Bankruptcy and Creditor’s rights.

a. General issues

The legislation grants exclusive jurisdiction over insolvency cases to the jurisdiction of the arbitrazh (commercial) courts. Bankruptcy proceedings may be instituted by the bankruptcy creditors, authorized agencies, and the debtor itself (Art. 7 of the Federal Law On Insolvency (Bankruptcy) of 26 October 2002 No. 127 FZ; hereinafter – the “Law on Insolvency”).

The Law on Insolvency provides for several principal types of bankruptcy proceedings:

• supervision (preliminary determination)

• financial rehabilitation;

• external management;

• straight bankruptcy (competition) procedure.

Bankruptcy procedure can also be closed by amicable settlement at any stage.

Generally only competition procedure and amicable settlement apply to individual entrepreneurs.

A company may be declared bankrupt if the amount of company’s obligations is not less than 100 thousands Rubles (approx. USD 3,500) with a condition that these debts remain delinquent for more than three months. An individual entrepreneur may be declared bankrupt in case of failure to perform its monetary obligation before creditors within three month from the due date if the amount of such obligations is not less than 10 thousands Rubles (approx. USD 350) and exceeds its assets (Article 3 and Article 6 of the Law on Insolvency). The structure and amount of the monetary obligations and mandatory payments shall be determined on the date of acceptance of a bankruptcy application and opening of a bankruptcy proceeding by arbitrazh court.

If an executive officer of a bankrupt company or members of a liquidation commission failed to file bankruptcy petition timely, they are secondarily liable for the company’s obligations. The same rule applies in case of a deliberate bankruptcy.
Bankruptcy cases shall be decided by the arbitrazh court within the period not exceeding seven months from the date of receipt of the bankruptcy application by the arbitrazh court.

b. Types of bankruptcy proceedings

Proceedings are commenced with the filing of a bankruptcy petition.

Supervision

If the court determines that bankruptcy procedures are justified, it orders supervision, which has the goal to assess financial situation of the debtor, prevent dissipation of the assets and give suggestions regarding the further course of the procedure (closing of the proceedings, including by the way of settlement with creditors, financial rehabilitation, external management and straight bankruptcy (competition) procedures).

A court ordering supervision should also appoint a Temporary Manager and determine its remuneration. During the supervision procedure, management and executive bodies of a debtor remain in place but are controlled by the Temporary Manager. However, during supervision procedure, substantial operations and transactions require prior consent of the Temporary Manager. Certain debtor’s operations (such as distribution of dividends) and enforcement of claims against the debtor are suspended from the date of submission of the bankruptcy petition. During the supervision period, a Temporary Manager determines the financial situation of the debtor, registers creditors’ claims and convokes the first meeting of creditors. The first meeting of creditors is called not later than ten days before the end of the supervision period. At the meeting creditors acting on the basis of the information collected during the supervision procedure shall determine whether to implement one of the three alternative bankruptcy procedures: financial rehabilitation, external management, straight bankruptcy procedure (competition procedure). They may also resolve to wind up the matter by means of amicable settlement. The creditor’s vote in the meeting is proportional to the amount of one’s claim.

The decision of the first meeting of creditors regarding the preferred type of bankruptcy procedure does not become final until ratified by the arbitrazh court. When selecting what mode proceedings shall be ordered, the court takes into account both the decision made at the first meeting of creditors and guidelines provided by the law. However, the arbitrazh court absolute discretion in deciding in which way to proceed, but may also rule to deny the bankruptcy petition; or to dismiss the bankruptcy proceedings.

Financial rehabilitation

Financial rehabilitation may be ordered by a court on the grounds of decision of the debtor’s founders or participants (shareholders) or petition of the agency authorized by the owner of debtor’s property (in case when the debtor is a unitary enterprise) or third persons.

The purpose of financial rehabilitation is to restore the debtor’s ability to pay and repay debtor’s liabilities in accordance with a repayment schedule. By agreement with the debtor third persons may petition for initiating financial rehabilitation. The petition must contain information about the security provided by third persons to secure the performance of the obligations in accordance with the repayment schedule by the debtor. An agreement between third persons must provide for their joint and several responsibility.

The period of financial rehabilitation shall not exceed two years.

When the arbitrazh court rules to initiate a financial rehabilitation it simultaneously has to appoint an Administrative Manager. During the procedure of financial rehabilitation executive bodies of the debtor exercise their powers with restrictions. Not later than one month prior to expiry of the established period of financial rehabilitation the debtor is obliged to submit to the Administrative Manager a report on the results of financial rehabilitation. Should thereafter the arbitrazh court determine that it is possible to restore debtor’s cashflow, it has a right initiate procedure of External Management.

External management

If the arbitrazh court considers rehabilitation of the company possible it may order for the external management procedure that shall not exceed eighteen months.

External management regime includes the following measures:

- withholding of consideration of creditor’s claims;

- appointment of an External Manager by the arbitrazh court;

- ceasing of authorities of the debtor’s executive bodies;

- withdrawal of previously taken measures for securing of creditors’ claims;

- declaration of a moratorium for satisfying of monetary creditors’ claims.

Within one month from the date of appointment the External Manager is obliged to develop an external management plan and submit it to the meeting of creditors for approval.

In order to restore the solvency of the company the External Manager may use the following measures: change of the business profile, disposition of unproductive assets by sale or otherwise, management, and/or optimization of the company’s accounts payable and receivable. The sale of the enterprise may be included in the rehabilitation plan and realized through the open sale in the form of an auction.

Large-scale transactions and so-called “related party transactions” shall be concluded by the External Manager only with consent of the meeting of creditors (or committee of creditors).

Within three months from the date of initiating the external management procedure the External Manager has a right to refuse from performing the contracts and other transactions of the debtor. The refusal to perform contracts and other transactions of the debtor may be declared only in respect of transactions not yet performed by the parties fully or partially, provided such transactions could prevent the restoration of the paying ability or the performance of such transactions could entail losses for the debtor in comparison with analogous transactions concluded under comparable circumstances.

Competition procedure

The arbitrazh court’s decision to declare the debtor a bankrupt entails opening of a straight bankruptcy proceeding (competition procedure), lasting for a period of up to one year. This period may be extended by another six months at the court’s discretion. The court appoints a Competition Manager to perform inventorying and evaluation of debtor’s property. The purpose of this procedure is to disclose debtor’s assets, determine the efficient way of distribution of the assets and proceeds among creditors. The straight bankruptcy procedure ends up with liquidation of a debtor company.

Amicable settlement

An amicable settlement agreement between the debtor and the creditors may be concluded at any stage of bankruptcy proceedings (Article 150 of the Law on Insolvency). Such agreement shall be approved by the court, which verifies the legality of the agreement and sufficiency of protection of third parties’ rights.

Simplified bankruptcy procedures

The Law on Insolvency also provides for a simplified procedure to be used in cases when the debtor’s assets are clearly insufficient to satisfy all creditor's claims (Articles 224 230 of the Law on Insolvency). The Law also provides for a simplified voluntary bankruptcy procedure that can be carried out from consent of all creditors.

c. Priorities

Certain payments shall be made prior to repayment of debts to creditors. Such payments are made to cover court and administration fees and fees of the external manager, to satisfy current claims of the utility companies and claims of other creditors that have arisen during bankruptcy procedures. The following obligations shall be fulfilled in priority at the expense of the debtor’s assets:

1. judicial expenses of the debtor, including expenses for the publications of notices required under the bankruptcy legislation;

2. expenses connected with the payment of remuneration to an arbitration administrator (Temporary Manager, Administrative Manager, External Manager) and a register-holder;

3. current communal and running costs necessary for of the debtor’s activity;

4. creditors’ claims that have accrued during the period after acceptance by an arbitrazh court of a petition for bankruptcy but before declaring the debtor bankrupt, and also Creditors’ claims regarding the monetary obligations, which arose in the course of a bankruptcy proceeding;

5. debts to employees, which arose after the acceptance by an arbitrazh court of bankruptcy application; and

6. other expenses connected with the conducting of the bankruptcy proceeding.

Creditors’ claims shall be satisfied in the following priority:

1. individuals’ claims regarding indemnification for death or personal injury. Such demands are satisfied by means of capitalization of respective payments, and also compensation of moral damages/pain and suffering;

2. debts for remuneration under author’s contracts;

3. debts to other creditors.

Demands of each subsequent category of creditors are paid when claims of all creditors with higher ranks are satisfied. If the debtor’s assets are not sufficient to cover all claims of a particular rank of creditors, the amount available is distributed pro rata to the amounts of their claims; claims with lower ranks in this case are not eligible for compensation at all.