Expanded vicarious liability rules
New Federal Law No. 266-FZ dated 29 July 2017 (the Amendment Law) introduces notable changes to Russia's insolvency rules. Importantly, the law does away with the original provisions on vicarious liability of controlling persons in RF Law No. 127-FZ on Insolvency of 26 October 2002 (the Insolvency Law). The Amendment Law expands this concept in a series of new clauses. The rules came into force 30 July 2017.
The new rules define a controlling person as any individual or entity who, during three (3) years prior to emergence of signs of insolvency or the court's acceptance of a bankruptcy application, was able to give the debtor mandatory instructions or otherwise direct its actions, including by exerting influence over entry into transactions and determining their terms.1
The Amendment Law gives specific examples of how such a person may "direct the actions of the debtor," e.g., by being related to the debtor or its executive officers, by authority granted under a power of attorney, and the like.
The following persons are presumed to be controlling unless proven otherwise:
- The CEO of the debtor or its management company, or members of the debtor's executive board, liquidator or members of the liquidation committee
- Any shareholder holding, individually or together with interested persons, (i) 50% or more of the debtor's shares, (ii) more than half the debtor's charter capital, or (iii) the power to cast more than half the votes in a shareholders' meeting of the debtor, or a shareholder that could otherwise elect the debtor's CEO
- Any person receiving some benefit from the unlawful or bad-faith actions of persons authorized to represent the debtor under its constituent documents or by power of law2
However, additional persons can also be deemed controlling if they meet relevant general criteria. Meanwhile, the Amendment Law specifically establishes a safe harbor provision stating that a shareholder below 10% is not a controlling person solely by virtue of such shareholding.
Controlling persons may be held vicariously liable if:
- Their action or inaction precludes full satisfaction of
creditors' claims, including if:
- Bankruptcy proceedings were terminated due to a lack of funds sufficient to finance them, or the Federal Tax Service bankruptcy application was returned.
- Their action or inaction subsequently seriously harmed the debtor's financial condition, even where the debtor's insolvency arose irrespective of the controlling person's action or inaction.3
- They failed to take obligatory actions to ensure submission of the bankruptcy application4 (the Amendment Law also introduces new and expanded obligations with respect to the proper submission of the bankruptcy application).5
- They violated the Insolvency Law, including if a bankruptcy procedure was initiated while the debtor was still capable of paying its obligations in full, or if the debtor failed to challenge unjustified claims in the bankruptcy proceedings.6
The Amendment Law does provide exemptions from liability (or otherwise limits liability) for persons who can prove that while acting as executive officer or shareholder of the debtor they could not actually determine its actions, if such persons provide information identifying actual controlling persons or revealing concealed assets of the debtor or the controlling person.
An application to subject a controlling person to vicarious liability (an Application) can be submitted by a receiver, creditors, a representative of the debtor's employees and employees or former employees to whom the debtor is still indebted. An Application must be submitted within three (3) years from the date the applicant became or ought to have become aware of grounds for vicarious liability, but no later than three (3) years after the debtor was declared bankrupt (or termination of bankruptcy proceedings or return of a Federal Tax Service application). This may be extended in certain cases, subject to a longstop of ten (10) years after the relevant action or inaction took place.7
The court will review the Application as part of the debtor's bankruptcy case and may as a result freeze a controlling person's assets as interim relief for a vicarious liability claim.
Where an Application is submitted due to a controlling person's action or inaction that precluded full satisfaction of creditors' claims, the amount of vicarious liability may not be immediately evident. In this situation, the court will confirm that grounds for vicarious liability exist, and then postpone review of the claim until settlements with creditors are finalized. Once the settlements are finalized, the receiver is to request that the court resume the vicarious liability proceedings and submits information on creditors' remaining unsatisfied claims.8
The court's decision on a vicarious liability claim will include specific instructions on the manner of satisfaction of the claim, depending on how the creditors dispose of the right to vicarious satisfaction.
Each creditor may demand:
- That a claim be repaid as part of the insolvency proceedings
- That a claim be sold according to the rules for sale of the debtor's rights of claim in insolvency
- Partial assignment of the claim to the creditor in value equal to the value of the creditor's claim (this option is not available, however, in cases of insolvency of financial and credit institutions and real estate developers)9
While creditors acting under the third option become direct claimants against the controlling person, the remainder of the claim is satisfied either by way of the first or second option, depending on a majority vote (by volume of claims) of the creditors.
After satisfying the claim, the controlling person will have a subrogated claim against the debtor, to be satisfied last in bankruptcy.
If the Application is submitted after the conclusion of bankruptcy proceedings, it must name all creditors whose claims were not satisfied. The court then reviews the claim as one made in defense of the interests of a group of persons, regardless of how many persons actually joined the proceedings (with some exceptions). An offer to join the proceedings may be made via the Unified Federal Register of Bankruptcy Information.10
Parties may also settle vicarious liability claims where settlement is reached between all claimants and all respondents, provided a controlling person discloses assets sufficient to satisfy all claims.11
New draft law introducing rescue proceedings is submitted to State Duma
Entering bankruptcy in Russia is almost invariably a death knell for a business. Although rescue procedures (that is, judicial proceedings aimed at restoring debtors' solvency) do exist, they are rarely if ever utilized. Bankruptcy is always viewed by creditors and debtors alike as a 'last resort.' Bankruptcies therefore almost always are brought when it is too late to restore the debtor's business.
Problematically, bankruptcy rules always require an initial six-month so-called 'supervisory' period (with exceptions for some categories of debtors). During this period the debtor's business (and goodwill) invariably atrophies. This initial period is then ordinarily followed by liquidation and cessation of business.
Russian legislators have previously made various attempts to introduce a viable rescue procedure into Russian law. It appears another may be in the works.
The RF Government recently submitted a draft bill on amendments to the Insolvency Law and several other laws (the Restructuring Bill) to the State Duma.12
The amendments aim to introduce a new formal rescue procedure into the Bankruptcy Law: judicial debt restructuring. The debtor or any of its creditors may apply for this procedure, in lieu of applying for more "traditional" insolvency procedures. As a key point, this new procedure cannot, by definition, result in liquidation. This feature is designed to encourage parties genuinely interested in rescuing the debtor to utilize this procedure in lieu of insolvency procedures that may lead to winding up.
Within four (4) months following entry into a judicial debt restructuring, the debtor should submit a restructuring plan. This can also be done by the creditors, the receiver, the debtor's shareholders or various other entities. The plan should aim to restore solvency of the debtor and settle existing indebtedness (there should be no overdue indebtedness left after completion of the plan). The plan should provide for full payment of current expenses and to the first- and second-priority creditors within three (3) months of the bankruptcy court's approval of the plan, prior to settlement of overdue indebtedness to other creditors. Additionally, before tax and treasury legislation is amended following the potential adoption of the Restructuring Bill, the plan should provide for the full payment of mandatory debts to the state and state funds.
A plan may also include various approaches to corporate governance of the debtor for the restructuring period, as well as special rules for the creditors whose claims are to be satisfied under the plan.
A plan may be approved by a vote of creditors and then confirmed by the bankruptcy court. Notably, only a simple majority of participating creditors with voting rights is required to approve the plan. However, the Restructuring Bill provides that terms and conditions of the plan with respect to creditors voting against the plan (except interested party creditors) may not be less favorable than those with respect to creditors voting in favor of the plan (except secured creditors). Other limitations exist: for example, debt to equity conversions may only occur for those creditors that voted in favor of it.
The term for completion of a plan as a rule should be no longer than four (4) years following the court's approval of the plan, though this period can also be extended by another four years. During the first two months of the restructuring, the debtor may unilaterally terminate pre-existing contracts if performance thereunder would materially complicate rescue of the debtor's solvency or would carry losses compared to similar transactions on the market (with the exception of facility agreements and security arrangements).
The Restructuring Bill also appears de facto to allow prepack bankruptcies. In particular, the bill allows a debtor to obtain creditors' consents to a draft plan in advance (during a period of up to six (6) months prior to commencement of judicial proceedings on debt restructuring, or more where a creditor is a credit institution). That said, advance consents may also be revoked. It would improve on the procedure significantly if the legislature would amend the Restructuring Bill expressly to state that a plan may be filed simultaneously with the application for judicial debt restructuring, with the consent of the majority of creditors.
The new procedure would appear to be a sensible concept. If successfully introduced it would hopefully bring the Russian bankruptcy system more in line with developed countries' models, which heavily rely on rescue procedures. However, implementation in Russia will require a major shift in attitudes by debtors, their shareholders and creditors. As a rule, successful restructurings in Russia have only been carried out on a contractual (non-judicial) basis, with the judiciary being used instead for insolvent liquidations.
Notably, the proposed amendments would also introduce the possibility of proceeding immediately with a debtor's liquidation, in lieu of having to wait the current mandatory six-month supervisory period. This should hopefully cut the costs and time frames for bona fide liquidations.
1. Art. 61.10(1) of the Insolvency Law, as amended by the Amendment Law.
2. Art. 61.10(4), Ibid.
3. Art.61.11(1), Art.61.11(12), Ibid.
4. Art. 61.12, Ibid.
5. Art. 9(3.1), Ibid.
6. Art. 61.13, Ibid.
7. Art. 61.14, Ibid.
8. Art. 61.16(7), art. 61.16(9) Ibid.
9. Art. 61.17(2), Ibid.
10. Art. 61.19(4), Ibid.
11. Art. 61.21, Ibid.
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