Bankruptcy in Russia: Trends and Forecasts
No increase in business bankruptcy is expected unless another crisis breaks out. However, the number of “consumer” bankruptcies may grow.
Business no longer trusts itself: the economic turnover participants are giving up hope for the voluntary fulfillment by counterparties of their obligations and turning to the bankruptcy procedure as the most efficient method of their enforcement. The situation with individuals is completely opposite: unlike commercial organizations, people get involved in bankruptcy by themselves thinking it to be the solution of all problems. The article talks about the present-day bankruptcy developments in Russia as well as about the main trends and forecasts.
Bankruptcy of Legal Entities
Presently, bankruptcy of commercial organizations in our country is predominantly a liquidation procedure. The cases of instituting the recovery procedures of external management and financial rehabilitation in respect of a debtor are negligibly few as compared with the number of the receivership procedures. Moreover, even if a bankruptcy story begins with the rehabilitation procedures, it ends, all the same, with the institution of receivership.
We believe there are three reasons for that:
- the debtor having no interest in solvency restoration,
- the bankruptcy procedure being instituted at the last moment when solvency cannot be restored due to objective reasons,
- the rehabilitation procedures are applied so seldom that there is no improvement to the laws and law enforcement practices in this field.
In 2018, according to the Uniform Federal Register of Bankruptcy Information, the number of corporate bankruptcies came to its "natural" level. This is due to the fact that business adjusted itself for carrying out activities in the current economic conditions subsequent to the crisis events of 2014 and 2015.
In 2019, the number of corporate bankruptcies does not exceed the average figures, either. As compared with the last quarter of 2018, an upturn of 1.9% was observed in quarter I of 2019. However, it proved to be local, as noted by the Macroeconomic Analysis and Short-Term Forecasting Center, and was never continued: based on the results of quarter II, the number of bankruptcies among legal entities dropped by 3.7% relative to the previous quarter.
With reference to the improvements in the Federal Law "On Bankruptcy" and the court practice, no increase in business bankruptcies is expected unless there is yet another economic downfall.
Main Trends in Bankruptcy of Legal Entities
1. Establishing a higher proving standard for affiliates.
Normally, independent creditors and bankruptcy commissioners come across the debtor's affiliates' claims in bankruptcy cases. To have their claims included in the register of the debtor's creditors' claims, such persons seek to create the total visibility of an ideal obligation, with all facts documented and documents containing no external flaws.
In considering one of such claims, the Russian Supreme Court ascertained as follows: "An even more stringent proving standard should apply to the [debtor's affiliated] company's claim than to a regular creditor in a bankruptcy case. Such creditor should exclude any reasonable doubts in respect of the debt being real since the community of economic interests, among other things, increases the probability of the creditor producing externally impeccable evidence that an essentially fictitious transaction was carried out for an unlawful purpose of the subsequent distribution of the bankruptcy assets in favor of a "friendly" creditor and having the number of votes accounted for by independent creditors reduced for the benefit of the debtor and its affiliates which is inconsistent with the standards for the good-faith exercise of rights" (Ruling No. 305-ES18-3533 of the Chamber for Commercial Disputes of the Russian Supreme Court dated August 23, 2018, with regard to case No. А40-247956/2015).
This position made it possible for independent creditors to prevent any non-existent claims of the debtor's friendly creditors from being included in the register.
On this basis, the courts started dismissing affiliated creditors' claims for inclusion in the register. As a result, independent creditors were enabled to prevent a group of affiliates from conducting controlled bankruptcies and increased their chances for having their claims satisfied from the bankruptcy assets.
In addition, the courts of first instance started using the rule for establishing a higher proving standard for the debtor's affiliates not only when considering claims for inclusion in the register but also when considering disputes over declaration of the debtor's transactions settled with its affiliates to be invalid.
2. Expanding the scope of persons falling within the concept of the "debtor's controlling person" and possibility of bringing them to subsidiary liability.
Once Chapter III.2 "Liability of the Debtor's Executive Officer and Other Persons in a Bankruptcy Case" has been introduced in the Federal Law "On Bankruptcy", subsidiary liability has been increasingly imposed not only on the debtor's executive officer and members but also on any other persons.
In particular, this is associated with the appearance of sub-paragraph 3 in paragraph 4 of Article 61.10 of the Federal Law "On Bankruptcy" which states that: "Until proven otherwise, it shall be assumed that any person acted as the debtor's controlling person if that person derived benefit from the unlawful or inequitable conduct of the debtor's executive officer".
Paragraph 7 of Regulation No. 53 of the Plenum of the Russian Supreme Court dated December 21, 2017, "Concerning certain issues related to holding a debtor's controlling persons liable in case of bankruptcy" indicates who can be such person:
- any person that has derived a material (relative to the scope of the debtor's activities) benefit in the form of increased (saved) assets that could not have been created had the actions of the debtor's executive officer been consistent with the laws, including with the principle of good faith;
- any beneficiary that has derived material benefits from such system of business activity organization which is aimed at the redistribution (including on the basis of unreliable paperwork) of the aggregate income earned from the conduct of such activities by any persons united by a common interest (for example, a common manufacturing and/or sale cycle) in favor of those persons with the simultaneous accumulation of the principal debt burden on the debtor's side.
The list of examples provided is not a complete list.
Thanks to the provisions mentioned above, creditors and bankruptcy commissioners have been enabled to bring to subsidiary liability not only the debtor's executive officers but also the persons that have amassed the debtor's siphoned-off assets which, in turn, allows the debtor's bankruptcy estate to be replenished more efficiently.
3. Reducing the number of bankruptcies controlled by the debtor.
This trend is a direct consequence of the first two trends. It becomes increasingly difficult for debtors acting together with "friendly" creditors to conduct controlled bankruptcy procedures for the purposes of avoiding fulfillment of obligations and concealing assets.
In the first place, this is attributed to the courts' higher quality of monitoring the inclusion of affiliated creditors' claims in the register. It's getting increasingly difficult for friendly creditors to secure a majority vote at creditors' meetings.
In the second place, the debtor's controlling persons are now fearful of subsidiary liability being imposed on them and the cases when they invoke bankruptcy procedures are fewer and farther between.
In the third place, creditors have been granted considerable powers to raise objections when considering affiliated creditors' claims to challenge the debtor's transactions, to impose subsidiary liability on the debtor's controlling persons. In such situation, even the appointment of a friendly bankruptcy commissioner to the debtor does not minimize the consequences referred to.
All of that has resulted in an increasing number of bankruptcy procedures taking place under the control of independent creditors which is undoubtedly a positive trend for the entire insolvency (bankruptcy) institute.
In general, all the trends specified can be combined under a common proposition – shifting away from formalism. In rendering their awards, the courts are increasingly focused on the circumstances of a specific individual dispute, with their conclusions more often than not based on the principles of the good-faith behavior of the dispute participants rather than on the formal interpretation of the provisions of the Federal Law "On Bankruptcy".
Bankruptcy of Individuals
Good-faith individuals who have found themselves in a tight financial situation are increasingly using the bankruptcy procedure as a chance to restore their solvency. This is evidenced by statistics: according to the Uniform Federal Register of Bankruptcy Information, the number of individuals' bankruptcies grew by 1.5 times in 2018 versus 2017. The figures for 2019 are comparable with the last year's figures.
The number of the so-called "consumer" bankruptcies related to a high loan exposure and a difficult financial position can be projected to increase. However, individuals' bankruptcies will not become a mass phenomenon because of the lawyers' services to support that procedure being expensive.
There is one more fine point: for the most part, bankruptcy commissioners are reluctant to deal with individuals' bankruptcies because of the remuneration level (25,000 rubles plus a percentage of the amount of the claims satisfied) being inconsistent with the level of the administrator's labor input and responsibility.
Prohibited Bankruptcy "Tourism" as the Main Trend in Individual Bankruptcy Sphere
According to the general rule, a bankruptcy petition for an individual shall be filed at the place of his/her residence (part 4 in Article 38 of the Russian Arbitration Procedure Code, paragraph 1 in Article 33 of the Federal Law "On Bankruptcy").
The courts used that rule formally and accepted the debtors' bankruptcy petitions at the place of their residence. Such approach of the courts was put to use by bad-faith debtors. A debtor being conscious of the occurrence of the insolvency signs would change his/her place of registration to a remote region. Following the registration change, s/he would file a bankruptcy petition to the arbitration court at the new place of registration. Since the majority of the debtor's obligations would arise at the previous place of residence, the creditors would continue to be there.
Such actions would enable the debtor to conduct the procedures for his/her own bankruptcy in bad faith, avoid claims being filed, and conceal his/her property.
The problem was resolved by the Russian Supreme Court in Ruling No. 308-ES18-25635 of the Judicial Panel for Economic Disputes dated March 21, 2019, with regard to case No. А63-9583/2018. In that case, the debtor changed the place of registration from the city of Moscow to Stavropol Territory and filed a bankruptcy petition with the Stavropol Territory Arbitration Court. The court of first instance concluded that the debtor's actions constituted an abuse of right and that the case should be transferred to the Arbitration Court of the City of Moscow on the basis of judicial jurisdiction.
The court of appeals and the court of cassation reversed the judicial act and applied the aforementioned formal approach to determining the judicial jurisdiction at the debtor's place of registration.
The Supreme Court reversed the acts of the appellate and cassation courts and agreed with the conclusions of the court of first instance: "An individual's registration at the place of residence which has the recording function cannot be used by him/her to perform any bad-faith actions intended, in particular, to change the judicial jurisdiction of a dispute on the basis of formal registration at a new place of residence to conduct the bankruptcy procedure in the territory of another constituent entity of the Russian Federation".
The Supreme Court also noted the following: "If a stakeholder has provided good reasons and produced evidence planting reasonable doubts for the court regarding the debtor's registration data corresponding to the actual state of things, the burden of proving that the registration data changes are driven by objective reasons and related to relocation to another region for residence shall pass to the latter.
At the same time, it should be admitted that the closer the registration changing date to the date of initiating bankruptcy proceedings (and, correspondingly, to the date of the court resolving on the case judicial jurisdiction) the higher the a priori probability of the debtor's registration changing actions having the bad-faith signs and, consequently, the more simplified the procedure for the debtor to assume the burden of procedural activity to substantiate the judicial jurisdiction".
The approach of the Supreme Court certainly entails positive consequences for creditors. When detecting the debtor's bankruptcy case in another region, creditors will be able to successfully insist that the case be transferred, subject to judicial jurisdiction, to the region where the debtor effectively lives and carries out activities.
In addition, the said position will probably also apply to the cases where the creditor files a bankruptcy petition against the debtor at the last registration place, and the debtor, in turn, seeks to procure that the case be transferred to another arbitration court because, allegedly, he has recently changed the place of residence. If sufficient evidence is produced that the change in the place of residence is fictitious, the court will accept bankruptcy petitions for debtors at their previous place of registration which was known to creditors.
As a consequence, creditors will be able to cut their costs for participation in the bankruptcy proceedings for the debtor and ensure that the debtor's good-faith behavior is controlled to the maximum extent possible which will contribute to the satisfaction of the creditors' claims.