belykh noted. This includes managing complex bankruptcy cases requiring technical industry knowledge, he added.  

Alterations possible

There is no guarantee that this draft will pass three hearings at the lower chamber of parliament, which will then need to be approved by the upper chamber of parliament and then the approval of the President, said Kroll. He noted that there have been many draft laws that didn't pass the lower chamber, but if it does, 99% of the time it gets the approval from the president.

Even if the law gets the approval and although the draft proposal looks highly promising, both Kroll and Belykh emphasised the possibility that there may be substantial changes during the approval phase and therefore the final version may be significantly different to what is submitted by the Ministry.

Members of the parliament are allowed to change the draft, and there are strong market participants, like the banks, which may have an influence on them by means of lobbying, Kroll noted.

Due to the specific nature of this law and the nascency of its development, it suggests that it may be passed with significant changes following intense discussions, Belykh noted, adding that this is not the first attempt to change the bankruptcy law and implementing further changes will likely not be easy. 

Additional COVID-19 measures

On a separate note, the COVID-19 pandemic may also impact the status of the draft law. The proposal was before COVID-19 became a pandemic and bankruptcies are likely to increase due to the current state of the market, hence there may be more incentive for various market players to influence the current draft law, Kroll noted.

The Ministry of Economic Development started working on the draft bill more than a year ago. The President has since proposed the second draft law, which aims to resolve the disruption caused by the current COVID-19 pandemic, said Belykh.  

The second draft proposal by the Ministry is much shorter than the draft bankruptcy law itself, Kroll noted. The one-page proposal will allow the government to enact a law to prevent a significant, viable company going bankrupt if there are extraordinary market circumstances – like the current devaluation of RUB – and enables the introduction of a moratorium or stopping the ongoing enforcement proceedings for a company’s debt, Kroll said. This draft proposal will be applicable to companies that began to struggle recently, not for ones which have been struggling for a long time. 

Regarding timeline, the law is unlikely to be implemented before autumn 2020, Belykh noted. The spring State Duma session will end before July and due to the current global situation will most likely be occupied with other matters, said Belykh. However, there is a high probability that this second draft bill proposed by the President may be pushed through rather fast and implemented first under the current unpresented economic environment, both Kroll and Belykh agreed.

Supreme Court precedent

Apart from the two drafts, there has been a recent “practice overview resolution” handed down by the Supreme Court of the Russian Federation that provided guidance, amongst other things, limiting the ability of shareholders and third parties controlling the debtor, such as banks holding a security over the debtor’s shares, to influence the bankruptcy proceedings, Kroll noted.

There have been various schemes used to allow controlling shareholders to influence the whole proceeding, such as shareholder loans granted to manipulate the bankruptcy mechanism, Kroll added.

While Russian law does not feature the concept of judicial precedent, lower courts in practice always follow resolutions of the Supreme Court. This important ruling could impact bankruptcy practice in Russia, in particular protecting the rights of bona fide third-party creditors that are “unrelated” to the debtor, said Kroll, but potentially creates problems for bona fide creditors holding security over the bankrupt entity’s shares.

However, if the draft proposals are enacted, these new laws will take precedent over any earlier judicial practice, he continued.

Proposed Changes

One of the biggest fundamental changes proposed is aiming to minimise the influence of creditors that are controlling or otherwise affiliated or related with the company, Kroll noted. The other important proposed change is the introduction of legal framework for standstill agreements which are currently problematic under Russian law, he added.

It is now proposed that there will be two main procedures – one being liquidation and the second a financial debt restructuring, said Belykh. Creditors will have to choose one of them and if the they choose the restructuring option, it will not be possible to switch to the liquidation other than by refiling the application.

Dutch Auction

There are also various proposed changes of a technical nature, Kroll said. For example, the existing law regulates a public auction proceeding for the property that is secured against the loan and there is often little appetite to increase the bids, which results in many auctions failing, he added. To tackle this problem the new proposed law is introducing the concept of a Dutch Auction, where the bidders need to offer lower price rather than the classical auctions where the bidders are required to bid higher, Kroll added.

The draft bill offers an upgrade in terms of the bankruptcy estate sale process to make it more convenient and transparent to buyers, Belykh noted. Currently, there are various stages to participate in a bankruptcy estate auction, and usually it is not easy to track such auctions in the first place, he noted, adding that the new law offers one, open, transparent and common marketplace for the most marketable assets.  

Collective liability of the managers

Another important change is with regards to the status and involvement of bankruptcy managers, according to Belykh.

One of key concerns was that often bankruptcy managers could quite often be affiliated with, or loyal to some of the creditors or the owners of the companies but the new law could potentially resolve this conflict of interest, Belykh added.

“The new law introduces a more sophisticated and independent method of appointing bankruptcy managers – automatically and based on their rating/performance. But how will it work in practice? Firstly, the proposed rating (scoring) method is quite complicated and, secondly, the extent to which this method will be immune to attempts from creditors and other interested parties to influence and misuse it,” he continued.

It is also proposed that the self-organised associations of managers will be obligated to compensate for damages that a manager — member of such association – caused during a bankruptcy proceeding, Belykh added.

If the respective insurance and reserves of the association are not sufficient to cover such liability claim, the members of the association are collectively liable, he continued. If the reserves of the association are not reinstated by its members, such association must be de-registered and all its members shall be banned from practicing for three years. This idea could encourage the community of bankruptcy managers to develop and maintain stricter professional and ethical standards and policies, Belykh noted. 

Are you in or out?

Kroll noted that debt restructurings in the bankruptcy scenario are handled in court, rather than out-of-court. However, the out-of-court settlement is more common for difficult and complex cases, unless bankruptcy liquidation is unavoidable, according to Belykh.

If the proposed restructuring mechanism proves its effectiveness, this disposition may change, Belykh continued. Among other things, the mechanism suggests that debtor or the creditors may devise a restructuring plan for up to four-year period with an option to extend it for another four years of controlled restructuring, he added. 

According to Belykh, this approach potentially creates more reliable and protective framework for reaching an agreement with creditors but “with these new restructuring provisions in place, it is unclear what will be considered as settlement, since a formal settlement remains in the Russian bankruptcy laws as a separate procedure”, he added.  

By Asli Orbay, Reporter, Arbitration and Litigation, Debtwire CEEMEA

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