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New law on insolvency of credit organizations

In response to the financial crisis since August 1998, and the corresponding collapse of its banking system, Russia has enacted a Law on the Insolvency of Credit Organizations (Law No. FZ-__, which was published and became effective on March ___, 1999). The law supplements the general Law on Bankruptcy adopted in March 1998, providing badly-needed clarification of the procedures for dealing with insolvent banks.

Under Articles 2(1) and 2(2) of the new Law, a bank may be declared insolvent when it is unable to satisfy the demands of its creditors with respect to monetary obligations (including tax payments owed to the state), and such obligations have remained unfulfilled for one month. The Arbitration Courts (a category of state commercial courts) may find a bank insolvent and initiate bankruptcy proceedings, which generally follow the rules in the year-old Law on Bankruptcy. However, the law establishes special features for bankruptcies of banks, as described below. For the most part, these features provide the central bank with broad control over the insolvency process, including the ability to prevent bankruptcy where desired.

Prior to formal bankruptcy, Article 3 of the Law describes three measures which are intended to be used to rehabilitate troubled banks: financial rehabilitation, temporary administration and reorganization. These measures should be undertaken by bank management with the approval of the appropriate governing bodies (eg, the Board of Directors or shareholders), in circumstances defined by Article 4 of the Law (such as insufficient funds in correspondent accounts for defined time periods, reduced capital of at least 20% with violation of central bank norms, or other violations of central bank reserve or liquidity requirements). If no action is taken by management, the central bank may itself step in and impose such measures.

Essentially, financial rehabilitation involves the voluntary infusion of new capital by investors; temporary administration means the appointment of an outside manager (who must be specially licensed and accredited by the central bank); and reorganization refers to consolidation or merger with another banking organization. The functions of the temporary administrator are described in some detail in Articles 16 to 22 of the law, and it is expected that this approach will be favoured by the Russian authorities. Generally, the central bank appoints the temporary administrator once defined grounds exist (which may include the same grounds appropriate for revocation of the bank's license). The temporary administrator may work alongside bank management, or may replace management (once the central bank has suspended the authority of management, under Article 16(3)). The term of temporary administration may be up to 6 months. The central bank may decide to extend this term up to 18 months. Once in place, the temporary administrator has authority over certain categories of transactions (Articles 21 and 22 of the Law), including the power to refuse to perform contracts (Article 27 of the Law).

Once formal bankruptcy proceedings commence, the above measures are replaced by liquidation procedures under the Law on Bankruptcy, with the Arbitration Court, the creditors and a new "liquidation manager" presiding. However, under Article 36 of the Law, bankruptcy proceedings cannot begin until the central bank has revoked the bank's operating license. This decision is solely within the authority of the central bank, although Article 35 of the Law contemplates that creditors may apply to the Arbitration Court, or to the central bank, for such revocation (and, accordingly, put pressure on the central bank to act). This unilateral veto right of the central bank could be used to block bankruptcy proceedings indefinitely, and is a potentially serious weakness in the legal regime for bank insolvency.

Brian L Zimbler and Dmitri Gorelov

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