Baker & McKenzie : Bankruptcy law changes to protect creditors’ rights

On 28 April 2009 Federal Law No. 73-FZ “On Amendment of Certain Legislative Acts of the Russian Federation” was adopted (the “Law”), which introduces amendments into the Russian bankruptcy legislation.

In response to the growing number of bankruptcy cases and suspected instances of asset stripping prior to and during the bankruptcy process, the legislators have broadened the circumstances under which creditors in a bankruptcy can challenge transactions by the debtor or with respect to the debtor’s assets. Previously under the bankruptcy law, transactions were generally reversible by the court in favour of creditors if they had occurred within 6 months prior to bankruptcy, in case of the transactions providing preference to one creditor over other creditors, and within 1 year limitation period, in case of transactions with an interested party.

The amendments to the bankruptcy law introduce a new concept of “suspicious transactions” which include sales or transfers by a bankrupt entity (a “Debtor”) of assets for a below market value which have taken place within 1 year prior to bankruptcy having been initiated, and also transfers where the parties are assumed to have known that the intent of the transaction was to prejudice the Debtor’s creditors. The latter type of transactions are challengeable if they occurred within 3 years prior to the bankruptcy proceedings of the Debtor. Importantly, these amendments introduce the concept that intent of the Debtor to prejudice the Debtor’s creditors as well as knowledge of the transferee thereof will be presumed in certain circumstances, which represents an important advance in this Law.

The amendments to the bankruptcy law also expand the previous definition of “preferential transactions” relating to Debtor’s existing creditors, which in the first instance will have to be considered by creditors seeking additional security from Debtors with respect to a pre-existing debt.

Finally, the Law aims to protect creditors’ rights by increasing the liability of the management and other controlling persons of Debtors (including credit organizations) in bankruptcy proceedings and imposing new liability and penalties for credit organization executives and members of management boards which fail to take action in event of bankruptcy of the credit organization.

The Law will enter into force on 5 June 2009 and will be applicable to bankruptcy proceedings initiated thereafter. However, it is not entirely clear how courts will apply its provisions on “hazardous” periods of challenging of transactions which were concluded prior 5 June 2009, because the Law does not provide for any restrictions on challenging such transactions. Also the Law will apply to bankruptcy proceedings initiated prior to 5 June 2009 as to challenging transactions concluded after that date.

 

I. Extension of liability in bankruptcy

The Law introduces a new concept of controlling person who is broadly defined as a person (an individual or a legal entity) who can control the Debtor’s activity and give mandatory instructions to it (including a member of a liquidation commission and an owner of more than 50% of the Debtor’s stock) or who could do so within a period of 2 years prior to the initiation of bankruptcy proceedings in relation to the Debtor.

If a controlling person infringed the rights of the Debtor’s creditors by its actions or instructions to the Debtor, such controlling person may be subsidiarily liable for monetary obligations of the Debtor if the Debtor’s assets are insufficient to satisfy all of the creditors’ claims. The amount of such liability may be reduced by court at its discretion if the creditors’ losses are significantly lower than their claims against the Debtor.

The Law also introduces subsidiary liability for the chief executive officer of the Debtor (in particular, the general director) for the loss or falsification of the Debtor’s accounting statements prior to the initiation of bankruptcy proceedings.

 

II. Challenging transactions during bankruptcy

1. Suspicious transactions

The amendments to the bankruptcy law introduce a new concept of “suspicious transactions”, which may be challenged during bankruptcy proceedings. Two types of transactions are defined as suspicious, namely undervalue transactions and transactions which are deemed to infringe the rights of the debtor’s creditors.

An undervalue transaction can be overturned by the court in bankruptcy proceedings if it is proven that:

  1. the counterparty to such transaction provides incommensurate consideration to the Debtor; and
  2. the transaction is concluded within 1 year prior to, or after the initiation of, bankruptcy proceedings against the Debtor.

Consideration will be deemed incommensurate where a materially lower price is paid to the Debtor or when other conditions of the transaction are materially worse for the Debtor, when compared with analogous transactions concluded in similar circumstances. The Law gives as an example the sale of property at a price substantially lower than the market price.

A transaction which is deemed to infringe creditors’ rights may be challenged if the following conditions are simultaneously met:

  1. the conclusion of the transaction was intended to prejudice creditors’ rights and has resulted in such infringement;
  2. the counterparty to the transaction was aware or should have been aware of the aim of such transaction;
  3. the transaction was concluded within 3 years prior to, or after the initiation of, bankruptcy proceedings against the Debtor.

The concept of the infringement of creditors’ rights is defined by the Law as any reduction in the Debtor’s assets or any increase in the value of the claims against the Debtor or any other consequences of the Debtor’s transactions or actions which result in the inability by creditors to obtain satisfaction of their claims.

According to the Law, it is assumed that a transaction was concluded with the purpose to infringe creditors’ rights if at the time of its conclusion the Debtor was insolvent and:

  • the transaction was gratuitous; or
  • the transaction was entered into with an interested party; or
  • the transaction aimed at the repayment of capital to a participant by the Debtor; or
  • the amount of the Debtor’s assets alienated under such transaction equals to more than 20 % of the balance sheet value of its assets (or more than 10% for banks); or
  • the Debtor changed its address without notifying its creditors before or immediately after the conclusion of such transaction, or concealed its property, or destroyed or falsified title documents, or accounting statements of the Debtor; or
  • after the conclusion of such transaction the Debtor continued to own and use the property alienated under such transaction or to give orders to the owner on the disposal of such property.

2. Preferential transactions

The Law clarifies what particular transactions may give preference to one creditor over other creditors for purposes of challenging them during bankruptcy proceedings.

A transaction gives preference to an existing creditor if such transaction:

  • provides for security to an existing creditor; or
  • entails any change of priorities in which the existing creditors’ claims are satisfied; or
  • may entail satisfaction of claims that have not yet matured; or
  • results in preferential satisfaction of claims of one creditor over other creditors’ claims.

3. Actions that may be challenged

The new rules on challenging transactions of the Debtor now apply not only to civil law transactions (e.g. contracts) concluded by the Debtor, but also to any actions relating to obligations arising from civil, labor, family, tax, customs, or court procedural legislation. Thus, the Law allows almost any action of the Debtor that meets the criteria of a suspicious or preferential transaction to be challenged.

4. Consequences of invalidation

Suspicious and preferential transactions may be challenged by the Debtor’s receiver at its own initiative or at the request of the creditors committee or the creditors meeting. If a transaction is invalidated under the above grounds, the court will apply dual restitution and all assets transferred under such transaction shall be returned to the Debtor and form part of its bankruptcy estate. The claims of the counterparty under the invalidated transaction which is deemed to infringe the creditors’ rights and certain types of preferential transactions may only be satisfied after satisfaction of all claims of creditors of all priorities. Claims of recipients of invalidated undervalue transactions may be satisfied in the third priority together with other unsecured claims of the creditors.

 

III. Bankruptcy of banks

The Law also introduces certain new procedures for the bankruptcy of banks and other credit organizations.

The Debtor’s governing bodies are now expressly obliged to apply to the Central Bank for the revocation of the Debtor’s banking license if any of the bankruptcy criteria are met or the Debtor’s capital adequacy becomes lower than