22. Corporate bankruptcy

General

Bankruptcy proceedings are governed by the Insolvency Law, which is the principal piece of legislation on bankruptcy in Russia. The Insolvency Law provides for bankruptcy regimes for both corporates and individuals.
Сommercial (“arbitrazh”) courts conduct these proceedings both in relation to businesses (corporates, private entrepreneurs) and individuals. Self-regulated bankruptcy practitioners (bankruptcy managers) supervise and, at certain stages, manage the business and (or) estate of bankrupts.

Insolvency criteria

The main criteria are the debtor’s inability to meet creditors’ claims or to fulfil mandatory payment obligations for three months from the date on which they fall due.

Initiating bankruptcy proceedings

The petition for bankruptcy can be filed by:
· The debtor (i.e. its management bodies);
· A creditor;
· The authorities such as the Russian Federal Tax Service or the Russian Federal Customs Service; or
· A current or former employee.
A debtor must file a bankruptcy petition with a commercial court to initiate its own bankruptcy proceedings if one of the insolvency criteria below is met:
· The debtor will be unable to pay to its creditors after settling some of their claims;
· The debtor will be unable to continue, or will be significantly restricted in continuing, its operations if claims against the debtor’s assets are enforced;
· The debtor meets the “inability to pay” test (i.e. the debtor fails to perform its payment obligations when due because of insufficient funds);
· The debtor meets the “insufficient assets” test (i.e. the value of the debtor’s payment obligations exceeds the value of its assets); and/or
· As a result of insufficient funds, the debtor is unable to pay its (ex-) employees for over three months.
The right of a creditor to file a bankruptcy petition with a court arises if an aggregate debt of a company exceeds RUB 2,000,000.
As the general rule, an enforceable court decision confirming the debt is required.
However, a credit institution or a facility agent¹ acting on behalf of other creditors under syndicated loan agreements may open proceedings immediately after their debtor has met an insolvency criterion.
To file for bankruptcy a creditor should also publish a notice in the special online register² at least 15 days before filing.

¹ The facility agent can be a Russian credit institution, VEB.RF, a foreign bank or an international financial institution.
² Unified Federal Register of Legally Significant Data about the Facts of the Activities of Legal Entities at www.fedresurs.ru

Stages of bankruptcy proceedings

The insolvent company may be subject to five stages of bankruptcy proceedings:
· Supervision;
· Financial rehabilitation;
· External management;
· Bankruptcy liquidation; and
· Voluntary arrangement.
In practice, however, most companies undergo only supervision and bankruptcy liquidation stages.
Supervision
Supervision is a provisional stage. A temporary manager steps in to oversee the activities of the debtor and its management bodies.
Supervision aims to (i) preserve the debtor’s property; (ii) analyse its financial state; (iii) register creditors’ claims; and (iv) hold the first creditors’ meeting to decide on the next stages.
The court may also impose interim measures (e.g. an arrest, a freezing order) to secure the assets.
The temporary manager is entitled to, amongst other actions, (i) take measures to preserve the debtor’s assets; (ii) obtain information from the debtor; (iii) obtain documents relating to the debtor’s activities; (iv) seek invalidation of transactions made by the debtor; (v) request the court to remove a director; and (vi) challenge the claims brought by creditors.
The debtor’s business will be restricted as follows:
· Paying out profits and dividends, as well as making set-offs that violate the order of priorities established by the Insolvency Law (subject to certain exceptions) is impossible. The debtor may not alienate or purchase shares, facilitate the apportionment of a participatory interest or pay out its fair value, issue securities (excluding shares), reorganise its company structure or incorporate subsidiaries.
· Any property deal with a value exceeding 5% of the debtor’s balance sheet value and any credit-related transactions require the prior written consent of the temporary manager.
The debtor in the form of a joint-stock company may increase its share capital but only by way of a private placement of additional ordinary shares to be allotted to the shareholders or certain third parties. No issuance of any other emission securities is allowed. However, a debt-to-equity conversion is permitted. If the debtor’s shareholders/participants or third parties repay all creditors’ claims according to the creditors’ register, the bankruptcy proceedings will terminate.
Supervision stage is closed by termination of the bankruptcy proceedings (if the debtor’s solvency has been restored) or the introduction of one of the next stages of bankruptcy proceedings.
In most cases, however, bankruptcy liquidation is introduced.
Financial rehabilitation
This procedure is aimed at restoring the debtor’s solvency and rescheduling payment of the outstanding debts. Financial rehabilitation may last up to two years.
It requires introduction of a financial rehabilitation plan, a debt repayment schedule, and the security for performance of the debtor’s obligations
At this stage most major transactions require the consent of a creditors’ meeting.
Transactions which increase the debtor’s level of indebtedness by more than 5%, sale and purchase of the debtor’s property, assignments and borrowings require consent of the bankruptcy manager.
External management
This procedure intends to restore the debtor’s solvency and may last up to 18 months (with a possible six-month extension).
When it is introduced, the powers of the debtor’s general director are terminated and transferred to the bankruptcy manager. However, the debtor’s management retain limited powers relating to capital, additional share issues and entry into specified major transactions (subject to the consent of the creditors’ meeting).
Unless the debtor’s solvency is restored during this stage, or other alternative bankruptcy stage is agreed, bankruptcy liquidation will be introduced in the end of this procedure.
Bankruptcy liquidation
This stage is designed to settle the creditors’ claims through the sale of the debtor’s assets. It can be instituted for up to six months (with a possible further six-month extension(s)).
The immediate effects of this stage are:
· Monetary obligations and mandatory payments of the debtor are accelerated.
· Interest no longer accrues.
· Encumbrances over the debtor’s property are removed.
· The powers of the debtor’s general director and board of directors are terminated and vested with the bankruptcy manager.
The duty of the bankruptcy manager is to search, return, evaluate, pool and arrange for a sale of the debtor’s assets, and to pay out the proceeds to creditors. The bankruptcy manager also dismisses the debtor’s employees.
The Insolvency Law provides a specific priority order by which creditors’ claims are to be satisfied. The priority order includes first, second and third tiers.
First tier includes personal injury claims and moral damage claims.
Second tier includes: (i) severance benefits; (ii) the wages of the debtor’s employees; and (iii) copyright royalties.
Third tier includes all other claims, both unsecured and secured by a pledge or a mortgage, including taxes.
Secured claims are settled from the proceeds from the sale of the pledged property (capped to the principal amount and accrued interest).
Obligations under financial agreements that are based on certain recognised master agreements (derivative or repo), stock exchange trading rules or clearing rules can be settled by liquidation (close-out) netting.
The debts that were not settled during bankruptcy are deemed written-off. Upon completion of bankruptcy the legal entity terminates.
Voluntary arrangement
A voluntary arrangement can be made by the creditors, third parties, and the debtor at any stage of the bankruptcy proceedings.
The parties are entitled to file for the termination of the voluntary arrangement if the debtor defaults or significantly breaches its terms.
If the voluntary arrangement is complied with, bankruptcy process terminates.

Additional (“subsidiary”) liability

The Insolvency Law provides for the specific liability of a bankrupt company’s “controlling persons”. A controlling person is someone (an individual or entity) who has the right to give mandatory instructions or otherwise has an opportunity to determine the debtor’s actions. A general director or a shareholder having at least 50% of shares or votes are presumed to be in control. The controlling position may also arise on other grounds (de-facto control or “shadow” director).
The controlling person bears so-called “subsidiary” liability for the subsidiary’s debts. The creditors in bankruptcy may bring their claims against the controlling person only to the extent the primary debtor’s assets are insufficient. The liability arises if full settlement of the company’s debts is not possible due to the actions or a failure to act of the controlling person.
Application of this kind of liability is fact driven. The court is required to establish a causal link between a specific action (e.g. approval of a loss-making transaction) and a claimed amount.
The controlling person cannot be held liable if it acted within common business practice, reasonably and in good faith, and the controlling person is able to show that it acted to prevent a greater loss to the creditors. The controlling person’s fault is presumed, and the standards of proof to have this presumption rebutted are high.
The number of claims against controlling persons by way of the subsidiary liability is substantial. It is widely accepted that a claim for subsidiary liability is used in almost any insolvency process. Interim measures are often imposed by the court to secure the verdict in respect of the potential culprits, such as a travel ban for individuals, or a seizure of assets/prohibition to undertake certain actions against legal entities.

Claw-back claims

The judge’s role in bankruptcy proceedings in Russia is rather inquisitorial, so they usually act quite actively, including ordering extensive disclosure of evidence by defendants.
Bankruptcy managers also act rather actively. They usually scrutinise the available documents and information (including those received from bankrupt’s counterparties, banks and tax authorities) to find ways to accumulate the assets of the bankrupt. This typically includes finding transactions subject to challenge through claw-back claims. “Transaction” is understood rather vaguely – as any contract, deal, performance thereunder, payment and transfer of assets, including collectibles, etc.
The following transactions may be contested under the claw-back claim:
· “Suspicious transaction” – a transaction made in advance of insolvency with the purpose of withdrawing assets from the company.
· “Preferential transaction” – a transaction that gives preference to a certain creditor in comparison to other creditors (e.g. when this creditor gets a priority payment from the bankrupt’s assets).

Expected changes

From 27 June 2027, debtors and their creditors may apply for the new procedure called “restructuring of debts”. According to it, up to four years may be granted to a debtor to restore the solvency and to avoid bankruptcy. The court shall approve restructuring plan to enable it.
Also, a “sanation” procedure will be introduced as an alternative to a court-administered bankruptcy process. As the general rule, it will not require court’s involvement at all. However, businesses with asset value exceeding RUB 1bn will need to apply to the court to have their sanation plan approved.