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However, the existing notions as to possible solutions to the above said problems in many cases frequently turned out to be directly con tradicting one another. There existed no relatively uniform standpoint adopted by all State bodies concerning the possible transformation of insolvency regulation. It should be noted that in recent years the views of some of the State departments have undergone dramatic changes.

The intensity of the discussion on the new (third) Law on bankruptcy has increased, primarily, due to the drawbacks of this law (as well as any other law) within the general institutional context, which is charac terized by problems associated with corruption, property redistribution, arbitrary approaches and incompetence of various State structures.

As a result, the new (third) Law On insolvency (bankruptcy) No. 127 FZ, adopted on 26 October 2002, contains the following fun damentally new provisions:

greater protection of the rights and legitimate interests of creditors;

an extended range of the right of honest owners (founders, partici pants) of a debtor enterprise, as well as stronger protection of their interests in bankruptcy procedures;

the protection of honest participants in bankruptcy procedures from unfair actions of other persons;

a change in the status of the bankruptcy commissioner;

a change in the status of the State bodies participating in the pro cedure of bankruptcy;

the introduction of a new procedure of bankruptcy to be applied to the debtor in order to restore solvency and redeem debts (financial rehabilitation).

The main goals of the present study are to analyze the formation of the institution of bankruptcy (insolvency) in Russia in particular, to in vestigate the evolution of its legal base, the specific purposes of apply ing the institution of bankruptcy as a mechanism for property redistribu tion in Russias economy in transition, and the motives and objects for applying these procedures; as well as to develop appropriate recom mendations applicable to Russias situation.

The study is designed as follows.

When analyzing the theoretic approaches to the problem of bank ruptcy, the main focus of attention is the market mechanisms for finan cial regulation, the forms of bankruptcy (liquidation or reorganization) and the choice of bankruptcy procedures.

The discussion of the general evolution of legal phases in the devel opment of the institution of insolvency in modern Russia is preceded by a brief analysis of traditional models and the peculiar features of the economy in transition. In addition to an overall description of the first (19931997) and the second (19982002) phases, some specific is sues are discussed like, for example, the peculiarities of bankruptcies of certain groups of debtors, the basic insolvency procedures, etc.

Nevertheless, in legal terms, the focus of attention is placed on the third phase (from 2002 onward), which implies an analysis and a general es timation of the main innovations introduced in the 3rd Law on Insol vency, a discussion of the issues pertaining to the formation of the sub ordinate base, the regulation of the powers of the State authority, and the prospects for the modification of legislation on bankruptcy. The analysis of the legal aspects is augmented by a discussion of the issues of bankruptcy in terms of regional legislations, as well as of a number of specific problems, e.g., that of the institution of bankruptcy commis sioners, and some other issues.

The study on the economic aspects of the formation of the institution of bankruptcy involves a statistical analysis of the evolution of specific cases, as well as an investigation of the specific economic and institu tional conditions for the application of bankruptcy procedures. This section addresses the main trends in the application of bankruptcy pro cedures during 19982002 and analyzes the preliminary results of ap plying new legislation in the year 2003.

When analyzing the economic aspects of the problem, special atten tion was paid to the practice of applying bankruptcy procedures for control seizure and property redistribution, as well as to the financial aspects of the activity of large industrial enterprises in the context of their potential insolvency.

Considerable attention in this study has also been given to the most important problems associated with law enforcement in the sphere of bankruptcy legistation. In particular, the following aspects of the law enforcement practice have been investigated, which were of utmost importance in 20032004: the initiation of proceedings in the instance of insolvency (bankruptcy proceedings); a new procedure for appoint ing bankruptcy commissioners; the application of the norms concerning financial rehabilitation; the application of the norms concerning external administration; the application of the norms regulating bankruptcy pro ceeding and the procedure of amicable settlement; the application of the norms concerning bankruptcy in respect to an absent debtor; the bankruptcy of a debtor which is being liquidated; bringing to responsi bility those violating the Law On bankruptcy.

When analyzing the experience of corporate bankruptcies in Can ada, the economic foundations of bankruptcy are discussed, and an overview is offered on the contemporary system of law and law en forcement in this sphere. Of especial interest, in terms of Russias con temporary practice, is the study on the issues of reforming Canadian laws on bankruptcy. The case of Air Canada is discussed as an exam ple of dealing with the most acute problems that may arise in bank riptcy.

The conclusion contains the principal deductions achieved during the study, as well as the main recommendations regarding further im provement of the institution of bankruptcy in Russia.

Chapter 1. The problems of bankruptcy:

theoretic approaches The determination of property rights in a situation where financial markets do exist cannot be regarded as complete, or even, quite sim ply, clear enough without finding solutions to problems associated with companies insolvency2. To which degree the automatic functioning, as such, of the market mechanisms and/or the actions of the legal agencies undertaken in accordance with existing legislation are capa ble of protecting the interests of an owner of debt notes And to what degree those bankruptcy procedures, which are being offered as the optimal ones, are capable not only of determining the range of an owners rights, but also of ensuring a sufficiently active protection of his interests The economic and legal regulation of problems arising as a result of a companys insolvency belongs to the category of key issues pertain ing to the functioning of private property and market relations; in par ticular, smooth functioning of the system of settlements and payments, as well as the intensity and profundity of the development of financial markets depend on the efficiency of such regulation. Nevertheless, so far the issues of bankruptcy, obviously, have not become fully reflected in standard neoclassical theory3. In day to day life and in the actual strategies of banks, corporations borrowers and other participants in the economic process, the prospects of potential bankruptcy and its expected results usually are assigned a far more important role than in refined theoretic models of corporate behavior.

Since only the most general aspects of the issue of bankruptcy are being dealt with here, while the technical (narrowly legal) details are left out, in the majority of cases (with the exception of some clearly specified points) no special distinctions are made between the notions of a companys bankruptcy, default, inability to pay or insolvency.

J. Stiglitz in his Nobel Winners Speech specially mentioned this circumstance. Stiglitz J.

Information and the Change in the Paradigm in Economics. American Economic Re view, 2002. Vol. 92, pp. 460501.

1.1. Market mechanisms for financial regulation and their boundaries The analysis of the prospects for financing investment projects al ways takes into account the risk of bankruptcy (credit risk), and the interest rates being established on the market invariably include a risk premium. The amount of a credit risk premium depends on many fac tors: the borrowers credit history, the current and expected liquidity indices, the volatility of prices of the products manufactured by the borrower, etc. Thus, within the framework of certain boundaries, the market itself is redistributing incomes (or property) so as to answer the requirements established for private property functioning: all other terms being equal, the current value of a company on the verge of bankruptcy goes down, and accordingly increases the value of the creditor company.

Strictly speaking, the requirement that all the losses resulting from a failure to effect timely payments be redeemed can be envisaged in the terms of an appropriately drawn credit contract. However, the complex ity of modern economic life and the impact of the factors of uncertainty and risk result in a situation when the formalization of a more or less complete contract might involve unreasonably high transaction costs4.

It would be sufficient just to refer to the great variability of potential situations arising from insolvency, as well as to the possibility that, with time, the size and structure of a borrowers assets may undergo fun damental changes, whereas the terms for creditor compensation as stated in a contract will remain fixed.

An important role is also played by those information structures that determine the relationship in question. Given the existing uncertainty and information asymmetry, it is not easy to describe a situation when the problem of liquidity becomes acute and timely payments are impos sible to effect by means of an ordinary determinist model of the market relations functioning. In actuality, the relationships developing on fi The concept of contract incompleteness put forth by O. Hart and J. Moore, as well as the on going theoretical debate concerning this issue, are discussed at greater length in the book: Radygin A., Entov R. (2001), Korporativnoe upravlenie i zashchita prav sobstven nosti: empiricheskii analiz i aktualnye napravleniia reform (Corporate governance and protection of property rights: empirical analysis and vital areas of reforming). Moscow, 2001.

nancial markets are characterized not only by uncertainty, but also by asymmetric information: as rule, a creditor has no direct access to the whole body of information available to the CEOs of a borrower company and is obliged to be oriented by current signals. The main signal, consolidated in a credit contract, becomes invariably the borrowers readiness to make the standard commitment to pay the debt and the interest thereof (as well as the consent to pay the established fines in the event of the said conditions being violated).

The equilibrium in a model that implies the use of such uniform sig nals and excludes any better differentiated information has been tradi tionally called a pooling equilibrium. Economic theory states that in a situation of information asymmetry the participants (borrowers) would prefer to implement strategies implying that their signals will contain uniform (minimal) information. A pooling equilibrium is usually charac teristic of a situation of a higher spending level (as compared to struc tures characterized by bilateral information flows), and the resulting economic efficiency, according to Paretos criterion, will be lower5.

No less significant is the impact of externalities associated with the presence of several creditors and other participants in the economic process. This mutual dependency becomes especially obvious if one assumes for a moment that there exist no uniform bankruptcy proce dures, and that the problems arising from the borrowers insolvency are to be solved only on the basis of the terms stipulated in an individual contract. How could then the impact of the said external effects reveal itself in the situation in question In such a situation, each creditor would conclude with the borrower an individual contract, stipulating therein appropriate specific terms for debt servicing. In the event of a violation of these terms, the creditor must be granted the right to enforce the recovery, for his benefit, of (a part of) the debtors property. In reality, however, the range of liabilities of a borrower is almost never limited to money loans.

It will suffice to mention casual employees, who usually sign short term contract with their employer; such contracts, as a rule, do not en visage (at least explicitly) the companys possible insolvency. This con sideration may also be true in respect to those contracts which a given See, e.g., Mas Collel A., M. Whinston, J. Green. Microeconomic Theory. Oxford Uni versity Press: New York, 1995, Chapter 13, Section C.

borrower corporation has concluded with its other employees. Then, resulting from a violation of certain terms of the credit contract, the companys (entire) property will be utilized to cover its liabilities to a given creditor, while those to the employees (as well as to other partici pants in economic operations) will be left unpaid. Such situations rep resent an evidence as to how far from optimal (or simply unfair) may become the results of income and/or property redistribution in the event of a decentralized settlement of the financial problems of a bor rower.

Similarly, complete fulfillment of a companys liabilities to one of its creditors may result in an impossibility to fulfill its liabilities to all the other creditors. In this connection, alongside the contracts between a borrower, on the one hand, and each of its creditors, on the other, con tacts between creditors would also become necessary. The former group of contracts would then be determining the priorities of payments to different creditors, as well as the proportions of debt redemption in those instances when the mass of a bankrupts estate is insufficient for the redemption of all liabilities.

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