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The implementation of measures to address the above should considerably limit the market scope for manipulating the valuation process, which would be the greatest feasible achievement given current conditions.

5.3.4. 2009 draft legislation: the crisis as an impetus for addressing deficiencies Financial rehabilitation, bankruptcy of related entities, and cross-border bankruptcy The increase in corporate bankruptcy filings, in corporate and individual indebtedness, coupled with falling incomes, inefficiencies in the institution of bankruptcy given the increased workload, as well as within need to defuse social tension, jointly provided a strong impetus for legislative activity that has taken on a new aspect.

The most significant development has been draft legislation by the Ministry for Economic Development aimed at significantly expanding the scope of application of debtor financial rehabilitation procedures. Its submission for debate in October 2009 was accompanied by a statement by presidential aide A. Dvorkovich that financial rehabilitation of enterprises shall now become a state policy priority1. The final edition of the draft law was supposed to be agreed upon and submitted to the State Duma for review before the end of 2009. However, the preliminary schedule of State Duma legislative activities during the 2010 spring session does not envisage the review of this draft law.

This may be due to the fact that the draft law affects the contradictory interests of large banks and companies and thus came under heavy criticism by the Trade And Industry Chamber, bankers, tax authorities, etc. It is obvious that the heaviest criticism levelled against the draft law is based on the premise of undermining the financial condition of the banking system and creditors and is due to its pro-debtor bias.

Regardless of the need to remove the pro-creditor bias in developing bankruptcy legislation, the proposed innovations are seen as excessively radical due to the lack of a mechanism for protecting creditor rights that in turn creates conditions for abuse of rights and for responsibility avoidance by debtors.

Here and further below, E. Kukol, The debtor is sent for treatment Rossiiskaya Gazeta, No. 5024, October 22, RUSSIAN ECONOMY IN trends and outlooks In essence the draft law removes financial rehabilitation from the bankruptcy framework and envisages:

1. The possibility of the financial rehabilitation procedure being initiated by the debtor bypassing the supervision stage (up to seven months) and lasting up to five years regardless of creditor consent. In this case to arbitration court approves the arbitration manager candidate proposed by the debtor.

Despite the need to remove the pro-creditor bias in developing bankruptcy legislation, the proposed measure is deemed unacceptable due to the absence of a mechanism for protecting creditor rights that leaves ample room for the abuse of rights and for responsibility avoidance by debtors.

It appears that the interests of creditors and debtors can be balanced by (a) instituting a mechanism enabling administrative manager candidacies proposed by creditors, (b) instituting mandatory annual debt repayments throughout the duration of the financial rehabilitation stage, the amount of which repayments shall be stipulated in the financial rehabilitation plan and shall be no less than that stipulated by law.

It is also necessary to legally stipulate the possibility for creditors will to contest asset valuations for debtors who applied for financial rehabilitation, since the inadequacy of property valuation and the ease of manipulating value in the Russian context may result in the creditors later being deprived of the possibility of recovering outstanding debts.

2. The right granted to the debtor to submit to the arbitration court a financial rehabilitation plan agreed upon with the creditors that would envisage the full repayment of all creditor claims, including fines, penalties, and compensation for losses, during the financial rehabilitation stage.

3. The introduction of a special procedure for conducting transactions during the financial rehabilitation stage 4. The introduction of a special bankruptcy procedure for groups of related debtors 5. The introduction of a special procedure for cross border bankruptcies, etc Besides the traditional majority creditor vote mechanism (with certain qualifications regarding different classes of creditors), the approval process for the debtor financial rehabilitation plan envisages the possibility of its approval upon the debtors request in cases when fewer than 50% but more than 25% of votes by creditors and competent authorities at the creditors assembly have been cast in favour of approving the plan.

A necessary precondition for the adoption of such a decision is the opinion issued by the self-regulating organization of arbitration managers where the administrative manager is a member regarding the financial rehabilitation plan being in compliance with the law on insolvency. Such an opinion needs to be based on the analysis of the debtors financial condition, on its financial reporting, on data from the register of creditor claims, and other available information. It should be noted that such broadening of debtor rights, as well as the new mechanism of interacting with the self-regulating organization of arbitration managers, is being proposed for the first time. At the initial stage this may permit abuse of the situation by the latter, however, in the medium term, as the practice of claiming material liability for arbitration managers and their organizations becomes more widespread, this risk should diminish.

Furthermore, a simplified procedure has been envisaged for approving the financial rehabilitation plan in cases when the financial rehabilitation plan proposed by the debtor has been approved by the creditors and competent authorities by the moment of application.

Section Institutional Problems It is also proposed that regulatory provisions be introduced for out-of-court settlement procedures for indebtedness claims if agreed upon between the creditors and debtors. Such settlement agreements may define and regulate the mutual concessions that may help prevent company bankruptcies. Such agreements would also envisage the creditors rights to grant time to the debtor for solving financial problems, within which time creditors would refrain from filing indebtedness claims, while the debtor would voluntarily furnish information regarding its financial condition and would refrain from attempting asset transfers.

A positive feature of the proposed innovations within the bankruptcy framework is represented by the attempt at greater flexibility in settling debt repayment issues related to mandatory payments as part of the financial rehabilitation process that have long hindered the wider application of the practice of restoring company solvency. However, such mechanisms will only function efficiently following the development and adoption of the relevant regulations by competent government agencies (tax, customs, etc) The debate on the key provisions of this draft legislation inevitably touches upon the issue of the extent of protecting creditor vs. debtor interests in the bankruptcy process. Global practice shows evidence of both pro-debtor and pro-creditor bias in bankruptcy systems, and a choice of system or its development while taking into account both options is largely a politically motivated one. The degree of appropriateness of such choice in each specific case is evidenced by the extent of effective functioning of the bankruptcy institution in the economy, consisting of the liquidation of inefficient companies and the redistribution of assets in favor of efficient owners as well as the preservation of competitive enterprises.

In Russia, the transition to a market economy failed to bring about the creation of a competitive environment in the bulk of economic sectors. Furthermore, government expansion and the increasing direct participation of the state in the economy in the 2000s were accompanied by measures aimed at ensuring the concentration of large assets under government control that further distorted the legal environment. Such measures were adopted in the areas of bankruptcy law, legislation related to competition, and corporate law1. Financial support measures for companies during the crisis were also largely geared towards a limited number of companies with state or quasi-state interests and large state controlled banks.

At the same time, amendments were made to bankruptcy law that were once again meant to protect creditors. As a result, these economic entities received dual production, financial and legal, while debtors that received no financial support have also seen their legal protection diminish. The former are now considered efficient owners regardless of the fact that they received government support, while the latter are considered to be inefficient owners. In this situation, the relations between economic entities at the moment of bankruptcy are not governed by market principles and are not indicative of the efficiency of corporate management, but merely reflect the extent of access to state funding or other funding sources to cover outstanding indebtedness.

In this case, measures aimed at protecting debtor rights are the only means of redressing the balance to adjust for the state economic policy bias with regards to creating and sustaining See also Applied issues of internal corporate governance mechanisms by A. Radigin, R.Entov, E. Apevalova et al., Moscow, IEPP, 2009.; Bankruptcies in the 2000s: from a raiders tool to a double standard policy, by E.A Apevalova, A.D: Radigin, published by Economic Policy magazine, issue No. 4 for 2009, pages 91-124;

Modern trends in mergers and acquisitions, by A.D. Radigin, R.M. Entov, E.A. Apevalova et al., Moscow, 2010.

RUSSIAN ECONOMY IN trends and outlooks a competitive environment, instituting a culture of corporate governance, and providing financial support to companies.

As a possible measure, limitations may be imposed in a timely manner upon banks and companies that are the recipients of state financial support with regards to initiating the quick sale of debtor assets in the bankruptcy process so long as the debtor retains the prospect of restoring solvency. It is also possible to impose limitations on the initiation of debtor bankruptcy procedures whereby threshold indebtedness amounts would be linked to the amounts of state financial support received.

The development of criteria for assessing debtor prospects is a complex but necessary task in this context. As regards the Russian bankruptcy model per se, its pro-creditor bias is evidenced less by the focus on accumulating funds for their further redistribution among creditors than by its ensuring significant creditor influence upon the arbitration manager and his decisions. Given the practices of inadequate valuation of debtor assets and the closed sales of such assets, this is the only available means of ensuring some degree of protecting creditor interests.

The draft law under discussion also proposes changes to the ranking of creditor claims. It is proposed that the current payments that are made prior to payments to ranking creditors include insurance premiums paid to the Russian Pension Fund, the Russian Social Security fund, and the Federal and regional mandatory medical insurance funds. These claims would rank second following the payment of the legal expenses for bankruptcy proceedings.

A significant innovation is represented by the proposed division of creditors into classes based on either the nature of their claims or on the cause of their claims. The terms of the financial restructuring plan should be equal for all ranking creditors and/or competent authorities whose claims have been grouped together in the same class. This innovation is most advantageous for banks.

The proposed draft law devotes significant attention to bankruptcy procedures for groups of related debtors and to cross-border bankruptcies.

The demand for special bankruptcy procedures for groups of entities and the increase in the number bankruptcy filings submitted by debtors, as well as large-scale payment defaults, point to the need to discuss possible changes to insolvency criteria that would supplement the current criterion of outstanding indebtedness amounting to more than RUR 100,000 for over three months by the criterion of outstanding indebtedness in excess of company assets. This proposed amendment is due to the fact that the liquidity gap arising in the course of day-today business operations may not reflect the true financial condition of the business, especially given the diminished access to financing, shrinking production and sales volumes of late. The issue of managing the liquidity gap may be addressed by way of out-of-court debt settlement or financial rehabilitation but does not necessarily constitute insolvency as such. Furthermore, the potential for abuse of bankruptcy procedures by a group of related debtors is sufficiently high to merit special consideration.

It should be noted with respect to the issue of bankruptcies for groups of related debtors that the attempt to give proper treatment to this complicated issue, as well as to the issue of cross border bankruptcies, is noteworthy in itself. However, the task of giving maximum formal treatment to all the relevant terms and procedures is highly complicated, especially considering the Russian legal tradition. Complications arise from the very start of the regulatory process of the legal eligibility ruling with regards to initiating bankruptcy procedures for a debtor group. It is expected up and that the proposed five stage system of determining eligiSection Institutional Problems bility is too complicated to use in practice and will give rise to competing legal eligibility due, among other factors, to the difficulty of determining the principal location of entrepreneurial activity, the principal location of group member property, and the principal location of the majority of group creditors.

It is expected to rule that bankruptcy filings for groups of related debtors shall be reviewed as one legal case, by the same judge a group of judges. A unified set of supervision, financial rehabilitation, external administration, and receivership procedures shall be implemented with respect to groups of debtors.

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