Russian legislation contains mechanisms allowing the recovery of debts, but experience tells us that the reality can be very different from the theory, according to Semen Epshtein, managing partner of Russian law firm Padva & Epshtein.

The collapse of financial markets in 2008 revealed the underlying problems of many Russian companies. The ensuing liquidity crisis and systemic risk showed the importance of effective debt management. The most outstanding example of bad risk management was the failure of a former top 20 Russian bank.

In Russian business practice, unpaid debts can be recovered through court proceedings, through a debtor’s insolvency procedure or by the reorganisation of the debtor company. However, experience tells us that the picture can change when these mechanisms are implemented.

Court proceedings

According to the Russian Civil Code (RCC), the creditor can recover unpaid debts through the courts if the debtor fails to discharge its obligations fully or properly. Overall, Russian legislation protects the rights and interests of the creditors, so if the debtor possesses assets or if there is some security (guarantee), the recovery of debts should not cause special difficulties – at least in theory.

In practice, however, the main problems of debt recovery are the terms of court proceedings. For example, some court enforcement officers frequently postpone court orders (writs), sometimes indefinitely.

In 2010, amendments to the RCC's arbitration procedure were enacted, in which the term of a trial can be extended by the court from three months to six months “in connection with the special complexity of the case or a considerable number of participants in the court proceedings”. Such a provision allows courts to drag out legal proceedings and possibly even contradicts the right to a reasonable time limit in legal proceedings.

Pledges and sureties

In Russian practice, loan obligations are generally secured by a pledge of stocks, real estate or the like; by a surety (preferably with joint and several liability); or by a bank guarantee. In 2008, amendments to the legislation for pledges were enacted, allowing agreements on the extrajudicial recovery of the pledged property. These amendments simplified debt recovery where there are pledged assets. Broadening the freedom of contracts covering pledge obligations furthers the interests of Russian businesses.

The latest version of the RCC restricts the issuance of guarantees to banks alone. However, in international practice, guarantees can also be issued by non-bank entities. It would be beneficial for the government to enact amendments to the RCC that allow the issuance of non-bank guarantees.

The recovery of debts through the courts or through an insolvency procedure can become complicated if there are corporate conflicts in the debtor company. In particular, the existence of two parallel registers of shareholders, and hence two CEOs, can lead to problems in making shareholders or managers of the debtor company responsible for its debts. Legislators should probably consider establishing the right of creditors to accelerate the repayment of loan obligations if corporate conflicts occur in the debtor company.

Insolvency or reorganisation

If debt recovery under the loan agreement or the credit contract proves inefficient, an insolvency procedure is frequently applied. The outcome of insolvency procedures depends on who initiated the procedure, because the initiator has the opportunity to nominate a loyal person as arbitration manager.

Without a loyal arbitration manager, it is difficult to protect creditors’ rights and interests effectively. The arbitration manager has a wide range of rights, including the right to advance a claim that voids any decisions or transactions by the debtor that are deemed illegal, and to raise objections to the claims of creditors.

Russian legislation on insolvency could be improved by reducing the opportunities to abuse these rights. These opportunities are available due to the voting procedure at the meetings of creditors, where the law has established the principle of 'one ruble, one vote'. As a result, creditors’ committees can make decisions to the detriment of all creditors, for example, if exaggerated or fictitious debts allow a 'friendly' creditor (a creditor, genuine or otherwise, who is loyal to the debtor) to seize the majority of votes at the meeting of creditors.

Across the borders

It should be noted that a Russian law on cross-border insolvency, based on the provisions of the UN Commission on International Trade Law model, is being developed and will probably be enacted. The law on cross-border insolvency will promote the interests of creditors, including foreign creditors, especially when debtors spread their assets across different jurisdictions.

In terms of reorganising a debtor company, a merger or an acquisition can imply considerable risks for creditors, without necessarily increasing the assets available for debt recovery. Russian legislation provides guarantees of the rights of creditors in the event of a company reorganisation (article 60 of the RCC). These include mandatory notice to creditors regarding the reorganisation and the right to accelerate loan repayments.

But the right to accelerate repayments risks triggering the debtor’s insolvency if exercised by all creditors. The legislation should go further and overtly allow creditors the right to block the reorganisation of a company that did not discharge its debt obligations.

Semen Epshtein is a managing partner of leading Russian commercial law firm Padva & Epshtein.

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