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A new Russian bankruptcy law became effective on March 1 1998 (Federal Law No. 6-FZ On Bankruptcy). Given the difficulties being experienced by the Russian economy and the precarious state of many enterprises, the new law may assume growing importance in the reform process. Under previous legislation, bankruptcies proved difficult to implement and only infrequently resulted in the liquidation or material restructuring of troubled debtors. Key improvements in the new law include a revised and more practical definition of bankruptcy; a wider list of actors who may start bankruptcy proceedings; and new and more detailed procedures governing the activities of the courts, creditors and manager/trustees in connection with bankruptcy.

Under the old legislation, a legal entity was considered bankrupt if its total debts exceeded its total assets. Based on this definition and Russian accounting rules, a debtor with substantial assets could avoid bankruptcy, even though the assets were illiquid and the debtor was practically insolvent. Under Article 3 of the new law, a company may be declared bankrupt if it fails to satisfy its monetary obligations (including tax obligations owed to the state) for a period of three months after the obligations are due.

The right to start bankruptcy proceedings is now granted under Article 6 of the new law to a wider group of parties than before. As before, the debtor, its creditors and public prosecutors have the right to apply to a court for the start of bankruptcy proceedings. In addition, the tax authorities and other government bodies may now file the application. This change is particularly significant because the tax authorities are the principal creditor of many troubled Russian companies.

The new law sets out the procedures for starting and implementing bankruptcy proceedings. An application is made to an arbitration court (a state court specializing in commercial matters). The court may appoint an interim manager with certain powers over the company during the period in which the application is considered (generally, three months). For example, the interim manager must approve transactions involving real property, or more than 10% of the company's assets. Certain other transactions, such as dividend payments, are prohibited during this phase. Both the court and the interim manager may take certain actions to protect the interests of creditors.

If the bankruptcy application is accepted, one of several approaches must be chosen, as follows:

  • a voluntary settlement with the creditors;
  • transfer of control to an external manager who implements an agreed reorganization plan; or
  • satisfaction of the creditors' claims through sale of the debtor's property.

The new law contains a variety of provisions to protect the interests of creditors and promote fairness in the bankruptcy process. For example, interested persons (managers, members of the board of directors and their relatives) may not be appointed as interim or external managers (Articles 18 and 19.1). Illegal actions by the interim or external manager may result in civil liability to the debtor and creditors (Article 21.3). In certain circumstances, including where it would be impossible to satisfy a creditor's claims, a manager is obliged to file for bankruptcy, and failure may result in civil and criminal liability (Articles 8,9).

Similar to bankruptcy legislation in other countries, the new law provides for a moratorium on enforcement actions or foreclosure against the debtor during the bankruptcy process, and the possibility of retroactive termination of certain transactions before the bankruptcy. For example, after the court has approved the bankruptcy application, no claims may be brought outside the bankruptcy proceedings; and execution of existing judgments is suspended (with certain exceptions, including claims for wages). The court may invalidate certain transactions conducted before the start of the bankruptcy, including transactions with interested persons that caused or could cause losses to creditors; preferential satisfaction of claims of certain creditors within six months before filing the bankruptcy application; or redemption of equity interests within this six-month period (Article 78).

It is hoped that the new law will provide a more effective basis for restructuring Russian businesses. Clearly, the need is large for such measures. Even under the old legislation, the number of business bankruptcy cases increased dramatically over the last five years, from less than 100 cases in 1993 to 2628 cases in 1996, and 1861 cases in the first half of 1997. Further, under the Russian government's anti-crisis programme (which, among other goals, seeks to enforce tax laws and boost tax revenues), bankruptcy legislation has assumed a new function as a penalty of last resort for the government to wield against recalcitrant taxpayers.

Robert Wood and Brian Zimbler

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