the focus of attention became the inability of an enterprise to timely ful fill its obligations as regards the redemption, and in this instance the enterprise was recognized as insolvent on a cash basis. This resulted in considerable lowering of the barriers for initiating the proceedings in bankruptcy. Therefore, the scope of applying bankruptcy procedures in the economy began to grow rather rapidly.
Experts had warned that the enactment of the 2nd Law on bank ruptcy would result in a dramatic rise in the number of bankruptcies, because a majority of Russian companies prior to the year 1998 had accumulated substantial arrears of debt to the federal and regional budgets, as well as to private creditors, due to the absence of efficient regulations concerning bankruptcy. As expected, the number of bank ruptcies surged after the 2nd Law on bankruptcy had come into force.
Medlit’ s sozdaniiem effektivnogo mekhanisma bankrotstva opasno. Interv’iu s D. Noko logorskim. (It is dangerous to delay the creation of an efficient mechanism of bankruptcy.
An interview with D. Nikologorskii). –Rynok tsennykh bumag, 1997, No. 12.
K. Son in, Ye. Zhuravskaia. Bankrotstvo v Rossii: ni zashchity kreditorov, ni restrukturiro vaniia. Spetsial’nyi doklad. – Obzor ekonomiki Rossii. Osnovnye tendentsii razvitiia. 2000 g.
(Bankruptcy in Russia: neither creditors’ protection, nor restructuring. A special report. – An overview of Russia’s economy. Main trends of development. 2000). I: Transl. from the English. – M., RETsEP, 2000.
This growth in the number of bankruptcies was interpreted by many ex perts as an evidence that owing to the enactment of the 2nd Law on bankruptcy the budget restraints for Russian enterprises became harder.
8337 1108 10000 1993 1994 1995 1996 1997 1998 1999 2000 2001 Fig. 2. Numbers of petitions in bankruptcy resulting in initiated proceedings At the same time, the experience of applying the 1998 Law on bank ruptcy demonstrated the simplicity of initiating bankruptcy procedures against large enterprises when their debts were small, as compared to the scope of their business. The reason was that, in accordance with this law, a creditor could petition with the arbitrage court that its debtor be deemed to be bankrupt when the latter had failed to fulfill its obliga tions during three months, and the amount of debt exceeded 500 mini mum salaries. Thus, the principle of insolvency was to a markedly higher degree promoting payment discipline, creating equal opportuni ties for creditors in respect to initiating a bankruptcy procedure, was not requiring a mandatory high professional qualification for making a court decision concerning a specific case; however, this approach did not take into account the scope of a business or potential cash gaps that might not be necessarily indicative of the enterprise’s true ineffi ciency.
It should be noted that the 2nd Law on bankruptcy also made use, in a “soft” form, of the principle of unpayability. Thus, in accordance with Item 2 of Article 51 of this law, if a debtor possessed a liquid property sufficient to redeem its debts, the arbitrage court had the right to sus pend the proceedings in bankruptcy, having suggested that the debtor satisfy the creditors’ claims within a certain period of time.
The second phase in the development of the institution of insol vency, especially after the 1998 financial crisis, was characterized by a fundamental change in the composition of the main factors influencing the implementation of bankruptcy procedures:
• the “threshold” for initiating bankruptcy procedures was considera bly lowered;
• the processes of industrial integration were intensified, while the law making activity aimed at protecting the interests of minority shareholders became more intense;
• a significant number of enterprises showed production growth, with a still high level of tax arrears62; the State had no right of vote when the most important decisions were being adopted by shareholder meetings;
• the system of arbitrage courts was developing, however they were found to be strongly dependent on regional and local authorities;
• problems pertaining to the training of bankruptcy commissioners and their affiliation to certain creditors.
Issues relating to the initiation of the bankruptcy process have, in a variety of ways, been touched upon in a majority of publications con cerning legal regulation in the sphere of insolvency. Some categories of the institution of insolvency, like the criteria for and indicia of bank ruptcy and the grounds for initiating courts proceedings, are discussed in detail, for example, by V. Vitrianskii63, who disagrees with the com mon point of view that the main reason for the ability, under the 2nd Law on bankruptcy, to have any commercial organization be deemed “to be bankrupt”, no matter what the status of its property might be, were the too soft, too liberal criteria of bankruptcy established by this law: the three month delay in the redemption of a liability in the amount in ex cess of 500 minimum salaries. Actually, as the author argues, the Budget constraints began to be systematically hardened only from the second half of 2001 onward, due to the then initiated campaign for restructuring enterprises’ arrears of debts against mandatory payments.
V. Vitrianskii. Puti sovershenstvovaniia zakonodatelstva o bankrotstve. (Ways for improv ing bankruptcy legislation). – Vestnik VAS RF, No. 3, 2001.
amount of a liability and the period of delay in its execution are not the true criteria of bankruptcy, and represent only the external indicia of a debtor’s potential insolvency. The true criterion of bankruptcy is a debtor’s inability to satisfy its creditors’ claims and to make mandatory payments, as established by a court of justice. When this criterion in applied, the conclusion as to a debtor’s insolvency is based on the as sumption that a debtor who is not making proper settlements with its creditors and failing to pay taxes, evidently, does not possess sufficient liquid property, since any other causes of non payments are excluded in accordance with the principle of reasonability and honesty of the par ticipants in property turnover. Meanwhile, the law makers are free to determine those external indicia of a debtor’s financial status, in the presence of which creditors have the right to make assumptions as to the debtor’s insolvency in respect to property.
Thus, the role of external indicia of bankruptcy is that their presence grants a debtor’s creditors the right to make assumptions as to the lat ter’s insolvency. The final and decisive solution is to be made by an ar bitrage court, which (and none other!) may declare a debtor bankrupt.
Therefore, no less important than the criteria and external indicia of a debtor’s insolvency are also the grounds for the proceedings in bank ruptcy being initiated by an arbitrage court, in order to declare a debtor bankrupt.
It is exactly this that is regarded by the author as the most serious limitation of the 2nd Law on bankruptcy, its essence being that an arbi trage court operates under the conditions that force it to blindly obey the wishes of the creditors who are initiating the proceedings in bank ruptcy. According to this Law, in the presence of external indicia of bankruptcy, which, if desired, can be found in respect to any Russian participant in property turnover, and on the condition that the creditors comply with the basic requirements established by the law concerning the formalization of a petition that a debtor be deemed to be bankrupt, an arbitrage court, on accepting such a petition, must in the shortest possible period initiate the proceedings in bankruptcy. And under the specific Russian conditions, the very fact of the proceedings in bank ruptcy having been initiated against a particular debtor inevitably results in very negative consequences for the latter64.
The same point of view is shared by Head of the Department of the Ministry for Economic Development and Trade Ts. Tserenov. In his opinion, there should not be any discussion concerning the indicia of bankruptcy, because this is an issue relating to an enterprise’s financial policy. A good administrator must know ALL of his or her financial liabili ties, both big and small. At the same time, the initiation of the proceed ings in bankruptcy sometimes can be effected on grounds that are not really justified. A creditor may simply file a petition in bankruptcy, and the court will at once initiate the proceedings, thus triggering the pro cedure65.
After the enactment of the 2nd Law on bankruptcy, there was much campaigning in order to demonstrate the “creative potential” of bank ruptcy procedures66. It was postulated that in 90% of cases the causes of an enterprise’s troublesome situation have their roots in the sphere of business management, and only in 10% the inherited structure of the economy is to be blamed. Therefore it was hoped that the procedures of external administration would make it possible to dismiss an incom petent manager and replace him or her by a competent bankruptcy commissioner, who would “rehabilitate” the enterprise. Many experts at that time (and some are still doing it) tended to “demonize” the image of a “red director”, seeing neither any possible ways for his self development nor any instruments for CEOs’ replacement that would be an alternative to bankruptcy.
A number of specialists have also noted the problem of premedi tated bankruptcy. It can be applied as a measure for protecting the di rector from shareholders. Managers can relatively easily arrange for their trusted partners to consolidate an enterprise’s deliberate debts, buy out its bills and effectuate a bankruptcy procedure, making a rep V. Vitrianskii. Puti sovershenstvovaniia zakonodatelstva o bankrotstve. (Ways for improv ing legislation on bankruptcy). – Vestnik VAS RF, No. 3, 2001.
Institut bankrotstva stanovitsia vsio bolee vostrebovannym ekonomikoi mekhanizmom (The institution of bankruptcy is becoming a mechanism the demand for which is more and more growing in the economy.) An Interview with Head of a Department of the RF Ministry for the Management of State Property Tseren Tserenov. See www.opec.ru.
Gorelov A. O rossiiskoi spetsifike instituta bankrotstva (On the Russian specificity of the institution of bankruptcy). – Rynok tsennykh bumag, 1998, No. 19.
resentative of the former CEOs the new top manager. The representa tives of the RF Ministry for the Management of State Property67 have stated that bankruptcy is becoming an instrument for protection from the State as an owner. For example, in some instances, when preparing an enterprise for privatization, potential buyers were trying to “knock down” its price by means of threats that bankruptcy procedures could be initiated in respect to the object of privatization; in others, when the State attempted to use its shareholder rights in order to replace a direc tor, the latter initiated bankruptcy procedures against the enterprise in question.
Some representatives of state authorities68, as one of the motives for premeditated bankruptcy that appeared after the enactment of the 1998 Law, have named the desire to withdraw the most liquid assets from an enterprise burdened with tax arrears. They associated such opportunities with the State’s limitations as a tax creditor in the course of effectuating bankruptcy procedures. As estimated by the Federal Service for Financial Rehabilitation and Bankruptcy69, every fifth bank ruptcy has the indicia of premeditated criminal actions (in particular, bankruptcy in order to write off debts).
It should be admitted that the State, in its turn, sometimes resorts to the threat of bankruptcy as an instrument for exerting pressure on an enterprise in order to force it to redeem its tax debts, or for other pur poses.
In one of the studies70 it has been demonstrated that the danger of bankruptcy of a large regional enterprise results in a merger of the in terests of CEOs and those of the regional authorities. Neither of them Bekker A. Pogonshchiki slonov (Elephants’ shepherds). (An interview with V. Pyl’nev). – Vedomosti, 7.06.2000.
Komarov Yu. Glavnoe – finansovoe ozdorovleniie (The main thing is financial rehabilita tion). (An interview with G. K. Tal’). – Zhurnal dlia aktsionerov (Journal for shareholders), 1998, No. 11.
Since September 1993, Russia had the Federal Agency for Issues of Insolvency (Bank ruptcy) (FAII) at the RF State Committee for the Management of State Property), in March 1997 the RF Federal Service for Insolvency and Financial Rehabilitation (FSIFR) was cre ated, and in June 1999 it was transformed in the RF Federal Service for Financial Rehabili tation and Bankruptcy (FSRFB).
Lambert Mogilianskaia A., Sonin K., Zhuravskaia Ye. Politicheskie aspekty bankrotstva v perekhodnyi period (The political aspects of bankruptcy during transition). – M., Russian European Center for Economic Policy, 2000.
have an interest in the enterprise’s liquidation or fundamental restruc turing, since the former do not want to make efforts in order to reform its business, while the latter are afraid of the possibility to lose tax reve nues, jobs and the public services being rendered, and do not think it necessary to contribute to the redemption of the enterprise’s debts to creditors from other regions.
However, it should be recognized that the behavior of regional au thorities in respect to bankruptcies of enterprises is by no means uni form. Thus, according to representatives of the Federal Service for Fi nancial Rehabilitation and Bankruptcy, it is often difficult to investigate the cases of premeditated and fictitious bankruptcies because of the pressure exerted by local authorities, since the latter regard the with drawal of assets, with subsequent foundation of a new enterprise on their basis, to be an important mechanism for improving business effi ciency.
During the part few years, certain fundamental changes have taken place in the sphere of corporate governance: the rotation of directors has become much more common and the number of enterprises with outsider’s stakes higher, while the influence of regional authorities has weakened. Thus, although the orientation toward a regional patronage of bankruptcy procedures is still maintained, and they are applied by CEOs in order to preserve their control, it is, nevertheless, giving way to property redistribution between different business groups.