Bankruptcy In Russia: Essential Framework, Current Trends, And Tips For Foreign Creditors

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To register a company in Russia, it is essential to have the amount of at least 10000 rubles to be contributed to the bank account as being the charter capital. Record setting forth the level of allocation of capital shares between all the founders of the LLC.

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List of documents required for registrating LLC company in Russia:

  • Passports of the founders and general director (copies);
  • Application filled in according to form P11001;
  • Decision of the founder or minutes of the meeting of founders of the LLC company;
  • Articles of Association of the LLC company in Russia;
  • Receipt for payment of state fee for registrating llc company;
  • Documents that confirm the existence of a legal address for LLC company in Russia;
  • Notification of the choice of a specific taxation system for newley opened LLC company in Russia.

How to start a business in Russia – read more in Articles

As the Russian economy continues to toil, issues relating to insolvency (bankruptcy) remain the focus for both local and foreign creditors. 

We include in this article the most recent statistical data, which may aid shape the expectations of companies finding themselves in insolvency scenarios and creditors considering their bankruptcy strategies.

Dynamics of Insolvencies(bankruptcy) in Russia

Following the economic downturn in the aftermath of the 2008 financial crisis, the numeral of insolvency applications has been fluctuating. Nevertheless, immediately after the imposition of Western sanctions in 2014, this number jumped by 20%, resulting in more than 50,000 insolvency applications filed and approximately 41,000 obtained by Russian courts in 2015. 

The majority of insolvency applications were filed by creditors (around 84%), whereas the rest belonged to debtors, who under certain circumstances are obliged to file for insolvency.

Legal Framework

Federal Act No. 127-FZ “On Insolvency (Bankruptcy)” dated October 26, 2002, regulates the insolvency of both companies and individuals. The insolvency of credit institutions is subject to a special law – Federal Act No. 40-FZ “On Insolvency (Bankruptcy) of Credit Institutions” dated February 25, 1999. 

Both laws were passed a long time ago and are revisited regularly. The insolvency of individuals (which became possible starting October 1, 2015) and credit organizations is outside the scope of this article.

According to the latest Doing Business 2016 report, Russia’s score for “resolving insolvency” is 51, which is 28 points lower than the OECD standard for high-income countries, but 14 points higher than Russia’s ranking in 2015. 

This shows a gradual improvement of the federal insolvency framework, specified by such criteria as time, cost, and outcome of insolvency proceedings, some of which are discussed below.

Initiation of Insolvency Proceedings

Under Russian law, insolvency is described as the inability of a debtor to meet in full the claims of its creditors, including monetary payments and other pecuniary responsibilities. A legal entity is deemed to be incapable of satisfying the claims of its creditors if the respective obligations have not been performed within 3 months of the date of the due performance. Two more requirements must be met before a creditor can file for insolvency of a Russian entity:

  • The claim must be no less than RUB 300,000, excluding fines and loss of anticipated profit;
  • As a general rule, the claim should be confirmed by a final judgment of a competent court. This suggests that, in most cases, foreign creditors would first need to file a regular claim with the Russian court (or obtain recognition and enforcement of a foreign court’s judgment or arbitral award), and only then file for the debtor’s insolvency.

Creditors are always free to decide whether to pursue bankruptcy, provided the above conditions are met. Moreover, when filing for insolvency they should continuously keep in mind that in case the debtor’s assets are insufficient to cover insolvency-related expenses, such expenses can be assigned to the creditor.

Debtors may be obliged to file for their insolvency in certain scenarios. 

In particular, a CEO must file for insolvency in several cases, including when the debtor does not have sufficient liquidity to repay its debts (“cash-flow” test), or its assets are not sufficient to fulfill the obligations (“balance-sheet” test).

At the same time, case law proves that the mere existence of accounts payable and an “unsatisfactory” balance sheet (when liabilities exceed assets) does not necessarily imply insolvency and, therefore, entails filing obligations.

Other conditions triggering the CEO’s obligation to file for insolvency include situations when paying to some of the creditors would make it impossible to fulfill other obligations or when a debtor is subject to an enforcement action against its assets that prevents it from continuing its operations.

A CEO must file for insolvency within one month of the relevant circumstance arising. 

Failure to do so may result in the personal liability of the CEO. 

Russian insolvency law has recently been amended to promote and secure employees’ rights, who may now file for their employers’ insolvency. 

The same requirements must be met (RUB 300,000 threshold, etc.) before employees may file for the employer’s insolvency. Although by May 2016 the total amount of wages payable (salary debt) in Russia exceeded RUB 4 billion (approx. EUR 55 million), employee-initiated bankruptcies remain unusual.

Insolvency Procedures (Stages)

In general, there are five possible insolvency procedures (stages) prescribed by Russian insolvency law:

  1. Supervision;
  2. Financial rehabilitation; 
  3. External administration;
  4. Liquidation;
  5. Amicable arrangements. 

While financial rehabilitation, external administration, and amicable arrangements are deemed as rehabilitative procedures, aimed at restoring a company’s well-being, they proved to be ineffective and thus are rarely used in practice. 

In the vast majority of cases, Russian insolvency proceedings start with the supervision stage followed by the liquidation

Rehabilitative procedures have always been rather unpopular, but from 2010 onwards their use has been further decreasing. 

This is usually explained by the ineffectiveness of the existing rehabilitative measures, limited involvement of the court, and the behavior of secured creditors, interested in the prompt sale of pledged assets. 

To improve the rehabilitative angle of the insolvency legislation, the Russian Ministry of Economic Development drafted a bill, presenting some of the elements of the American bankruptcy model, in particular, a procedure of restructuring (like the U.S. Chapter 11).

However, it remains to be seen whether such a bold proposal will be made law shortly.

Challenging Pre-Insolvency Transactions

Russian insolvency law witnessed a robust change in 2009 when a whole new chapter (Chapter III.1) regulating challenges to pre-insolvency transactions was introduced. 

Since then, setting aside pre-insolvency transactions has become a useful tool in fighting abuses and raising the value of the insolvency estate. 

According to Chapter III.1, at the stages of external administration and liquidation, a liquidator (an external administrator) or a creditor (a group of creditors) can challenge certain pre-insolvency transactions, i.e. questionable transactions and preferential transactions.

Suspicious Transactions Entail unequal care from a counterparty (undervalue transactions) when the price or other terms are materially less profitable than in comparable arm’s-length transactions. 

The most typical scenarios include overrated purchases (paying too much) and undervalued sales (receiving too little).

The general term for challenging suspicious transactions is 1 year. The extended 3-year term involves if such transactions had the purpose of harming creditors’ rights, delivered that actual damage occurred and another party was mindful of the debtor’s fraudulent intent. 

The burden to prove a harmful intent is on the party challenging the transaction; however, such purpose is presumed if the debtor had signs of bankruptcy and the transaction involved no consideration or was concluded with an affiliated entity.

  1. Preferential Transactions

Entail or may entail choosing a creditor(s) over other creditors. 

Such transactions include, inter alia, provision of security to a current creditor and fulfillment of a claim that has not yet developed.

The general term for challenging preferential transactions is 1 month. 

The extended 6-month term uses if the creditor or another party involved was aware that the debtor was on the brink of insolvency. 

Such awareness is presumed in cases involving “interested” parties.

Liability of Controlling Persons

More and more insolvency proceedings in Russia are accompanied by applications to have controlling persons liable – civilly, administratively, and criminally.

Such applications are sometimes used to exert force on the debtor’s management and owners. In other examples, the liability of controlling persons can stimulate the return of assets into the insolvency estate.

This is particularly the case when, as a result of a breach of the duty of loyalty, the debtor’s assets have been diluted.

  1. Civil Liability

A controlling person (a person who is or was entitled to give obligatory instructions to the debtor or otherwise determine the debtor’s actions, including a shadow director) may be held civilly liable if the insolvency occurred as a result of that person’s actions or inaction, provided that the debtor’s assets are not sufficient to satisfy the creditor’s claims. Managing persons would usually include the debtor’s CEO, plurality shareholder, and members of the board of directors.

It is presumed that insolvency occurred as a result of the actions or inaction of a controlling person if such person concluded or approved suspicious or preferential transactions or if the debtor’s accounting or reporting documentation is missing or incomplete (e.g. important information on the debtor’s assets is missing). 

Besides, the debtor’s CEO is also liable for flops caused by the failure to timely file for the company’s insolvency. 

Controlling persons are exempt from liability if they can prove that they acted in good faith and reasonably in the interests of the debtor.

  1. Criminal Liability

A debtor’s shareholders and managing bodies may be subject to criminal liability under the Russian Criminal Code

Such liability may follow unlawful actions, including:

  1. Concealment of assets;
  2. Alienation or destruction of property as well as concealment
  3. Falsification of accounting and other records reflecting economic activities provided that such actions have been committed in anticipation of insolvency and have caused damage amounting to RUB 1,500,000 or more. 
  4. Deliberate bankruptcy and fictitious bankruptcy.

Similar to civil liability, barely any high-profile insolvency case in Russia goes without a criminal element or a creditor initiating a criminal probe against the debtor’s management. 

However, the number of detected bankruptcy-related crimes stays relatively low, amounting to 279 in 2015 (701 in 2010). 

In contrast, the success rate of civil liability cases has been increasing.

Creditors Ranking and Insolvency Tendering

Russian law defines several ranks (categories) of creditors so that creditors in the higher ranks get paid first. 

  • Some claims are characterized as current claims – these claims include obligations assumed after the initiation of insolvency proceedings and are prioritized in comparison with other creditors in the ROC. 
  • Secured creditors (with pledge or mortgage) have priority, as they get 70% of proceeds from the sale of pledged assets (80% in the case of credit obligations). However, to take advantage of the security, secured creditors’ claims have to be included in the ROC.
  • Claims of creditors not included in the ROC (except for current claims) can only be settled after all other creditors’ claims have been satisfied. Therefore, it is crucial to timely file applications to be included in the ROC, as out-of-ROC creditors rarely get anything. Inclusion into the ROC should preferably be done at the supervision stage, but can also happen in other stages. In order not to miss the deadline, foreign creditors are advised to control the status of their Russian debtors (especially those in default) on the website of the Unified Federal Register of Bankruptcy Data (in Russian only).

At the end of the liquidation, the debtor’s assets are sold through tendering. According to the World Bank, the general recovery rate remains fairly low – 41,3 cents on the dollar (in Moscow) in contrast to 72,3 cents on the dollar in the OECD (high-income). 

In practice, however, such recovery may be even lower due to late insolvency filing, inexperienced management, large discounting (average of 65%), and fraudulent transactions. 

According to the latest statistics announced by the Supreme Court of the Russian Federation, creditors of 70% of Russian debtors have not acquired a penny as a result of liquidation proceedings completed in 2015. Therefore, getting security (pledge or mortgage) from a Russian counterparty can play a crucial role in hedging insolvency-related risks.

Insolvency is a complex process with many players on the stage. 

Finally, it is the proactive mindset of creditors that determines their fate. Recent changes to the bankruptcy legislation offer a multitude of opportunities for creditors to fight the abuses and defend their interests.

Timely actions (filings to be included in the ROC, challenging transactions, getting controlling persons to liability, etc.) together with pre-emptive shielding measures (getting security from the debtor and third parties) and attentiveness (monitoring the Unified Federal Register of Bankruptcy Data) are important in ensuring the protection of creditors’ rights and ensuring the adequate handling of otherwise counter-productive insolvency proceedings in Russia.

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