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Comments made by Andrei Mikonin, the lawyer and partner of legal firm S&K Vertikal to an article titled “Some are wise, and debtors are otherwise”

5 August 2011

The reason for irresolvable conflicts between borrowers and creditors is not in legal loopholes but in the lack of civilized informal conventions and practices in the Russian business.

“Don't have thy cloak to make when it begins to rain”: this proverb is better suited to describe the situation with corporate debts. The fact that this area is prone to serious problems became obvious in the crisis year. According to some estimates, as early as two years ago the bad debts measured up to 40 % of gross loans. About 30 % of arrears were qualified by bankers as net loss, which meant that national economy faced a disaster.

The doom-laden forecast for banks hasn't verified yet, and currently banks (at least those in the top echelon of banks) feel well enough. “The situation with debts has significantly changed for the better,” commented Mikhail Zaytsev, Vice President of the VTB North-West Regional Center. “In many banks settled debts make 40% - 50 % of “distressed debts”, as of beginning of 2009, and that may be considered very good result for such small post-crisis period”. Such result was mainly achieved due to renewal of global economic growth which allowed honest borrowers to start paying off their debts to creditors. “Moreover, banks grew more cautious as regards crediting, taking into account past galling experience, therefore bad debts ceased to increase,” continued Mikhail Zaytsev.

However, according to Maksim Sterin, Head of Corporate and M&A Practice at Hannes Snellman, it's too soon to say whether the danger is over or not. “The market has, to a certain extent, lost its unpredictability: weak business gone bankrupt, while stronger companies had their debts refunded,” he explained his point of view. “However, the problem was not solved, it just became latent.” Bankers and borrowers agree that the issue is rooted in the lack of efficient dispute resolution mechanics.

Inefficient bankruptcy

At the height of the crisis the government attempted to establish these mechanics at legislative level. In particular, legislative acts on bankruptcy were amended, aimed at providing creditors with additional protection of their rights. Amendments allow creditors to exercise better control over debtors in the course of bankruptcy proceedings.

New clauses concern not only bankrupts de jure, but any business displaying signs of insolvency as well. However, according to Sergey Yeliseyev, anti-crisis manager and managing partner at “М911 +”, the government tolerates an obvious “bias” in favor of creditors. “Currently even honest debtors have no legal protection at all, since creditors can start bankruptcy proceedings at any moment,” argues Mr. Yeliseyev. “The Russian legislation makes it an easy matter to force a business into insolvency.”

At the same time, mechanisms allowing to solve the debt problem other than bankruptcy were not supported by law-makers. What is meant here is, in particular, the possibility to introduce a specific legislation (similar to American Chapter 11), protecting debtors from aggressive actions of creditors. If past experience is any guide, bankruptcy is not the best instrument for both creditors and borrowers. “Should an independent bankruptcy commissioner be assigned, the efficiency of bankruptcy shall be quite low,” explained Sergey Yeliseyev. “Statistically, a creditor shall only be refunded 10 kopecks per a ruble of debt. They shall receive much more should they make accommodation with debtors.”

Hard talk

A common way to make accommodation is to reach an amicable agreement which provides for certain installment plan for borrower. Nevertheless, this instrument has serious drawbacks. According to Andrei Mikonin, the partner of legal firm S&K Vertikal, the most important drawback consists in the lack of uniformity of judgments delivered by courts of different jurisdictions regarding the same issue (see insert). Some experts believe that any attempts to introduce case law analogous to Anglo-Saxon model in Russian legal practice shall be doomed to failure. “Prior to attempting to introduce western legal constructions one should take into account the law tradition existing in this country which is closely associated with culture of Russian society,” argued Maksim Sterin. “That’s why many western norms cannot be adopted in Russia.”

On the other hand, some of the best Western mechanisms which proved to be efficient might be applied in Russia without any changes to the legislation. Both creditors and borrowers in advanced nation go by two types of rules. First, they abide by laws second, they are guided by the so-called protocols developed by branch associations (such as the International Association of Restructuring, Insolvency & Bankruptcy Professionals (INSOL), London market association, etc.). These reports provide for mutual obligation to refrain from any hostile actions in the course of debt restructuring negotiations.

Practically, the protocols are analogs of the above amicable agreement, however, they have one important difference. “The Russian legislation only sets forth principles and rights of the parties to the amicable agreement,” explained Maxim Sterin. “The amicable agreement should stipulate for specific action sequence to be implemented by the parties, concerning execution of the agreement and observation of its terms. Protocols are meant to reflect certain rules of conduct adopted by borrowers and creditors in advance.” The Russian business community already began using norms set forth in western branch protocols. One may cite an example of the agreement on restructuring debts of Rusala (creditors included about 70 western entities and a group of Russian banks), signed by the end of 2009.

However, both experts and business community members are positive that one should not expect for wide application of western protocols in Russia, at least in the near future. “One should understand that norms of protocols are not court rulings,” commented Sergey Yeliseyev. “The only reason to abide by these protocols are reputational risks which are still not an essential factor here in Russia.” According to one of persons interviewed by RBC daily, “When concluding an amicable agreement you should understand that the 30-40 % of the debt shall be paid according to schedule, while the remaining amount - with delays, sanctions, etc.”

So, in spite the above legal discrepancies the problem of outstanding debts is rooted in the fact that Russian arrangement practice as such is flawed. Therefore, the clue lies not in legislation. Experience shows that mores are slow to change. However, it is the mores that determine the mode of behaviour in any community. At the same time, there are the factors in business environment which are able to accelerate evolutionary changes. The major factor is - intensification of competition which shall compel companies to spent money wisely. And to understand that to be honest is economically advantageous.

Arkady Poddubny


RBC daily no. 130 (799) of August 04, 2011. 


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