Expert Severo-Zapad Magazine publishes comments made by senior associate Gennady Skutsky to an article entitled “Provocation caused by uncertainty”

27 October 2009

Bankruptcy laws remain very incomplete, and unscrupulous borrowers still enjoy a vast field of activity.

Russian bankruptcy laws underwent seriously change over this year. A number of new concepts and statutory provisions were put into practice, that made fundamental changes in some norms of the bankruptcy (insolvency) law”. “Four federal statutes were adopted which make amendments in the bankruptcy law, extensive enough as it is. Should one imagine these amendments in physical form, they shall take about 150 A4 sheets,” told Egor Noskov, the managing partner of the law firm “Duvernoix Legal”.

Perhaps the most important amendment is change in responsibility of debtor controllers. This is a new concept in the Law of the Russian Federation. Controllers may be owners of businesses, their managers, and also company decision makers that are making resolutions on behalf of the company and exercise a significant influence on its operation. Now they should constantly monitor the value of assets and prevent the company total debt from exceeding its assets. Should the total debt exceed the assets and should the company director fail to file a claim in bankruptcy within a month, he shall incur personal liability for debts of the enterprise that occurred upon the expiry of 30 days immediately upon emersion signs of insolvency. At the moment when the claim is accepted for consideration, should the company reports be unavailable or tampered with, managers will be held vicariously liable for all the debts of the enterprise.

Lack of certainty

However, the law enforcement practice isn’t generated yet, and some statutory provisions may be construed in different ways, say the lawyers. In particular, there is no clear understanding as to asset valuation methods to be applied by managers – should they assess them at balance value or at market value. The law provides no information pertaining to the matter and the Supreme Arbitration (Commercial) Court (SAC) has given no explanations about it yet, - pointed out Igor Gushchev, partner in “Duvernoix Legal”. Should the assets be assessed at balance value, there shall be a huge wave of bankruptcies because the property of any Russian company will be amortised in the course of time, therefore its book value gradually decreases. One may proceed from market value, but there is a great risk of its significant decrease because of economic fluctuations. Besides, business appraisals conducted once a month may prove very costly. Legal uncertainty has already forced several company executives to file claims in bankruptcy with the court, added Gushchev. And some other experts maintain that in some companies managers were replaced when the draft legislation was still discussed by mass-media.

Experts cannot give a confident advice to directors of enterprises as regards sensible course of actions in the new context. The senior lawyer of “S&K Vertical” Gennady Skutsky says that unless legal uncertainty is eliminated, it would be difficult to choose an appraisal methodology. But as long as SAC has given no explanations, Skutsky recommends, when it comes to company asset valuation, to proceed from specific context and take appropriate steps accordingly: “It is necessary to identify a more safe option: shall we implement a bankruptcy procedure, and this will result in reduction of risk of subsidiary liability, or shall we incur additional expenses due to valuation, and this will result in increase in risk to be held vicariously liable, but reduction of risk of bankruptcy procedure.”

Unemployed figureheads

It is quite logical to suggest that after amendments to bankruptcy legislation are accepted, directors shall be even more willing to disguise their personal assets. According to Egor Noskov, one may do it via a scheme which is prevalent in Russia involving the use of the off-shore companies. Besides, the demand may increase for dummy executives who are willing to participate in registration of a company for a modest fee and nominally are its managers.

Still, some lawyers believe that there will be no extraordinary demand for services rendered by figureheads, colleagues of Funt, a character from the novel “The Little Golden Calf”. Gennady Skutsky maintains that a nominal director can be held liable only on a pro forma basis. “Actually he would hardly be liable for anything. After all, it is common knowledge that nominal directors in Russia do not come out of woodwork: they are disadvantaged people, often homeless ones, who have no influence on decision-making. To discuss the efficiency of making them liable would be very unwise and unfair,” explained Skutsky.

Sergey Zimin, lawyer in Regional Agency for Debt Management (RADM) believes that today services provided by nominal directors and owner became inefficient since the law-enforcement agencies learned to investigate such cases and to identify the real owners or directors.

By the way, willingness of police or bailiffs to puzzle out the sophisticated schemes of ownership and to find out, whether directors are nominal or not will depend on a person invested with great authorities according to the bankruptcy law, i. e. on arbitration manager.

Creditors are dissatisfied

The logic of legislators who amended the bankruptcy law is easily seen: being exposed to the risk of asset loss,executives of companies should stop living on credit and adopt a more responsible borrowing policy. And still, spokespersons of some enterprises and bankers doubt that the law will actually increase responsibility of managers.

For instance, crisis manager Andrey Romanenkov is skeptical about amendments to legislation. As he said, business executives can only receive warrants of execution. No other responsibility is stipulated for them, absent bankruptcy fraud or premeditated bankruptcy, i.e., a criminal offence. However, it may be very difficult to establish a fact of premeditated bankruptcy and, as a rule, proceedings initiated under this article do not end with a guilty verdict, say the experts.

Some bankers, contrary to popular belief that amendments to the bankruptcy law should help them to recover debts and to combat against unscrupulous borrowers, even believe that innovations will only make things difficult for them. According to Andrey Pimenov, the director of St.-Petersburg lending and cash services office of Gorodskoy Ipotechny bank, any executive will transfer all assets to family members, friends or nominal owners long before the beginning of execution upon property. Besides, according to the Civil code of the Russian Federation, not all assets are subject to recovery. In particular, apartments which are a sole housing and are not mortgaged will fall within such unclaimable assets. “Even should the apartment floor area constitute 500 sq. m and is located at a high-end house, such apartment shall not be subject to recovery,” said Pimenov.

Asset stripping is still possible

The paramount objective held by any party in a bankruptcy case is to push through a friendly arbitration manager. According to Igor Gushchev, an arbitration manager actually controls the company during bankruptcy proceedings, i. e. convenes creditors' meetings, provides them with information, decides the procedure of bidding for the sale of property of the debtor and makes lists of the said property, does or does not challenge the transactions made by the debtor, etc. And it is a partisan arbitration manager engaged by business owners who can prevent creditors from challenging the deals made by the company.

The point is that the new bankruptcy laws contain much more ample list of voidability criterions allowing challenging transactions made by indebted company. Earlier on there were opportunities for challenging deals too, but now legislator has put into practice a new concept of suspicious transactions. These may include, for example, transactions made not at a market-dependent rate. They may be declared invalid within a year following the claim in bankruptcy. Any deals aiming to infringe interests of a creditor or to give advantages to a creditor over the rest, may be challenged, should they even be closed three years prior to acceptance of the claim in bankruptcy by court. Should the court grow suspicious that the transaction was made not at a market-dependent rate, it shall institute an independent inquiry in market value, said Gushchev.

These provisions are also considered as innovations aimed to substantially reinforce positions of creditors. Now there will be much less opportunities for asset stripping, believes Gennady Skutsky. “Every time when an executive will make a transaction, he’ll take into account that transaction may be challenged later on. And it applies to both sellers and buyers of any assets. As a result market participants will be more disciplined and ready to abide by laws,” argues Skutsky.

Nevertheless, bankers have many questions to the legislation on bankruptcy. Dmitry Prohorevich, the deputy corporate manager of the Petersburg branch of Yunikreditbank says that in most cases arbitration managers are engaged by ultimate beneficiaries of the companies going bankrupt. It creates additional opportunities for asset stripping, and the updated law has nothing to make up for it.

In separate occasions an arbitration manager can act for third persons, that’s why some bankers are afraid that a danger may arise of corporate raid intended to seize business of a company going bankrupt. Sergey Zimin points out that the bank, being the creditor of indebted company, is a participant in bankruptcy case. And bank experts are entitled to participate in court sessions, to supply explanations, to present their case, to give and require evidence, etc. “They should not give complete control over the process to arbitration manager. One way or another, creditors gained more rights to protect their interests in the process of bankruptcy,” emphasized Zimin.

Bankers and lawyers both agree with the truth of that statement. However, amendments to the law are of rather tactical nature, believes Andrey Romanenkov. Sure, controllers of the debtor are liable for their obligations to the extent of their property, but they still have tons of techniques enabling them to hide the property or to strip assets through the offshore companies or by transfer of property to his family members who are not liable for his debts. So the law, while making it much easier to repay loan or to recover credit out of the assets of debtor, has nevertheless failed to annihilate the mechanisms used by unscrupulous borrowers for breaching obligations and stripping assets.

Expert Severo-Zapad no. 41 (438), October 26– November 02

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