Insolvency and Bankruptcy Law Reform
in the Russian Federation
Vassily V. Vitryansky”
Russian insolvency and bankruptcy legislation has
developed into a sophisticated system of rules that enjoys a
unique place in the world of bankruptcy law. By referring
to United States and European bankruptcy laws, the author
situates the Federal law On Insolvency (Bankruptcy) within
the world’s various bankruptcy regimes. The author also
compares old Russian laws with the new system in order to
provide a vivid snapshot of the present state of Russia’s
bankruptcy laws.
Part I of the article underlines the historical inade-
quacies of Russian insolvency law and recent attempts to
address these deficiencies. In Part II, the author positions
Russia as the golden mean on the global spectrum of bank-
ruptcy regimes that range from radical pro-debtor to radical
pro-creditor. To emphasize the point, the author compares
and contrasts the new Russian law with United States and
European insolvency regimes in light of the possibilities of-
fered for rehabilitation of the debtor, satisfaction of credi-
tors’ claims, and criteria for determining bankruptcy. Part
III focuses on the evolution of bankruptcy procedures from
the old system to the new Federal law. This section in-
cludes a detailed discussion of various bankruptcy proce-
dures under the new law: observation, external manage-
ment, amicable agreement, and bankruptcy proceedings.
This section also contains an analysis of bankruptcy proce-
dures applicable to specific categories of debtors including
town-forming organizations, agricultural organizations, and
banking and other credit institutions (with a consideration
of the corresponding effects on individual depositors). The
author also contemplates the novel concept in Russian law
of the bankruptcy of an individual who does not have en-
trepreneurial status. Part IV evaluates a recently passed
government resolution concerning accelerated bankruptcy.
The resolution proposes the adoption of three measures: in-
creased coordination between various state agencies, con-
solidation of government claims against the debtor, and a
decision
to apply accelerated bankruptcy procedures
adopted at the first meeting of the creditors.
La legislation russe sur l’insolvabilit6 et la faillite
s’est d6veloppe en un syst~me fort 6labor6 de rfgles jouis-
sant d’une place unique dans le domaine du droit de la
faillite. C’est a la lumiie des regimes am~ricaln et euro-
p~en sur la faillite que ‘auteur 6value la Loifiddrale sur
linsolvabilitd (faillite) de la Russie. I1 compare aussi les
anciennes lois russes avec le nouveau systbme, de faqon a
nous donner un rapide coup d’ceil sur le prdsent dtat des
lois russes surla faillite.
La premiere section de r’article souligne les insuffi-
sances de la 16gislation russe sur l’insolvabilit, et les rd-
cents efforts investis pour parer hL ces manquements. Dans
la seconde section, l’auteur montre que la Russie constitue
un juste milieu parmi le vaste dventail de rdgimes sur
l’insolvabilit6, les uns favorisant les d6biteurs et les autres
les er6anciers. Pour illustrer ce point de vue, ‘auteur com-
pare la nouvelle loi russe avec les r6gimes amdricain et eu-
ropden sur l’insolvabilitd, ii la lumiire des critres utilisds
dans Ia dtermination de la faillite, mais aussi selon les
possibilit6s offertes dans chacun des rdgimes pour la r6-
adaptation du d~biteur et l’acquittement des r6clamations
des er.anciers. La troisiime section de l’article 6tudie
l’6volution des proc&lures sur la faillite, de ‘ancien sys-
time ii la nouvelle loi f.d6rale. Cette partie dfinit diffd-
rentes procalures de la nouvelle loi : observation, adminis-
tration exteme, convention A. ‘ramiable et demarches en eas
de faillite. Cette section contient aussi une analyse des pro-
cddures de la faillite applicables 4 certaines catdgories sp-
cifiques de ddbiteurs, telles que les organisations de ddve-
loppement urbain, agricoles, bancaires et autres institutions
h crfdit (en considdrant les effets correspondants sur les in-
dividus). L’auteur considre aussi le concept inddit de la
faillite d’un
le statut
d’entreprise. Enfin, la quatriime section de l’article 6value
une rdsolution gouvemementale rdcemment adopte con-
cemant la faillite accdl6rde. Ladite rdsolution propose
‘adoption de trois mesures pr6cises: la coordination ac-
crue entre les diverses agences de l’ttat, la consolidation
des r.clamations du gouvemement contre les ddbiteurs et
‘application des proc~dures sur ]a faillite acc6l6r.e adop-
tIes lots de la premiere assemblde des cr6anciers.
individu qui ne ddtient pas
Deputy Chairman of the Higher Court of Arbitration of the Russian Federation.
McGill Law Journal 1999
Revue de droit de McGill 1999
To be cited as: (1999) 44 McGill L.J. 409
Mode de r6f6rence: (1999) 44 R.D. McGill 409
MCGILL LAW JOURNAL / REVUE DE DROITDE MCGILL
[Vol. 44
I. The Necessity of Reform
I1. General Characteristics of the New Russian Law and its Place in the
World Insolvency and Bankruptcy Systems
Ill. Key Provisions of the New Legislation on Insolvency and Bankruptcy
A. Specific Features Regarding the Bankruptcy of Certain Categories of
Debtors and Legal Entities
B. Bankruptcy of Individuals
IV. The Practical Application of the New Russian Insolvency and Bank-
ruptcy Regime
Conclusion
References
1999]
V V VITRYANSKY- INSOLVENCY & BANKRUPTCY LAW REFORM
411
I. The Necessity of Reform
The former law of the Russian Federation On Insolvency (Bankruptcy) of Enter-
prises’ was adopted by the Supreme Soviet of the Russian Federation on November
19, 1992, and became effective as of March 1, 1993. Cases on insolvency of debtors
are heard by the courts of arbitration-the incidence of which over the years has been
as follows: in 1993, a little more than 100 cases of this category were considered; in
1994, 240 cases; in 1995, 1,108 cases; in 1996, 2,618; and in 1997, there were over
4,600 cases. The number of debtors annually recognized as insolvent increased during
this period from 50 in 1993 to 2,600 in 1997.
The growing insolvency jurisprudence and a systematic analysis of court of arbi-
tration practices reveal important drawbacks in the legal regulation of relationships
relating to the insolvency of debtors. The first attempts to apply insolvency law re-
flected its imperfection and lack of depth, but it also brought to light numerous gaps
in legal regulation. The search for ways of perfecting insolvency legislation required
an appraisal of Russia’s historical experience in the area, including the development
and application of insolvency law in the pre-revolutionary period, i.e., prior to 1917.
In addition, foreign bankruptcy legislation would have to be studied. Before the Rus-
sian Revolution, gaps in domestic bankruptcy legislation were filled in by the active
work of the Federal Agency on Insolvency and by the adoption of appropriate meas-
ures by the Russian Federation’s Higher Court of Arbitration, both of whose goals
were to provide a uniform approach in the court of arbitration procedure.
In 1995, the first attempt to reform Russian legislation on insolvency was under-
taken when the first draft of the Law on Insolvency of Enterprises was prepared. In
December 1995, this draft was adopted by the State Duma of the Russian Federation’s
Federal Assembly on its first reading. In the process of preparing the draft law for its
second reading, over 600 amendments were studied and analyzed. At that time, how-
ever, the work on the draft law was suspended for two reasons: (i) the appearance of
an alternative draft law (with 70% of the text repeating that of the first draft law), and
(ii) the adoption by the State Duma on first reading of the draft Federal law On Insol-
vency (Bankruptcy) of Banks and Other Credit Institutions-an independent draft law
unrelated to the comprehensive law on insolvency. It became obvious, however, that
in this disparate form, legislation on bankruptcy would not work effectively. It was
necessary to return to the conceptual issues of legal regulation related to insolvency
and bankruptcy. To this end, discussions in the respective committees of the State
Duma, the National Bank Council of the Bank of the Russian Federation, and the
Russian Federation’s Higher Court of Arbitration produced a compromise solution to
provide for the regulation of relations connected with insolvency through laws on in-
‘ Vedomosti S”ezda Narodnykh Deputatov R.E i Verkhovnogo Soveta R.E (1993) No. 1., item 6
[hereinafter Law on Insolvency of Enterprises].
2 The words “insolvency” and “bankruptcy” are used interchangeably throughout this article.
‘Hereinafter Law on Insolvency of Banks.
MCGILL LAW JOURNAL / REVUE DE DROITDE MCGILL
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solvency and bankruptcy of credit organizations. Meanwhile, it was recognized that
the draft Law on Insolvency of Banks should establish only the specifics of regulating
procedures related to the bankruptcy of banks and other credit organizations, i.e., pre-
judicial procedures aimed at preventing the bankruptcy of these organizations. In this
sense, it was thought that the law should be comprehensively brought into line with
the principles and norms of the draft Federal law On Insolvency (Bankruptcy).’ These
concerns required that both draft laws be returned for a first reading after considerable
revision.
The work has now been completed on the Law on Insolvency of Banks. It has
been adopted by the State Duma, but not yet approved by the Federation Council. At
the time of writing this article, this draft law is in the process of finalization in the
reconciliatory commission established by the chambers of Parliament.
Why should Russia develop new legislation on insolvency? One could answer by
pointing to a number of deficiencies in the current legislation. For present purposes,
however, we shall focus on the most essential ones.
First, the previously effective Law on Insolvency of Enterprises attempted to
combine, in an eclectic manner, elements of different insolvency regimes applied in
different countries. In France and the United States there is a pro-debtor bankruptcy
system which allows the debtor in difficult financial straits to free itself from debts
and to attempt a fresh start. In such systems, the interests of creditors are not fully ac-
counted for. Rather, creditors have to adjust themselves to the conditions established
by the court to clear the debts of the debtor. Therefore, in the United States most cases
on bankruptcy are commenced on the initiative of debtors.
By contrast, in Europe (with the exception of France) a pro-creditor system has
long been applied. The priority of this system has been the best possible satisfaction
of creditor’s claims, while the interests of the debtor are rarely taken into account. The
key element in this system is rigid control over the preservation of the the debtor’s as-
sets and the debtor’s prompt liquidation. Undoubtedly, the existing bankruptcy re-
gimes borrow from and inform each other. The recent amendments to bankruptcy
legislation in the United States, Germany, and other countries is evidence of this fact.
The Russian law offered the possibility of applying both the pro-creditor and pro-
debtor systems without attempting to regulate in detail the mechanism for its imple-
mentation. What this means is that bankruptcy procedures would be identical regard-
less of whether the debtor or creditor initiated court intervention-and the same
would be true with respect to the bankruptcy procedures.
Second, the very concept and characteristic features of bankruptcy used in the
previous law did not accord with present-day commercial reality. In fact, application
of the previous law meant that the inability of a debtor to satisfy the claims of a
creditor due to “the excess of the debtor’s liability over its assets, or in connection
‘Sobranie zakonodatelstva R.E (1998) No. 2, item 222 [hereinafter Law on Insolvency].
1999]
V V VITRYANSKY-
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with an unsatisfactory structure of the debtor’s balance threatened to bankrupt the
creditor as well.”
It is not just that the debtor, for a lengthy period of time (i.e., over three months),
would not pay its debts for it to be recognized as bankrupt, the court also had to check
the composition and value of its assets, and evaluate the structure of its balance from
the perspective of its assets’ degree of liquidity. Only if the indebtedness toward its
creditors exceeded the value of all the assets could such a debtor be recognized as
bankrupt. Such an approach allowed commercial actors who were unable to pay to
continue in operation, thereby dragging their creditors into insolvency with them. The
domino principle thereby took effect, stimulating the non-payment crisis affecting the
Russian economy.
Such conditions allowed top managers of commercial organizations who had no
reason to fear bankruptcy to withhold debt payment and use the available money as
their own enterprise funds, ensuring only that the total amount of accounts payable
did not exceed the asset value of the organization. From this, it is obvious that the le-
gal concept and characteristics of bankruptcy that used to be applied protected bad-
faith debtors and were thus destroying the principles of commerce.
Third, the old legislation could be characterized by its identical approach to all
categories of debtors in bankruptcy proceedings. The law did not make any distinction
between a legal person and an individual entrepreneur, a major enterprise and an in-
termediary organization which did not have its own assets, a commercial enterprise
and a peasant (i.e., a farm) enterprise, or an industrial enterprise and a credit organi-
zation. Bankruptcy thresholds for all such debtors and the procedures that applied to
them were the same, although it was quite obvious how different the consequences of
the law would be for different classes of debtors.
Fourth, in the regulation of bankruptcy procedures, the old law absolutely ne-
glected the diverse situations in which the debtor and its creditors could find them-
selves. For instance, courts of arbitration would most frequently face situations where
the top manager of a debtor organization was missing and it was impossible to iden-
tify his whereabouts, or where the debtor had no assets sufficient to cover court ex-
penses. In all cases, the court of arbitration was directed by law to declare the debtor
bankrupt, start bankruptcy proceedings, and appoint a bankruptcy manager. Naturally,
no creditor would agree to transfer to the deposit account of the court of arbitration
the money necessary to pay the bankruptcy manager (at least as advance payment).
The decisions of the court of arbitration on the bankruptcy of such debtors were im-
possible to implement. As a result, courts would keep the cases on file, while debtors
who were recognized as bankrupt would remain in the register of legal persons.
The gaps in the law stemmed largely from the adoption of many incoherent legal
acts. By the time the new insolvency law was adopted, over thirty Edicts of the Presi-
dent of the Russian Federation, Resolutions of the Government, and departmental
-‘Law on Insolvency of Enterprises, art. 1.
MCGILL LAW JOURNAL / REVUE DE DROITDE MCGILL
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regulatory acts had been in effect. What matters of course is not so much the number,
but the quality of those acts, which were incoherent and at times contradictory. Fur-
thermore, the recent adoption of a number of legal acts treat insolvency either as a
remedy for all economic troubles or as a vehicle to resolve current economic prob-
lems-i.e., as a means to struggle with tax evaders or as an additional way to carry out
privatization-is cause for concern.
II. General Characteristics of the New Russian Law and its Place
in the World Insolvency and Bankruptcy Systems
According to some European experts, the insolvency systems in place throughout
the world fall into five categories arranged along a continuum from radical “pro-
creditor” legislation to radical “pro-debtor” legislation. Between the boundaries of
these extreme categories are “moderate pro-creditor”, “neutral”, and “moderate pro-
debtor” legislation. The prevailing protection of either the creditor or debtor serves as
the general basis for distinguishing between categories. The degree of creditor or
debtor protection is, in turn, determined by the content of the legislative regime sub-
ject to analysis.
The first variable taken into consideration is the measure of protection given to
secured creditors. From this perspective, the new Russian law cannot be classified as
“pro-creditor”. Under article 64 of the Civil Code of the Russian Federation,’ the
property that served as the object of a pledge on the liabilities of a debtor is not ex-
cluded from the property mass, and a creditor with a secured claim has no possibility
to levy execution against the object of a pledge in priority to other creditors. At the
same time, a creditor of a claim secured by a pledge is of the third beneficial prior-
ity-not only being placed ahead of most other creditors on civil law liabilities, but
also coming prior to the State with respect to tax and other mandatory payments. In
contrast to all other regimes, under Russian law a secured creditor receives satisfac-
tion of its claims at the expense of all the debtor’s property (not only the property
which is the object of a pledge). Creditors of secured liabilities enjoy certain privi-
leges at creditor’s meetings when key decisions are made. Specifically, to conclude an
amicable agreement with the debtor, a unanimous decision of all creditors of secured
liabilities is necessary (with more than half the votes of all other creditors participat-
ing in the bankruptcy procedure). Therefore, with respect to secured creditors, the
Russian legislation cannot be characterized as “pro-debtor”.
Another aspect of the legislation to be analysed is the treatment of assets trans-
ferred by creditors to a debtor in possession or use on a contractual basis which do not
belong to the latter by right of ownership (i.e., title finance). With respect to this vari-
6 Part I was enacted in 1994: Sobranie zakonodatelstva R.E (1994) No. 32, item 3301; and Part 2
was enacted in 1995: Sobranie zakonodatelstva R.E (1996) No. 5, item 410 [hereinafter C.C.R.F.].
For the English-language translation, see P.B. Maggs & A.N. Zhiltsov, eds., The Civil Code of the
Russian Federation, trans. PB. Maggs & A.N. Zhiltsov (Armonk, N.Y.: M.E. Sharpe, 1997).
1999]
V V VITRYANSKY-
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able, Russian law cannot be firmly categorized as either “pro-creditor” or “pro-
debtor”. On the one hand, if a debtor is declared bankrupt and the bankruptcy proce-
dure starts, the assets that do not belong to the debtor but were transferred to it by the
creditors under the contract (i.e., sale by instalment, leasing, etc.) are not included in
the bankruptcy estate of the debtor. Instead, the assets are to be returned to the credi-
tors. On the other hand, when the external management procedure is introduced, all
such assets remain with the debtor and are used for the purpose of recovering its sol-
vency without any special compensation for the respective creditors.
In assessing any insolvency regime, an important factor is the possibility for the
rehabilitation of the debtor provided for by the system. In this respect, account must
be taken of the degree to which rehabilitation procedures encroach upon the rights of
individual creditors, and how easy it is for the debtor to get such rehabilitation. It is
also important to determine whether the legislation entrusts the former administration
of the debtor (i.e., the general manager of the organization) with the implementation
of rehabilitation measures (i.e., debtor in possession), or requires the appointment of
an external manager for that purpose.
Russian law does provide real possibilities for the rehabilitation of the debtor so
that it can recover its solvency, both within the external management procedure and
through the conclusion of an amicable agreement. At the same time, there are a num-
ber of provisions indicating that the legislation cannot be categorized as “pro-debtor”.
First, the very procedure for initiating bankruptcy in a court of arbitration is
“neutral” for the debtor. The court of arbitration is not forced to consider the case by
conducting a rehabilitation procedure, which is the practice in the United States
whereby an application may be filed by a debtor under Chapter 11 of the Bankruptcy
Code7 for the reorganization of business.! In this sense, Russian law more closely re-
sembles the French insolvency law of 1994 (effective as of 1999), which employs a
neutral insolvency procedure and decides whether or not to apply rehabilitation or
liquidation measures to the debtor after the case is considered.
Second, those present at the first meeting of creditors-which is held prior to the
main session of the court of arbitration-are granted an opportunity to express their
opinion with respect to procedures (i.e., external management or bankruptcy pro-
ceedings) that should be applied to the debtor.
Third, Russian law prohibits the old administration of the debtor’s organization
from exercising rehabilitation procedures itself. To exercise measures for restoring the
solvency of the debtor within the external management system, the court of arbitration
must appoint an external manager acting under the control of the creditors.
Finally, it is important to distinguish between the rehabilitation of a debtor’s or-
ganization and the rehabilitation of its business (i.e., preserving the business ties, work
‘ II U.S.C. (1998).
8 Bankruptcy Code and Rules (Philadelphia: Clark Boardman Callaghan, 1993) at 107-34.
MCGILL LAW JOURNAL / REVUE DE DROITDE MCGILL
[Vol. 44
places, etc.). It is a mistake to believe that “pro-debtor” legislation aimed at the reha-
bilitation of the debtor contributes to the preservation of its business. On the contrary,
statistical court data confirms that in the United States and France-where legislation
is primarily aimed at the rehabilitation of the debtor through various compromises-
the percentage of businesses rescued due to court-supervised reorganizations is rather
low. Meanwhile, the “pro-creditor” English law-which applies procedures such as
receivership and administration-yields only a 50% resuscitation rate for previously
bankrupt businesses.
A critical factor for associating the national insolvency regime with one or an-
other legal system is whether creditors have an opportunity to satisfy part of their
claims at the expense of third parties who manage the debtor’s business or determine
its decisions. “Pro-debtor” legal systems, as a rule, grant creditors the right to levy
execution only against the assets of the debtor–excluding a possibility to file claims
against third persons. In this sense, Russian legislation has made a significant step to-
ward “pro-creditor” jurisdictions due in large part to the foundation laid by the
C.C.R.F It includes the subsidiary liability of founders for bringing the debtor to the
state of bankruptcy. Founders are those people who have the right to issue mandatory
instructions for the given legal person, or who have the ability to determine its actions
in some other manner.
The Law on Insolvency not only developed these provisions, but it also deter-
mined the vehicles for their implementation by granting the bankruptcy manager a
right to set up respective claims against third parties whose actions caused the insol-
vency of the debtor. The amount of such claims must be determined on the basis of
the difference between the amount of creditor claims and the value of the debtor’s
bankruptcy estate. The amounts recovered in this way are included in the bankruptcy
estate and may be used by the bankruptcy manager only to satisfy the claims of the
creditors in the established order of priority. Moreover, the law expands the list of per-
sons to whom such claims can be filed-including the debtor’s top manager and the
liquidation commission (i.e., the liquidator) who fail to apply to a court of arbitration,
with respect to the debtor’s bankruptcy, where required by law.'”
Comprehensively, it may be concluded that the Law on Insolvency cannot be clas-
sified as either “pro-creditor” or “pro-debtor”. It is, rather, neutral. This makes the
Russian insolvency system flexible, allowing it to fully account for the conditions of
the debtor’s insolvency in each specific instance. A few more conceptual issues will
now be considered, without which the general characteristics of the new Russian in-
solvency legislation cannot be fully appreciated.
A brief description should be made of the concept of insolvency and its main
features. The approaches of different bankruptcy systems with regard to a debtor’s in-
solvency can be reduced to two separate analyses; the basis for recognizing a debtor
9 Arts. 56, 105 C.C.R.F.
‘0 Arts. 9, 101 C.C.R.F.
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V V VITRYANSKY – INSOLVENCY & BANKRUPTCY LAW REFORM
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as bankrupt lies either in (i) the principle of its insolvency-proceeding from the
analysis of reciprocal cash flows–or (ii) insufficient repayment capacity-proceed-
ing from the ratio of assets to liabilities on the debtor’s balance sheet. The old law
used the principle of insufficient repayment capacity as a criterion of bankruptcy. This
caused a delay of court proceedings to the detriment of the creditor’s interests and,
most importantly, made it impossible for the courts of arbitration and creditors to re-
cover through bankruptcy procedures from those insolvent debtors whose asset values
formally exceeded their total accounts payable.
It should be noted that some legislative regimes use the criterion of insufficient
repayment capacity, which requires an analysis of the debtor’s balance sheet. For in-
stance, under German legislation the criteria for bankruptcy-apart from insol-
vency-includes “debt overhang”, which means that the debtor’s assets are insuffi-
cient to cover all of its liabilities. As a rule, however, this criterion is used in addition
to the insolvency criterion and mostly serves as a basis for choosing between liquida-
tion and rehabilitation as the appropriate procedure to be applied to the insolvent
debtor.
The new Russian law on insolvency follows the same pattern. The debtor-legal
entity or individual entrepreneur-can be declared bankrupt when it is insolvent, but
the fact that the debtor owns assets in excess of total accounts payable is grounds for
the possibility of restoring solvency. As a consequence, it can serve as a basis for the
use of an external management procedure with respect to the debtor. In the event of
insolvency of physical persons who do not have the status of individual entrepreneurs,
the principle of insufficient repayment capacity (i.e., the excess of accounts payable
over the asset value) will be applied.
Particular stress should be placed on the order of priority for satisfying the claims
of creditors. The new Russian law on insolvency, following the C.C.R.F., gives prefer-
ence to the claims of the debtor’s employees with respect to payment of wages and
salaries, thereby subordinating the claims of creditors on liabilities secured by pledge.
The social aspect of this solution to the problem is significant. The fact is that
bankruptcy regimes in many countries give priority to secured creditors, and address
the problem of protecting the interests of the debtor’s employees in other ways. For
instance, German law provides compensation for losses to the bankrupt debtor’s em-
ployees (i.e., wage arrears falling due in the three months prior to the commencement
of bankruptcy proceedings) through a special fund that is financed by contributions
paid by all employees. American bankruptcy law provides a detailed regulatory
scheme relating to payments to employees of bankrupt businesses under collective
agreements, and where such agreements do not apply, payments under various insur-
ance schemes are made.”
The absence of provisions protecting the rights of the employees of bankrupt
businesses and legal entities under liquidation under Russian legislation is an addi-
” 11 U.S.C. 1114.
418
MCGILL LAW JOURNAL / REVUE DE DROITDE MCGILL
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tional argument in favour of refusing top priority rights to creditors with secured
claims.
The Law on Insolvency, in contrast to the old law, contains provisions in Chapter
9 which provide for the bankruptcy of individuals who do not have the status of indi-
vidual entrepreneurs. These provisions evoked the greatest number of objections in
the adoption process. The key argument addressed by opponents of bankruptcy for
individuals is based on the presumption that this kind of provision runs contrary to the
C.C.R.F. The C.C.R.F. does not contain an article specifically providing for the bank-
ruptcy of individuals. That there are articles regulating the bankruptcy of individual
entrepreneurs” and legal entities” does not necessarily mean that the prohibition
should be read into the text of the Law on Insolvency.
Indeed, the implementation of a large number of provisions in the C.C.R.F is im-
possible without regulating the procedure for recognizing the bankruptcy of individu-
als. First and foremost, this relates to laws providing for subsidiary liability of the
founders of (or participants in) legal entities for causing the debtor’s bankruptcy,” as
well as the provisions on the liability of persons who–by virtue of law or the consti-
tuting documents of a legal entity-act in the entity’s name.” In such instances, the
degree of liability imposed upon individuals who do not have the status of individual
entrepreneurs may exceed the value of their property with extremely negative conse-
quences, both for these individuals and for some of their creditors. The same prob-
lems might arise in the implementation of other provisions of the C.C.R.F that im-
pose subsidiary or joint and several liability on individuals for the debts of legal enti-
ties. The only solution to this problem is to introduce the concept of bankruptcy for
individuals who do not have the status of entrepreneurs.
As for the protection of the rights and legal interests of creditors, it is difficult to
understand why creditors may apply to a court of arbitration in the event of the bank-
ruptcy of an individual entrepreneur who failed to pay for a small shipment of goods.
Yet it is impossible for them to initiate bankruptcy proceedings against a former bank
manager who defaulted on a multi-million dollar loan.
There is also another side to this problem. The general global practice is based on
the assumption that the concept of individual bankruptcy (i.e., consumer bankruptcy)
benefits good-faith individuals since it allows them, in the course of bankruptcy pro-
ceedings, to free themselves of their debts while giving their property to settle creditor
claims. This is the reason why United States bankruptcy courts annually consider
800,000 to 900,000 consumer bankruptcy cases, i.e., 92% of all bankruptcies in the
United States.
‘ Art. 25 C.C.R.F.
“Art. 65 C.C.R.F.
‘4 Arts. 56, 105 C.C.R.F.
‘ Art. 53(3) CC.R.F.
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V V VITRYANSKY- INSOLVENCY & BANKRUPTCY LAW REFORM
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Under article 185 of the Law on Insolvency, the provisions on individual bank-
rupts who do not have the status of an individual entrepreneur will come into force
only after the rule on individual bankruptcies comes into effect in the C.C.R.F. The
court bailiff service-which is to bear the responsibility for the execution of individ-
ual bankruptcy decisions-is still in the process of formation. This, however, does not
mean that the provisions on the bankruptcy of individuals contained in Chapter 9 of
the Law on Insolvency are not to be implemented prior to the incorporation of
amendments to the C.C.R.F. Under the rules of Chapter 9, the bankruptcy of individ-
ual entrepreneurs and farm enterprises will be executed. This will ultimately test the
provisions on the bankruptcy of individuals and develop certain practices for imple-
menting the decisions of the courts of arbitration.
Ill. Key Provisions of the New Legislation on Insolvency and
Bankruptcy
Under the new Federal law, insolvency will be understood as the inability of a
debtor to satisfy the claims of creditors on money obligations, and/or to fulfil its obli-
gation to make mandatory debt payments.
If the debtor is a legal entity, it is considered unable to satisfy the money claims of
creditors or fulfil its mandatory payment obligations if the outstanding liabilities have
not been met within three months of the due date. If the debtor is an individual, it is
also necessary that the total amount of his liabilities should exceed the total value of
the property owned. Thus, the concept of bankruptcy is based on the notion that the
commercial entity fails to either pay for goods, work, or services provided for under a
contract, or fails to pay taxes and other mandatory payments for a certain period of
time (i.e., three months) and is unable to meet liabilities vis-h-vis the creditors. To
avoid bankruptcy, the debtor must either cover its liabilities, or provide the court with
proof that the claims of the creditors, taxing authorities, or other authorized public
agencies are unjustified.
The amount of a creditor’s money and taxation claims will be proven if confirmed
by a court decision, or by documents showing that the amount has been recognized by
the debtor. The debtor can contest all other claims. In such cases, the validity of the
claim must be verified by the court of arbitration. Claims not contested by the debtor
are treated as undisputed. The value of each liability is identified when the bankruptcy
suit against the debtor is brought to the court of arbitration.
As under the old system, the new law gives the right to the creditor, prosecutor, as
well as the taxation and other authorized government agencies to bring a bankruptcy
suit against the debtor. The novelty, however, lies in the provision that specifies in-
stances when the manager of the debtor organization, or an individual entrepreneur, is
obligated to bring a bankruptcy suit against itself to the court of arbitration-for ex-
ample, when satisfaction of the claims of one or several creditors would make it im-
possible to cover money liabilities vis-L-vis other creditors, and when the manage-
ment of the debtor or the owner of its property have made the decision to take a suit to
the court of arbitration. In failing to fulfil this obligation, the manager of the debtor
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enterprise will bear subsidiary liability for the obligations of the debtor to its creditors,
and will be taken to court.
Where evidence of bankruptcy is not adduced, the court of arbitration will refuse
to proceed with the bankruptcy claim against the debtor. However, if evidence of
bankruptcy exists (i.e., the debtor is unable to cover money liabilities and pay taxes to
budgetary and extra-budgetary funds), it does not mean that the debtor will have to be
liquidated. Aside from the bankruptcy proceedings instituted in the event of the
debtor’s liquidation, other procedures-such as observation, external management, or
amicable agreement-can be applied. Procedures applied to individuals include either
bankruptcy proceedings or amicable agreement. The final choice of procedure, how-
ever, always rests with the court of arbitration.
The observation procedure is a new concept introduced into Russian legislation
which normally will be applied after the court of arbitration has commenced bank-
ruptcy proceedings against the debtor. The main purpose of this procedure is to ensure
the safety of the debtor’s assets pending the court of arbitration’s decision in the case.
At the same time, the manager of the debtor enterprise is not removed from his posi-
tion and continues to perform usual duties. However, a range of transactions which
may lead to the alienation of immovable and other property-depending on the
amount of the transaction-may only be executed with the approval of the temporary
manager.
Another function of the temporary manager during the observation period is to
assist the creditors and the court of arbitration in analyzing the debtor’s financial
status and establishing if there is a possibility of restoring the debtor’s solvency. The
temporary manager should convene the creditor’s meeting before the court of arbitra-
tion has made its decision on the bankruptcy case. The meeting should assess the in-
formation provided by the temporary manager based on an analysis of the debtor’s fi-
nancial status and make one of the following decisions: (i) appoint external manage-
ment, or (ii) apply to the court of arbitration to initiate bankruptcy proceedings. In this
way, the court of arbitration may follow the creditor’s wishes which-in the case of
appointing external management-predetermines the decision of the court of arbitra-
tion.
The external management procedure is not new to Russian law. One should note,
however, that the new draft law regulates this procedure in greater detail. Twenty-
seven articles are devoted to the issue instead of just one in the old law.” This in itself
is evidence of a more detailed and thorough regulation.
It should also be noted that numerous loopholes in the previous law served to dis-
credit the very idea of restoring the debtor’s solvency within the external management
period. The basic means for creating conditions for restoring the debtor’s solvency is
a moratorium on satisfying the claims of creditors. The old law limited the effective-
ness of such a moratorium. By stating that “within the period of external management
” Law on Insolvency of Enterprises, art. 12.
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of the debtor’s assets, a moratorium shall be imposed on satisfying claims of creditors
vis-h-vis the debtor,”” the old law failed to extend the moratorium to cover the accrual
of forfeits (i.e., penalties or fines) on money liabilities and financial (i.e., economic)
sanctions on mandatory payments. As a result, the debtor’s chances to restore its sol-
vency were nil, since during the whole period of external management and the period
when the moratorium was effective it would be threatened by forfeits and financial
sanctions. Under the circumstances, the moratorium on old debts was rendered practi-
cally meaningless.
Under the new law, the moratorium on satisfying creditor claims will mean more
than a mere suspension of court decisions and other compliance documents for with-
holding payments from the debtor on liabilities which fell due prior to the appoint-
ment of external management. There will be no accrual of forfeits on these liabilities,
financial sanctions on obligatory payments, or interest on the use of resources be-
longing to other parties within the same period. With a view to compensating for the
losses incurred by the creditors and government (on mandatory payments), only one
type of interest should be accrued on all “proven” accounts in accordance with the re-
finance rate of the Central Bank of the Russian Federation.
External management is carried out by a manager nominated at the creditor’s
meeting and subject to the approval of the court of arbitration. The external manager
may be the temporary manager who was previously appointed by the court of arbitra-
tion for the period of observation. The manager of the debtor organization is then re-
moved. The authority of all units within the legal entity is transferred to the external
manager, including the power to dispose of the debtor’s assets. However, the external
manager may effect high-value transactions-i.e., transactions in immovable prop-
erty-if the value thereof exceeds 20% of the book value of the debtor’s assets. This
is subject to the agreement of the creditor’s committee, unless otherwise provided for
in the external management plan.
The external manager has the right to refuse to honour the debtor’s contracts if
they are long-term, or if they are meant to yield positive results only in the long-term.
Similarly, the external manager may disregard contracts that would result in grave
losses for the debtor. It is true that in such cases the creditors will have the right to
claim damages for actual losses incurred as a result of a default on the contracts, but
these claims will fall within the moratorium.
Measures aimed at the restoration of the debtor’s solvency will be taken by the
external manager in line with the external management plan approved at the creditor’s
meeting. The Law on Insolvency specifically provides for such restoration measures
as the sale of the business, sale of assets, assignment of the right to the debtor’s
claims, and payment of the debtor’s liabilities by a third party.
If the court of arbitration decides to declare the debtor bankrupt, bankruptcy pro-
ceedings will ensue. This procedure, as well as external management, is not one of the
7 Ibidt, art. 12(3).
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novelties of the new law. The opening of bankruptcy proceedings means that all
money liabilities of the debtor will be considered as falling due: accrual of forfeits, fi-
nancial sanctions, and interest on all types of debtor liabilities will be terminated, and
all claims vis-t-vis the debtor-including the claims of taxation authorities–can be
filed only within the framework of the bankruptcy proceedings. Moreover, to conduct
bankruptcy proceedings, the court of arbitration appoints a bankruptcy manager by
choosing one of the candidates nominated at the creditor’s meeting. This individual is
responsible for organizing the debtor’s assets in accordance with the order of priority
provided by article 64 C.C.R.E
At any stage of a bankruptcy case before the court of arbitration, the debtor and
creditors have the right to conclude an amicable agreement. The conclusion of such
an agreement-which envisages a debt deferral or rescheduling, assignment of rights
to the debtor’s claims, payment of the debtor’s liabilities by third parties, partial debt
write-offs, etc.-is a normal way of terminating bankruptcy proceedings. The old law,
however, created a practically insurmountable obstacle for an amicable agreement. It
provided that within two weeks of the conclusion of the agreement, the creditors were
supposed to have no less than 35% of their total claims vis-A-vis the debtor satisfied.
The new law removes this obstacle and facilitates an amicable agreement, which
is now regulated as an arm’s-length agreement. The only requirement for the approval
of such an agreement by the court of arbitration is satisfaction by the debtor of out-
standing debt vis-a-vis creditors of the first and second priority-more specifically,
claims of individuals to whom the debtor owes indemnity for accidental or death-
causing injuries, severance payments, payments to contractual employees, and pay-
ments regarding copyright agreements. The approval of an amicable agreement by the
court of arbitration terminates bankruptcy proceedings. If such an agreement is made
in the course of bankruptcy proceedings, the decision by the court of arbitration to de-
clare the business bankrupt is considered null and void, and the bankruptcy proceed-
ings are discontinued.
The main players in practically all bankruptcy proceedings are the temporary
manager, external manager, and bankruptcy manager, all of whom are covered by the
general term, “arbitration manager”. Needless to say, these managers bear immense
responsibility and function under extreme circumstances.
The old law did not define the status of these persons. It also did not resolve the
problem of remuneration of managers or ensure, at least to a minimal degree, their so-
cial security. Under the new law, a physical person registered as an individual entre-
preneur and possessing the required knowledge may be appointed as an arbitration
manager. Arbitration managers will operate on the basis of a license issued by the
State Agency for Bankruptcy and Financial Recovery. With regard to social security
issues, the manager appointed in case of bankruptcy must have the same powers as
the manager of the debtor organization.
Remuneration, as a rule, consists of two parts. For each month of work as man-
ager, remuneration is determined at the creditor’s meeting and approved by the court
of arbitration. A bonus is then calculated and paid depending on the results of the
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manager’s work. The maximum and minimum compensation for arbitration manag-
ers, as well as the procedure for payment, is established by the government.
A. Specific Features Regarding
the Bankruptcy of Certain
Categories of Debtors and Legal Entities
The new regime, in contrast to the old system, takes into account the specifics of
certain categories of debtors and applies different bankruptcy procedures accordingly.
These categories include debtors such as town-forming organizations, agricultural or-
ganizations, insurance companies, banking and other credit institutions, professional
participants in the securities market, as well as individual debtors including individual
entrepreneurs and farm enterprises.
Town-forming organizations are defined as those legal entities whose number of
employees-including household members-make up no less than half the popula-
tion of the city, town, or village where they are located.’8
While establishing specific bankruptcy procedures for town-forming organiza-
tions, the law takes into account the possible social consequences of their liquidation.
Accordingly, the group of people participating in a bankruptcy case against town-
forming organizations must include representatives of the corresponding local ad-
ministration. The court of arbitration may also require participation in the case of
certain federal executive bodies, or executive bodies of a specific division of the Rus-
sian Federation. On the application of one of these parties, the court of arbitration
may appoint external management to a town-forming debtor organization even if the
creditor’s committee votes to have the debtor considered bankrupt and to initiate
bankruptcy proceedings. In this case, however, the authorities will have to provide a
guarantee for the debtor’s liabilities, and therefore assume subsidiary liability to the
debtor’s creditors.
Moreover, on the application of the above agencies, the external management pe-
riod may be prolonged by the court of arbitration for up to one year. Thus, the total
duration of external management-and the duration of the moratorium on satisfying
creditor claims-may last two and a half years. Within this period, the concerned
authorities may rehabilitate the town-forming organization by investing in its opera-
tions, finding jobs for the existing employees, and creating new jobs. In extreme
cases, the duration of external management may be prolonged for a period of up to
ten years, provided the debtor and its guarantor start effecting settlements with the
creditors no later than two and a half years after the external management is ap-
pointed.”
Through authorized representation, the Russian Federation, a subject of the Rus-
sian Federation, or a municipal administration may complete settlements with all
‘8 Law on Insolvency, art. 132.
” Ibid., art. 135.
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creditors or satisfy money claims and cover the debtor’s arrears on obligatory pay-
ments in some other way.
In the process of external management, the town-forming debtor organization
may sell the enterprise as a single property complex (i.e., as a going concern), which
will make it possible to receive funds necessary for settlements with creditors without
liquidating the debtor or eliminating jobs. In addition, if there is an application from a
government agency or a local self-governing body, the sale of the enterprise will be
carried out through a tender, the mandatory terms of which will be the preservation of
at least 70% of the jobs generated by the enterprise. Should the buyer decide to re-
structure or reinvent the enterprise, there is an obligation to retrain and find employ-
ment for any existing employees. Even if the town-forming organization is bankrupt,
the bankruptcy manager is obliged to sell the enterprise as a single property complex.
Only in the event that there are no buyers will the bankruptcy manager be authorized
to sell the assets of the enterprise separately. Provisions relating to the bankruptcy of
town-forming organizations will also be applied to organizations employing in excess
of 5,000 people.
Bankruptcy of agricultural organizations is regulated with a view to the special
activities of such entities, normally characterized by the use of land parcels (primarily
of agricultural designation) and the seasonal nature of their work. Under article 139 of
the Law on Insolvency, agricultural organizations are defined as legal entities whose
primary activity consists of growing agricultural produce whose proceeds amount to
no less than 50% of the entity’s total revenues.
The essence of the first special rule regulating the bankruptcy of agricultural or-
ganizations is that when the immovable property of the bankrupt organization is sold,
other agricultural organizations or farm enterprises have priority to buy it. The aliena-
tion of land parcels may be carried out to the extent allowed by legislation.
The second special rule is that the duration of external management of an agri-
cultural organization is extended to account for the seasonal nature of its operations
and the necessity to wait until the end of the respective agricultural campaign. Taking
into consideration the possible time needed for the sale of the grown products, the
legislator considered it appropriate to extend the external management period to one
year and nine months. Moreover, if a natural disaster occurs in the period of external
management, the term may be extended by the court of arbitration for another year.
Thus, the maximum period of external management may last up to two years and nine
months. Generally, however, the maximum period is one and a half years. In all other
aspects, the insolvency procedure for agricultural organizations should be carried out
in accordance with the general rules.
The bankruptcy of banks and other credit organizations must be conducted in ac-
cordance with the Law on Insolvency of Banks. The norms of the Law on Insolvency,
however, will be applied by default in the absence of specific rules.
When the bankruptcy procedures of banking and other credit organizations were
regulated by the former Law on Insolvency of Enterprises, the specifics of establish-
ing and monitoring the activity of credit organizations were not yet formulated. All
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special rules with respect to banks and other credit organizations contained in the Law
on Insolvency of Enterprises were limited by article 11. This provision indicated that a
commercial bank or other credit institution (in the position of debtor), their creditors,
and the prosecutor had the right to apply to the court of arbitration for the initiation of
bankruptcy proceedings once the debtor-institution’s licence for performing banking
operations was revoked by the Central Bank of the Russian Federation.
The absence of special insolvency procedures for banks and other credit organi-
zations was an unfortunate loophole in the legislation. Applying the old Law on Insol-
vency of Enterprises to the commercial context of the credit industry caused a host of
problems in the courts of arbitration which were almost impossible to resolve.
First and foremost, the rights and legal interests of citizens with accounts in
commercial banks were inadequately protected. This was manifested in the failure of
banks to execute the orders of their depositors on the issuance of funds from the de-
posits-as well as to perform other bank operations-when the depositors might ex-
pect compensation for their losses only after initiating a bankruptcy procedure against
the bank. The depositors, or their representatives, act as regular creditors upon whose
request an insolvency case may be initiated against a commercial debtor bank.
As a rule, individual depositors first applied to civil courts where they tried to re-
ceive appropriate remedies and writs of execution-but since it was impossible to
execute court decisions without the assistance of bailiffs, they often requested the
court of arbitration to initiate bankruptcy proceedings against the respective bank. The
satisfaction of depositors was further arranged in accordance with two schemes that
are mutually exclusive: (i) through the bankruptcy manager of the bank, and (ii)
through court bailiffs who execute the decisions of civil courts. In the first instance,
fair distribution of the money funds is provided for among the depositors on a pro
rata basis. In the second case, settlements with individuals are often carried out in a
voluntary manner.
An alternative to such a procedure for satisfying claims of individual depositors
was the insurance of deposits-including mandatory insurance-or the securing of
deposits by funds raised through fees levied by banks and credit institutions. In either
case, depositors would receive compensation in the amount of the deposit (or a sub-
stantial part of it) from the respective insurance funds or organizations providing
guarantees on the deposits. These insurance entities, in effect, accumulated their
claims against the bank, and in the event of the bank’s insolvency acted as a single
creditor on all bank deposits. Thus, claims of depositors who were already fully pro-
tected were absolutely excluded.
In June 1996, the State Duma of the Federal Assembly of the Russian Federation
adopted, on first reading, the draft Federal law On Providing Guarantees on the De-
posits of Citizens in Banks. This provided for the creation of the Federal Reserve Cor-
poration for guaranteeing bank deposits in the form of a specialized non-commercial
organization. Under this law, the guarantees would be backed by reserve funds of the
corporation formed with the mandatory licensing fees paid by banks for the right to
attract money funds of individuals for deposits. The corporation would guarantee each
depositor in a registered bank the payment of compensation (from 80% to 100% of
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the deposit) in the event that the bank’s license for attracting the funds of citizens for
deposits-or a license for banking operations-is revoked, or if the bank is recog-
nized as insolvent. This implies that after the payment of the appropriate compensa-
tion to the depositor, the depositor’s claims against the bank would be transferred to
the Federal Reserve Corporation.
Unfortunately, in December 1996 the State Duma removed the draft law from
consideration until the different positions of various parliamentary factions and the
govemment were harmonized. As for the draft of the Law on Insolvency of Banks, it
is not proof of guaranteed deposits that matters, but rather of the mandatory insurance
thereof. Under the circumstances, the prospect of adopting such a law in the foresee-
able future is uncertain. Until then, individual depositors retain the right to file a claim
to the court of arbitration to initiate bankruptcy proceedings against a credit organiza-
tion.
One cannot ignore the different consequences of initiating bankruptcy proceed-
ings against an ordinary debtor and a bank. The decision of the court of arbitration to
commence consideration of a bankruptcy case against a bank often stirs panic among
creditors, thereby provoking them to withdraw money from their bank accounts. The
consequent drain only assures the bank’s insolvency. At the same time, the old legis-
lation did not contain any provisions restricting the number of creditors who could
initiate bankruptcy proceedings against a bank-or make the initiation of such pro-
ceedings more difficult–compared with the bankruptcy of ordinary debtors.
As noted above, a solution to this problem is to exclude individual creditors from
the category of creditors who have the right to bring a bankruptcy suit against a bank
by providing guarantees for household deposits, or by implementing mandatory de-
posit insurance schemes. Another method proposed in the draft Law on Insolvency of
Banks is the introduction of special pre-trial procedures to be applied before the court
of arbitration commences a bankruptcy suit. Today, before creditors (including credi-
tors of banks) file a bankruptcy suit to the court of arbitration against the debtor, only
a notification need be sent to the debtor requesting confirmation of receipt. The better
course is for a bank insolvency case to be considered in the court of arbitration only
after the creditor has followed an obligatory, strictly specified procedure whereby the
Central Bank has to consider the creditor’s application or the withdrawal of the com-
mercial bank’s licence. Thus, the financial status of the indebted bank will be deter-
mined by the Central Bank, taking account of all the indicators characterizing its sol-
vency.
If there are no indications of bankruptcy, the Central Bank will refuse to withdraw
the licence. Thus, the possibility of commencing a bankruptcy suit is excluded in such
cases, and the creditor will have to confine itself to an ordinary suit following its pri-
vate law claim. If there are indications of bankruptcy, the Central Bank will have a
possibility to apply rehabilitation measures to the insolvent bank, i.e., appoint tempo-
rary administration or suggest that its founders or participants reorganize the bank
through a merger with a more viable and stable bank. Only if there is no possibility to
take any such measures should the court of arbitration pursue a bankruptcy suit
against the insolvent bank. Such problems were resolved in the draft Law on Insol-
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vency of Banks, which properly takes into account all the specific features typical of
this category of debtors.
B. Bankruptcy of Individuals
The bankruptcy of an individual who does not have the status of an entrepreneur
is a new concept in Russian law. As noted above, most legal systems have special
provisions regulating the insolvency of individuals. The old Russian law allowed the
possibility of bankruptcy only where an individual had the status of an entrepreneur;
and even then, it did not specifically regulate such bankruptcies.
Meanwhile, the concept of individual bankruptcy is considered in developed legal
systems as one of the most effective ways to protect citizens who find themselves in a
difficult financial situation-allowing them to rid themselves of their debt burden and
start over again. This applies to any individual who receives a loan from a bank or
who bought immovable property or expensive goods on an instalment sale. A special
chapter regulating the specifics of individual bankruptcy is included in the Law on In-
solvency to help address the problem of debtors faced with an unbearable debt
burden.”
The grounds for declaring an individual bankrupt are the inability to execute
money liabilities or pay taxes and other mandatory payments in connection with the
excess of the amount of debts over the individual’s own property. A bankruptcy suit
against an individual will be commenced by the court of arbitration upon application
by the debtor or his creditors. In conducting the bankruptcy procedure, the claims
against the individual also may be filed by creditors on liabilities related to compen-
sating the harm inflicted on the life and health of the individual. Recovery of alimony
and other liabilities of the individual will continue to be exigible after the bankruptcy
proceedings are over.
After the settlements with creditors are paid out of the proceeds from the sale of
the individual’s property-with the exception of the property against which, accord-
ing to procedural legislation, execution cannot be levied-the individual declared
bankrupt will be relieved of all debts, including those that remain outstanding.
Declaring an individual entrepreneur as bankrupt will also mean that his state
registration as an individual entrepreneur will lose force, and the licence for exercis-
ing certain kinds of entrepreneurial activity will also be cancelled.
The Law on Insolvency as well as the analyses of draft laws prepared in the field
of credit organization bankruptcy confirm that in the event that all the draft laws are
adopted and put into force, Russia will have a bankruptcy system that is in line with
those of other major states in the international community.
20Ibid., c. 6 (arts. 101-112).
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IV. The Practical Application of the New Russian Insolvency and
Bankruptcy Regime
Even the most perfect law cannot hope to succeed in its aim without faithful and
consistent application. Ultimately, the court of arbitration’s practical application of the
Law on Insolvency will identify the regime’s benefits and shortcomings. The Higher
Court of Arbitration has the right to provide explanations with respect to the applica-
tion of laws. Currently, certain provisions of the legislation are being interpreted in
relation to the new law’s implementation. However, it will only be possible to take
this work seriously after the Higher Court of Arbitration has had an opportunity to
analyze cases related to the application of the new law. Adequate analysis cannot be
expected before at least a few years have gone by.
There is currently a lot of discussion in Russia about accelerated bankruptcy
which relates to the Resolution of the Russian Federation No. 478 “On Measures to
Increase Efficiency of Bankruptcy Procedures Application.”” In practice, there may
be no new accelerated bankruptcy procedures. All the possible procedures-such as
observation, external management (i.e., court rehabilitation), bankruptcy proceedings,
amicable agreement, simplified bankruptcy procedure (of a debtor who is under liqui-
dation or absent), and voluntary declarations of bankruptcy-are established and
regulated by the Law on Insolvency effective March 1, 1998. Resolution No. 478 was
not aimed at the introduction of new bankruptcy procedures, but at the increased effi-
ciency of bankruptcy procedures application provided for by the Law on Insolvency.
Resolution No. 478 contemplates the achievement of this goal by adopting three par-
ticular measures.
The first measure is the coordination of various state agencies, which are granted
the right to file a claim to the court of arbitration on the debtor’s bankruptcy, in order
to project a unified state position with respect to the debtor organization. Apart from
the tax agencies, such agencies would include public extra-budgetary funds (with re-
spect to claims on mandatory payments) and the Federal Service of Russia on Insol-
vency and Financial Recovery (“Federal Service”). The latter is authorized to repre-
sent the interests of the Russian Federation relating to mandatory payments and
money liabilities in the event that issues relating to the insolvency of organizations are
considered.
To achieve the desired coordination between the above agencies, the Collegium of
Authorized Representatives-i.e., the State Tax Service, Pension Fund, Federal Fund
for Mandatory Medical Insurance, Social Insurance Fund, and State Employment
Fund-are being set up under the Federal Service and its territorial departments. If
there are grounds to initiate bankruptcy proceedings against a debtor organization, the
taxation department and other authorized agencies submit documents to the Federal
Service necessary for filing with the court of arbitration. This centralized process al-
“‘ (22 May 1998) Sobranie zakonodatelstva R.F (1998) [hereinafter Resolution No. 478].
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lows for a single statement of claim to be filed with the court containing a consoli-
dated claim on all mandatory payments.
Government instructions to the state agencies concerning the coordination of their
activity cannot refer to the norms contained in the Law on Insolvency (specifically to
article 6) which grant the right to tax and other authorized agencies to independently
apply to the court of arbitration (on taxation and mandatory payments, respectively).
Therefore, such independent applications, without preliminary submission of appro-
priate documents to the Federal Service and the discussion of the respective issues at
the Collegium of Authorized Representatives, should not be accepted by courts of ar-
bitration and considered by them in a general procedure. Another matter for concern
is that such independent actions of state agencies that fail to follow government in-
structions may be considered by the latter as non-compliant with state policy.
Resolution No. 478 also provides for a second measure, namely, the consolidation
of government claims against the debtor in the government’s capacity as a public
body with respect to taxation and other mandatory payments, and in its capacity as
creditor on civil law money liabilities-e.g. with respect to centralized credits from
the budget. Apart from the above documents, there are government instructions of an
organizational nature aimed at providing representation by the Federal Service-as an
institution with the status of a legal entity-of certain creditors. For example, the
Gazprom Joint Stock Company, U.E.S. of Russia, as well as enterprises and organiza-
tions involved in railroad transportation.
In the latter instance, the Federal Service will act as an agent with power of attor-
ney executed by the respective creditor (i.e., principal). This, however, does not de-
prive the creditor of the right to independently apply to the court of arbitration with
respect to the debtor’s bankruptcy, and directly participate in the consideration of the
case, as well as in the creditor’s meetings.
Finally, the coordinated activity of the taxation department and other authorized
agencies in consolidating claims on mandatory payments and money liabilities is
aimed at ensuring that the first meeting of creditors adopts a decision on the introduc-
tion of a rehabilitation procedure and external management. Within this procedure,
the so-called “accelerated” procedure for its implementation can be introduced.
However, it is only at the first meeting of creditors, held prior to the main session
of the court of arbitration during the observation procedure, that the taxation depart-
ment and other authorized agencies participate with a right to vote. At other creditor’s
meetings, only creditors on civil law liabilities have the right to vote. Under article 65
of the Law on Insolvency, it is at the first meeting of creditors that the decision is
made to apply the external management procedure, or to file a statement of claim to
the court of arbitration to recognize the debtor as bankrupt. The decision of the credi-
tors’ meeting is binding on the court of arbitration which, under the circumstances,
should proceed to order the introduction of external management and appointment of
an external manager approved by the first creditors’ meeting.
There are two other issues which should be addressed and resolved at the first
creditor’s meeting. These issues are whether to apply accelerated bankruptcy proce-
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dures and whether to approve an external management plan. These decisions cannot
be considered as mandatory or binding on the external manager. Under article 82(1)
of the Law on Insolvency, the external manager-no later than a month after his ap-
pointment-should develop a plan of external management and submit it for approval
at the creditors’ meeting. Therefore, an external management plan providing for “ac-
celerated” bankruptcy procedures which is adopted at the first creditors’ meeting
should be considered only as a recommendation to the external manager, and a credi-
tors’ meeting held after external management should proceed in accordance with the
procedure provided for by the Federal law. This document may serve as an external
management plan only after it is approved at the creditors’ meeting.
A few words about the essence of the “accelerated” bankruptcy procedure are in
order. Here, “accelerated” is taken to mean a special way of reorganizing and reha-
bilitating the debtor’s business. The essence of this measure is that, on the basis of all
the debtor’s assets-with the exception of property which is not included in the bank-
ruptcy estate’ 2– an open joint stock company is being formed. From this moment on,
the assets of the debtor are in the form of shares of a newly established joint stock
company. The said shares will be subject to sales at a public auction and the amount
received will be used for settling accounts with the creditors.
In the event the amounts received from the sale of shares of a newly established
joint-stock company are sufficient to satisfy the claims of all creditors, the proceed-
ings on the bankruptcy case are terminated, and the future of the debtor will depend
exclusively on the decision of its founders (i.e., participants) in accordance with the
general procedure.
However, if the amount received after the sale of shares is insufficient to settle ac-
counts with all the creditors, the external manager will have to apply to the court of
arbitration requesting the termination of the external management procedure and the
recognition of the debtor as bankrupt. In short, bankruptcy proceedings will be initi-
ated.
A laudable aspect of such an external management procedure (regardless of the
outcome) is the preservation of the debtor as a going concern. However, the disad-
vantages are inescapable. The most notable downside is the increased risk for credi-
tors that their claims will not be satisfied. Therefore, the issue of whether to apply this
procedure of external management should be determined on a case-by-case basis,
taking into account all the circumstances and provided that the procedure is approved
by the creditors.
Depending on the situation, the external manager and the creditors may choose a
different, more desirable way to recover the solvency of the debtor, which will simi-
larly allow for the preservation of the debtor’s business and work places, but at a
lower risk. Such measures may include the sale of the debtor’s enterprise under article
86 of the Law on Insolvency. Imagine a situation in which a wealthy buyer is willing
2′ Law on Insolvency, art. 204.
1999]
19 V ViTRYANSKY-
INSOLVENCY& BANKRUPTCY LAW REFORM
to purchase the enterprise as a property complex and is ready to pay the price that will
allow for the repayment of all the debts. Why, then, is it necessary to establish a new
joint stock company and organize an open auction for the sale of its shares? Inciden-
tally, if an enterprise of the debtor is sold, the external management procedure may be
completed a great deal sooner than in the case of the founding of a new joint stock
company aimed at the sale of its shares.
Furthermore, in a number of instances “accelerated” bankruptcy may prove to be
quite inefficient. For instance, the regime governing town-forming organizations con-
templates an external management procedure lasting for two and a half years and, in
exceptional cases, for ten years. Given the moratorium on the satisfaction of creditors’
claims, in this period available funds may be used to purchase new equipment and
change the profile of the enterprise. Is it reasonable to pass on outdated equipment to
the charter capital of a joint stock company and condemn new shareholders to the sad
destiny of their predecessors?
Conclusion
From the very start of the movement to revive the insolvency and bankruptcy re-
gime in Russia-i.e., from March 1, 1993-proposals never ceased to use this proce-
dure either as a remedy for all economic troubles, or as a means to struggle specifi-
cally with tax dodgers or the concern for fostering the growth of privatized industry
(there are a number of Edicts by the President of the Russian Federation with respect
to this).
The new Law on Insolvency, in principle, allows Russia to have a legal system of
bankruptcy that would fully conform to all the requirements of the day. There is still
something that remains, and this is to ensure an adequate enforcement system that
* meets these high standards. By all indications, the necessary prerequisites for such an
enforcement mechanism are already in place in Russia. Indeed, the country benefits
from the extensive experience of the courts of arbitration, the large number of quali-
fied judges specializing in bankruptcy cases, and a marked increase in the number of
bankruptcy managers.
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 44
References
Legislation
Bankruptcy Code, 11 U.S.C. (1998).
Civil Code of the Russian Federation, Part 1: Sobranie zakonodatelstva R.E (1994)
No. 32, item 3301; Part 2: Sobranie zakonodatelstva R.E (1996) No. 5, item 410.
Federal law On Insolvency (Bankruptcy), Sobranie zakonodatelstva R.E (1998) No. 2,
item 222.
Federal law On Insolvency (Bankruptcy) of Enterprises, Vedomosti S”ezda Narodnykh
Deputatov R.E i Verkhovnogo Soveta R.E (1993) No. 1, item 6.
Resolution of the Russian Federation No. 478 “On Measures to Increase Efficiency of
Bankruptcy Procedures Application” (22 May 1998) Sobranie zakonodatelstva R.E
(1998).
Books
Bankruptcy Code and Rules (Philadelphia: Clark Boardman Callaghan, 1993).
Maggs, P.B. & Zhiltsov, A.N., eds, The Civil Code of the Russian Federation, trans.
RB. Maggs & A.N. Zhiltsov (Armonk, N.Y: M.E. Sharpe, 1997).
