The concept of “controlling member of the group of the entities” has been introduced to designate the entity that effectively controls the activities of a debtor within the group1.
The controlling member of the group of entities may incur civil legal liability with respect to settling creditor claims for current payments.
The lack of information transparency regarding the true owners of many Russian assets poses the question of determining beneficiary ownership within the framework of corporate bankruptcy procedures given that such determination is often impossible even in the context of criminal cases. It is quite probable that the application of this legal provision will be limited to a select number of demonstration cases.
The mechanism for filing a single creditor claim with respect to a group of debtors that has been proposed by the authors of the draft law (as per the proposed new edition of Article 201.3 of the Federal Law on Insolvency (Bankruptcy)) leaves unclear the fate of group companies whose rights and interests may be significantly impacted, for example, by carving out specific assets within the debtor group in cases when all group assets are concentrated in one of several companies.
For the first time, the draft law proposed by the Ministry for Economic Development encompasses treatment of cross border bankruptcy issues, i.e. the bankruptcies of Russian and foreign legal entities involving different national domiciles of various parties, including cases when debtor property is located abroad, the creditor is a foreign person or legal entity, or legal proceedings against the debtor have been started in a foreign court.
For the purposes of determining the competence of Russian arbitration courts in the crossbow the bankruptcy procedures and determining the governing law in such cases, the notion of “center of principal debtor interests” is introduced to signify the place of its registration as a legal entity unless otherwise provided by law or determined by the nature of debtor operations or by other considerations. The law provides a non-exhaustive list of such considera Effective control is deemed to comprise the following rights:
– The right to directly or indirectly control 50% or more of the voting stock of a joint stock company, or a share greater than half in the statutory capital of a limited (subsidiary) liability company forming part of a group of entities;
– The right to give instructions that are mandatory for execution by the debtor forming part of a group of entities based on contractual agreements or statutory documents and the right to otherwise determine the activities of a debtor forming part of a group of entities;
– The right to determine the decisions and/or actions by a debtor forming part of a group of entities, including the terms on which such debtor entity carries out business activities;
– The right to appoint an executive person and/or more than 50% of the executive body of the debtor forming part of the group of entities and/or the possibility to elect more than 50% were of the board of directors (supervisory council) or other collegiate management body of the debtor forming part of a group of entities;
– The right to act in the capacity of managing company for the debtor forming part of a group of entities.
RUSSIAN ECONOMY IN trends and outlooks tions including the location of principal debtor assets, the location of the majority of the creditors, of the debtor’s production facilities, of its controlling shareholders (beneficiary owners), as well as the location of its principal business activities, the geographical source of the bulk of its revenues, etc.
It is expected that Russian arbitration courts shall review cross-border bankruptcy cases in situations when Russia is:
– The center of principal debtor interests – The center of principal interests of an entity (Russian or foreign) controlled by the debtor – The center of principal interests of an entity controlling the debtor – A permanent representative office and/or property of the debtor (Russian or foreign) when the center of principal debtor interests is located abroad.
Bankruptcy procedures for debtors whose center of principal interests is located in Russia are within the exclusive competence of Russian arbitration courts. Such court proceedings apply to the entirety of debtor property regardless of the country of its location. The competence of Russian arbitration courts in these cases also extends to reviewing bankruptcy cases with regards to entities controlled by the debtor and controlling the debtor.
In case of bankruptcy proceedings for an enterprise that does not constitute the principal production entity, the competence of Russian courts extends to:
1. Initiating bankruptcy proceedings in cases when the debtor has a permanent representative office in Russia – In case the bankruptcy filing against the debtor is made by a creditor that is permanently domiciled in Russia – In case the bankruptcy filing against the debtor is based on a claim that is related to the activities of the permanent representative office.
2. Reviewing bankruptcy cases for cross-border bankruptcies in cases when debtor property is located in Russia if debtor and or creditor rights with regards to bankruptcy cannot be realised otherwise (bankruptcy proceedings cannot be initiated against the debtor in the country representing the centre of its principal interests; the bankruptcy process in a foreign country extends only to debtor property located within its territory, etc)1.
In cases when bankruptcy proceedings are initiated in Russia, such proceedings, as well as their outcomes (with few exceptions), are governed by Russian law.
The proposed mechanism for the regulation of cross-border bankruptcies raises doubts as to the adequate application in Russia of the provisions for determining the centre of principal debtor interests. Apart from the objective difficulty of estimating the size of debtor assets in different countries, determining the location of the majority of creditors, and weighing other factors, other obstacles exist to the determination of legal eligibility using this method by courts that, in the case of the Russian legal system, frequently use formal criteria. These obstacles include:
1. The high level of dependency of the judiciary system upon executive power governing bodies and the practice of selective application of legal responsibility provisions;
2. The significant extent of manipulation with respect to property valuation, coupled with inefficient mechanisms for contesting valuation results;
See also paragraph 3 of Article 223.5 of the Draft Law On Financial Rehabilitation and Bankruptcy (Insolvency) by the Ministry for Economic Development Section Institutional Problems 3. The high level of formality in making court rulings resulting from established historical practice.
Given the above, the adoption or legal provisions envisaging significant discretion on the part of judges may only become acceptable at a time when the extent of influence of the above factors will be significantly decreased. Until such time, the regulation of such issues shall be more in line with the Russian legal and regulatory traditions, i.e. more formal. The practice of implementing regulatory provisions envisaging significant judiciary discretion should be gradual and should be carefully monitored in order to minimise any negative trends.
Bankruptcies of individuals outside the scope of entrepreneurial activity In November 2009, a new edition of the law on the bankruptcy of individuals outside the scope of entrepreneurial activities was submitted to the Russian government.
According to the Central Bank of Russia, the volume of past due indebtedness for individual loans amounted to RUR 231 billion, or 6.8% of all loans granted, as of the 1 October 2009. Other estimates place these figures at significantly higher levels due to the fact that the Central Bank includes only the past due portion of loans in its estimate of past due indebtedness without considering the principal loan amounts which total another 12%. Experts estimate that the shortening of repayment terms shall start no sooner than 20111.
The draft law on individual bankruptcies that was developed in 2007-2009 and has been submitted to the government by the Russian Ministry for Economic Development will create stimuli for individual debtors and their creditors for using civilized methods of restructuring consumer loans2. In particular it envisages the possibilities:
– Of granting the possibility to a debtor in financial difficulty to write off its debts against the assignment of its property and a proportion of its income to creditors (the so called fresh start doctrine) – Of lowering creditor risks and expenses related to bad debt recovery – Of lowering the administration costs for individual bankruptcies.
The duties of arbitration manager may be placed upon the debtor itself except for cases where the total amount of claims against the debtor is in excess of RUR 500,000 and except for cases when the creditor enters a plea for the appointment of an arbitration manager.
Under the draft law, failure to repay debt exceeding RUR 50,000 (RUR 100,000 in the first draft) for a period of six months constituents individual bankruptcy. Following an eligibility check upon the bankruptcy claim, the court institutes monitoring of the individual debtor for a period of three months. Within the monitoring period, the debtor has a right to submit a debt restructuring plan to the arbitration court that must be prepared in accordance with the provisions of the draft law and should be agreed with the majority of creditors. The draft law also envisages the possibility of approving a debt restructuring plan without the creditors’ consent.
If the plan is adhered to, the individual is freed from indebtedness and retains his social standing. Conversely, if the individual fails to repay the creditors within the debt restructuring framework, the arbitration court makes a ruling for the bankruptcy of the individual in question and for the initiation of asset receivership proceedings whereby the assets of the debtor The past due portion of individual loans has reached unprecedented proportions Thus, in Europe, bad debt levels for consumer loans of 5-6% are considered critical, while the latest Central Bank data show such levels in Russia exceeding 4%. It therefore appears that the state wishes to create the legal basis for reviewing individual insolvency (bankruptcy) cases. See also Russians will undergo mandatory bankruptcy by T. Koshkin (www.utro.ru/articles/2007/02/21/626934.shtml).
RUSSIAN ECONOMY IN trends and outlooks that are included in the receivership fund are distributed among creditors in proportion to the amounts of their claims1.
It is further proposed that the provisions for administrative and criminal liability for performing prohibited actions during bankruptcy and for a deliberate bankruptcy, punishable by fines of up to RUR 5,000 for administrative misdemeanors and by fines of up to RUR 500,000 and/or other punitive measures including incarceration for a term of up to six years for criminal breaches the extended to apply to individuals outside of the scope of entrepreneurial activities.
According to a statement by A. Ivanov, Chairman of the Russian Supreme Arbitration Court, the adoption of this law will result in an increased workload for judges which will in turn raise the issue of creating judiciary representative offices2 dealing with individual bankruptcy cases3. At the same time, according to V. Vitrianski, Deputy Chairman of the Russian Supreme Arbitration Court, there will be no significant increase of debtor bankruptcy filings at arbitration courts4. Meanwhile, G. Tosunian, President of the Russian Banking Association, believes that the institution of individual bankruptcies in Russia is at present doomed to fail5.
Bankruptcies of housing construction companies In November 2009, a draft law envisaging special bankruptcy procedures for housing construction companies6 (“legal entities carrying obligations to provide housing or subject to monetary claims by mutual construction financing participants”) with a view to protecting the financing participants was prepared for a second reading. The defining characteristic of housing construction company bankruptcies is the preferential right of federal subjects to acquire incomplete apartment housing construction projects prior to auction.
Federal subjects are entitled to buy incomplete apartment housing construction projects or land parcels at a fair market price as determined by an independent valuation specialist. A necessary condition of any such sale and purchase agreement is the undertaking to complete construction and to transfer the housing to construction financing participants upon completion. The deadline for completing construction is set at three years following the signing of the purchase and sale agreement7.
Given that construction companies have recently increasingly disregarded the requirements for signing housing construction investment agreements, the fact that individual citizens who signed agreements with the construction company will nonetheless be entitled to receiving the housing they financed regardless of the compliance of the investment agreement with the provisions of the Law on Housing Investments is a positive development.
The law on individual bankruptcy was expected to come into effect at the beginning of 2009 (www.primetass.ru/news/show.aspid=779274&ct=news).
The permanent representative office of the arbitration court of appeals and the permanent representative office of the arbitration court of a federal subject are detached administrative units of the respective courts outside of their permanent seat and are vested with the powers of such courts.
Supreme Arbitration Court Chairman: arbitration courts expect an increase in individual bankruptcy filings (http://www.dp.ru/a/2008/04/17/Predsedatel_VAS_arbitra).
The judicial workload issue has been dealt with, by V. Vitrianski (www.kp.ru/daily/24091.3/321906) See also Russians will undergo mandatory bankruptcy by T. Koshkin (www.utro.ru/articles/2007/02/21/ 626934.shtml).
Draft Law On Amendments to specific legal acts of the Russian Federation aimed at the protection of instalment-financed construction participant rights.
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