The new Federal Law of the Russian Federation "On Insolvency (Bankruptcy)"¹ (hereinafter "Bankruptcy Law") was signed by the president on January 8, 1998. The Bankruptcy Law became effective on March 1, 1998 and replaced the former Law of the Russian Federation "On Insolvency (Bankruptcy) of Enterprises."²

Under the Bankruptcy Law, individuals (citizens), including individual entrepreneurs,³ and certain legal entities, including commercial enterprises and non-profit organizations, are eligible to file for bankruptcy. However, the effect of the Bankruptcy Law with regard to individuals—but not individual entrepreneurs—has been suspended until the introduction of the conforming amendments to the Civil Code of the Russian Federation.⁴

Currently, the Civil Code of the Russian Federation provides only for the insolvency of individual entrepreneurs and legal entities.⁵ The Bankruptcy Law has introduced a number of provisions to be applied to certain debtors, such as individuals, banks and other financial organizations, insurance companies, farmers, etc.

Under the Bankruptcy Law, 5,300 bankruptcy cases were filed between March 1, 1998 and December 25, 1998, whereas only 4,200 cases were under the courts' consideration before March. Furthermore, bankruptcy procedures of the Bankruptcy Law were applied to more than 900 cases opened before March.

Indicia of Insolvency

"Insolvency" and "bankruptcy" are co-extensive terms within the meaning of the Bankruptcy Law. For an individual debtor, the indicia of bankruptcy exists if (1) the debtor fails to perform the respective obligation(s) within a three-month period as of the date it/they fall(s) due; (2) the amount of the debtor's obligations exceeds the value of the debtor's assets; and (3) the amount of the debtor's unfulfilled obligations equals at least 100 times the monthly minimum wage rate. The indicia of bankruptcy for a legal entity does not include the second of the aforementioned requirements, and demands a higher amount of non-fulfilled obligations—at least 500 times the monthly minimum wage rate.⁶ However, the debtor is adjudicated as insolvent (bankrupt) only upon the entry of a final decree of the court to this effect.

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The current Bankruptcy Law represents a significant step forward in the development of Russian insolvency legislation.

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Commencement of a Case

A bankruptcy case starts with the filing of a bankruptcy petition with the arbitration (arbitrage) court⁷ serving the area where the individual debtor lives, or where the legal entity debtor is located. The petition can be filed by any of the following persons: a debtor, a creditor and, in some cases, a state attorney (public prosecutor). Several creditors can consolidate their claims in a joint bankruptcy petition. In certain cases, the Bankruptcy Law provides for the initiation of a bankruptcy case by other persons.

Under most circumstances there is no obligation for the debtor to file for bankruptcy. However, under certain circumstances the debtor is obliged by the Bankruptcy Law to file a bankruptcy petition. For example, this obligation applies when the payment by an enterprise (or by an individual entrepreneur) of its debts to one or several creditors will keep the debtor from complete satisfaction of its obligations to other creditors.

The case will be opened, i.e., formally commenced, if the petition meets all requirements provided by the law. Not meeting major eligibility requirements, e.g., indicia of bankruptcy, results in a rejection of the bankruptcy petition. The court's order of rejection prevents the filing of the same bankruptcy petition again. If the petition does not conform with the minor (filing) requirements, e.g., the filing fee was not paid, the court sends the petition back to the petitioner. In this case, the petitioner has a right to resubmit the petition after the respective changes and/or actions have been made and/or undertaken. Of the 4,562 cases commenced in 1998 (starting from March 1), 567 bankruptcy petitions were rejected.⁸

Unlike in the United States, where a debtor can select the chapter (procedure) under which it will go through bankruptcy, in Russia the debtor cannot file a bankruptcy petition for relief under a particular bankruptcy procedure. The first meeting of creditors decides which bankruptcy procedure will be proposed to the court. On the basis of this decision, but not bound by it, the court selects the bankruptcy procedure to be applied.⁹

Bankruptcy Procedures

The Bankruptcy Law provides for four basic types of bankruptcy procedures: monitoring, external management, bankruptcy liquidation proceeding and composition. During bankruptcy procedures, the interests of all creditors are represented by the meeting of creditors and/or by the creditors' committee. If the number of creditors is less than 50, the meeting of creditors can determine that the responsibilities of the creditors' committee are assigned to those creditors.

Each bankruptcy procedure is administered by a bankruptcy trustee (arbitration manager). The Bankruptcy Law provides for interim, external and bankruptcy liquidation trustees. In general, the trustee's duties include convening the meeting of creditors and the creditors' committee, protection of the bankruptcy estate, reviewing the creditors' claims, maintaining the register of claims, etc.

Monitoring is an initial bankruptcy procedure that commences upon the opening of the bankruptcy case with the court. The main objective of monitoring is to maintain the debtor's assets until the appropriate decree is issued by the court. Monitoring is administered by the interim trustee, who takes all necessary measures to identify the debtor's creditors, determine the amounts of creditors' claims, notify creditors about the opening of the bankruptcy case, etc.

External management is a reorganization procedure aimed at restoring the debtor's solvency by means of transferring managerial authority to the external trustee. This procedure requires that the external trustee file a plan of external management, which must be submitted for the approval of the creditors within a one-month period from the external trustee's appointment. The plan is considered approved by the creditors if it is confirmed by a simple majority of creditors present at the meeting of creditors.

A bankruptcy liquidation proceeding (competitive proceeding) is initiated upon the decision of the court adjudicating the debtor as insolvent, and its purpose is the proportionate repayment of debts. To carry out a liquidation bankruptcy proceeding, the court appoints one or several bankruptcy liquidation trustees.

Composition (amicable agreement) is a bankruptcy procedure resulting in an agreement made between a debtor and its creditors, whereby the latter agree to defer and/or reduce payment of the debt in discharge and satisfaction of the whole debt repayment.

A composition deed (agreement of composition) is signed by the debtor, the respective bankruptcy trustee and the authorized representative of the meeting of creditors. The composition can be made at any point in the bankruptcy case, but only after the distribution for the first and second classes of claims is completed. If a simple majority of the total number of creditors, as well as all of the secured creditors, vote in favor of the composition, the composition is accepted by the meeting of creditors. The composition deed is subject to the court's confirmation.

More than 30 percent of cases opened after March 1, 1998 were in the monitoring stage in early January 1999. During the same time period, approximately 43 percent of debtors were adjudicated as insolvent, meaning that the outcome of these cases was liquidation; 10 percent of the cases ended in external management, and 1.5 percent of cases resulted in composition.¹⁰

Bankruptcy Estate and Completion of the Case

All assets of the debtor existing at the commencement of the bankruptcy liquidation proceeding or discovered during the bankruptcy liquidation proceeding constitute the bankruptcy estate. However, there are certain exemptions from the bankruptcy estate for both individual debtors and legal entities.¹¹

The Bankruptcy Law designates an order of priority for distribution of a bankruptcy estate.¹² The first preference is given to priority claims (e.g., court fees and expenses, compensation for the bankruptcy trustee's services, etc.). After satisfaction of priority claims, the estate is distributed among five classes of creditors, among which the preference is given to personal claims, claims under employment and copyright agreements, secured claims and compulsory charges (e.g., taxes).

The claims of each class shall be paid off only after the claims of the previous class have been satisfied, which is similar to some extent to the absolute priority rule in American law. If the amount of the distributed assets is insufficient to satisfy the claims of the respective class in full, these assets should be distributed in proportion to the amount of the claims.¹³ It should be noted that property serving as collateral for secured claims is not designated only for the satisfaction of the claims of the respective secured creditors. The aforementioned property is included in the bankruptcy estate in the same way as all other debtor's assets. The debtor is discharged upon the repayment of creditors' claims in the course of the bankruptcy procedure that was applied to the debtor.

A bankruptcy case will be dismissed if the debtor's insolvency was rehabilitated in the course of external management or if a composition deed was confirmed by the court. Where the debtor was adjudicated as insolvent and a bankruptcy liquidation proceeding has commenced, the case is closed after the court reviews the bankruptcy liquidation trustee's report and enters a final order on completion of the bankruptcy liquidation proceeding.

Conclusion

The current Bankruptcy Law represents a significant step forward in the development of Russian insolvency legislation. As a legal reform achievement, it stands in the same order as the Civil Code of the Russian Federation and Federal Laws "On Joint Stock Companies" and "On Limited Liabilities Companies." The new law will establish legal procedures to sort out the financial problems that arose both before and after the financial crisis in Russia.

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Footnotes

¹ Federal Law of the Russian Federation, No. 6-FZ "On Insolvency (Bankruptcy)", Jan. 8, 1998. See Sobr. Zakonod., RF, 1998, No. 2, Art. 222. Return to article

² Law of the Russian Federation "On Insolvency (Bankruptcy) of Enterprises" No. 3929-1, Nov. 19, 1992. See Vedomosti, Verkh, Soveta RF, 1993, No. 1, Art. 6. Return to article

³ An individual engaged in entrepreneurial activity without incorporation of a legal entity. See Civil Code of the Russian Federation (Part 1), infra note 5, art. 23, para. 1. Return to article

⁴ Civil Code of the Russian Federation (Part 1), Federal Law No. 51-FZ dated Oct. 30, 1994. See Sobr. Zakonod., RF, 1994, No. 32, Art. 3302. Return to article

⁵ See Civil Code of the Russian Federation (Part 1), supra note 5, arts. 25 and 65 respectively. Return to article

⁶ See Bankruptcy Law, supra note 1, art. 3, paras. 1-2 and art. 29, para 2. Return to article

⁷ Russian arbitration courts must be distinguished from arbitration associations and arbitration boards, which are associated with alternative dispute resolution. Arbitration courts constitute an independent branch of the Russian court system, having jurisdiction over most civil cases in the field of property and commercial issues, as well as business and entrepreneurial activity. These "commercial" courts play a very important role in the Russian legal system. Return to article

⁸ See "The New Law Has Intensified Consideration of the Bankruptcy Cases in Courts," supra note 15, at 4. Return to article

⁹ See Bankruptcy Law, supra note 1, art. 67, para. 1. Return to article

¹⁰ See "The New Law Has Intensified Consideration of the Bankruptcy Cases in Courts," supra note 15, at 4. Return to article

¹¹ See Bankruptcy Law, supra note 3, arts. 103-104, 155. Return to article

¹² See Bankruptcy Law, supra note 3, art. 106. Return to article

¹³ See Bankruptcy Law, supra note 3, art. 114, paras. 2 and 3. Return to article