Amendments to Russian Insolvency Law Enacted

On April 28, 2009, the president of the Russian Federation signed into law amendments to the Russian Law on Insolvency (Bankruptcy) of October 26, 2002 (Federal Law No. 127-FZ) (the “Insolvency Law”) that should be considered by all creditors doing business with financially troubled Russian companies, directors and other controlling persons of Russian companies, and participants in the market for distressed Russian assets.


Many of the changes reflect pro-creditor concepts that were introduced in another series of amendments adopted just before the end of 2008, but other aspects of the new amendments are likely to make it more difficult and time-consuming for creditors to obtain payment on their claims.


The 2009 amendments introduce two new concepts governing the obligation of the directors of a Russian company to file a petition with the Arbitrazh court (state commercial court) for insolvency: “insufficiency of assets” and “inability to pay.” “Insufficiency of assets” means that the aggregate value of a debtor’s monetary obligations under “civil” transactions and mandatory payments (taxes and duties) exceeds the value of the debtor’s assets. This is similar to the “balance sheet test” of solvency in U.S. and English law. “Inability to pay” refers to a debtor’s inability to satisfy monetary obligations due to capital inadequacy—a rough equivalent of the “cash flow test” in U.S. and English law.


Under the amended Insolvency Law, a company’s general director is obligated to file an insolvency petition within one month of learning that the company meets either of these criteria—a requirement that, according to some commentators, creates disturbing restrictions on the scope of potential alternatives for dealing with financial problems to avoid insolvency, such as debt or corporate restructuring.


The amended law also implements secondary liability of any “controlling person” as well as directors for a debtor’s obligations, by providing that, upon a finding of liability, such parties must compensate the debtor-company for “damages inflicted on creditors’ assets,” a concept defined as any decrease in value of a debtor’s assets and/or any increase in the value of claims against a debtor’s assets, as well as other consequences of transactions or legally significant acts performed by the debtor that make it impossible for creditors to satisfy their claims out of the debtor’s assets. A “controlling person” is not liable for damages if he can prove that he acted in good faith and reasonably in the debtor’s interests. Directors are also liable for a debtor-company’s obligations if the debtor’s books and records are inaccurate or incomplete.


The new provisions provide additional grounds for challenging transfers by a debtor that can be voided by an insolvency officer (i.e., an external administrator or bankruptcy receiver) on his own initiative or in accordance with any directive issued after a duly constituted creditors’ meeting. Under the amended Insolvency Law, “suspicious transactions” and “transactions with a preference” entered into by a debtor are subject to challenge in court. Any action by a debtor to perform obligations arising from civil, labor, family, tax, customs, or procedural law may also be challenged in court. “Suspicious transactions” include: (i) any transaction entered into by a debtor within one year prior to becoming the subject of an insolvency petition, or afterward, involving inadequate consideration; and (ii) any transaction entered into by a debtor “for the purpose” of inflicting damage on creditors’ proprietary interests in a debtor’s assets, so long as damage actually results and the other party to the transaction was aware of the debtor’s intent.


A “transaction with a preference” is defined in the amended Insolvency Law as a transaction entered into by a debtor for the preference of a creditor, subject to certain exceptions, including transactions entered into by the debtor in the ordinary course of business. If a suspicious transaction or a transaction with a preference is invalidated by the court, the transferred assets must be returned to the bankruptcy estate for distribution among creditors.


According to commentators, the new amendments to the Insolvency Law are intended to prevent asset stripping in a company on the verge of insolvency and to expand bankruptcy assets through the filing of claims against third parties. Moreover, the provisions relating to challenging transactions could constitute an extremely powerful tool in the hands of an insolvency officer. At this juncture, it remains to be seen how effective the amended law will be in achieving those goals.