Oda Russian Commercial Law 2007-1

202	COMPANY LAW

(2)Transactions with Interested Parties

Transactions by members of the board, the single executive body, members of the collective executive body as well as participants who hold 20% or more of the capital alone or in conjunction with af liated persons, are not allowed to effect transactions with interested parties without the consent of the general meeting of members (Art.45, para.1). The general meeting may give consent to the transaction by a majority vote without the interested members voting (ibid., para.3). If there is a board of directors, this power to give consent can be entrusted to the board, except in cases where the value of the transaction exceeds 2% of the assets of the company determined on the basis of the last nancial year (ibid., para.7).

Transactions are regarded as those with interested parties in cases where the above persons, spouses, parents, children, sisters and brothers as well as their af liated persons are (ibid., para.2):

i) party to the transaction with the company or acting in the interest of a third party against the company;

ii) holding 20% or more of the participatory share of a juridical person which is a party to the transaction with the company or which acts in the interest of a third party against the company, or

iii) holding a position in the management body of a juridical person which is a party to the transaction with the company or which acts in the interest of a third party against the company.

Members of the board, the single executive body, members of the collective executive body as well as the participants mentioned above are under an obligation to disclose the information listed in the Law to the general members’meeting (ibid., para.2).

Those transactions effected in violation of this provision are voidable (ibid., para.5).

A limited liability company, Mobiltelecom Sverdrovsk (hereinafter, the “Company”), brought an action vis-à-vis Proizvodstvennaia-kommercheskaia rma Mobiltelecom Sverdrovsk (hereinafter, the “Firma”), asking the court to acknowledge the transaction of transfer of property null and void and to return the property to the company. The rst instance court and the appellate court acknowledged the claim, while the court of cassation partly quashed the decision of the lower court.

The Presidium of the Supreme Commercial Court supported the decision of the lower court. In this case, M.Iu.Kozin, who was the director and the single executive body of the Company, was appointed director of the Firma. Kozin gratuitously transferred signi cant assets to the Firma.According to the Law on Limited Liability Companies, transactions effected by a person who holds the position of a single executive body are interested transactions and are subject to the approval of the

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members’ meeting. Kozin, who, at the time of the transaction, simultaneously held the position of a director of the Company and the Firma is an interested party. The resolution of the members’ meeting was never adopted, and therefore, the transaction was effected in breach of law. The decision of the rst instance court which found the transaction to be invalid and mandated the property to be returned should be upheld.219

10)Liability of the Directors and Executive Of cers

The above persons are under an obligation to act in the interests of the company in a conscientious and reasonable manner. They are liable to the company for damage caused to the company by their fault. Those who voted against the act in question or did not take part in the vote are exempted from liability (Art.44, paras.1 and 2).

As is the case with joint stock companies, not only the companies, but also members may initiate an action against these persons (indirect action, derivative action) (ibid., para.5).

The general director of company Liudmila, which was a successor to a limited liability company (TOO), forged a document needed to provide a non-residential building which belonged to the company as collateral and received a loan from the Saratov Bank – part of the Sberbank. Eventually, the general director defaulted and the building became the property of the Bank. The court ruled that the Bank was unaware and could not have been aware that there was no resolution of the general members’ meeting concerning the loan by offering the building as a collateral and that the general director had no power to effect the transaction. In such cases, the consequences must be borne by the juridical person, in whose name the director had acted in bad faith.220

Indirect (derivative) action is available to participants, but as is the case with the Law on Joint Stock Companies, no details are given (ibid., para.5).

11)Audit

The company may, under theArticles of Incorporation, set up an audit committee or have an internal auditor (revizor). In a company with 15 or more participants,

219Decision of the Presidium of the Supreme Commercial Court, April 3, 2002, Case 7611/01.

220Decision of the Presidium of the Supreme Commercial Court, February 11, 1997, Case 8365/95.

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this is mandatory. Members of the audit committee may not be members of the board of directors, a collective executive body, or a single executive body (Art.32, para.6). The audit committee is appointed by the general participants’ meeting for checking the “ nancial-economic activities” of the company (Art.47, paras.1 and 2).

In order to check and authenticate the accuracy of the annual report and the balance sheet, as well as to check the state of current business, the company may involve a professional auditor unrelated to the company. By request of any participant, the audit can be conducted by a professional auditor as above, at the expense of this participant (Art.48).

The requirement of publicity of their activities is less stringent in limited liability companies than in joint stock companies. Limited liability companies are under no obligation to publish their annual report. Only when they are making a public offer of bonds and other securities are they required to publish the annual report, balance sheet and other information (Art.49).

5

INSOLVENCY LAW

1HISTORICAL BACKGROUND

In Russia, the term bankrotstvo denoted the entire procedure dealing with insolvency, while the term konkurs denotes the procedure for the sale of the debtor’s assets and the distribution of proceeds among the creditors. In the Tsarist period, the term konkurs was commonly used. The current Russian Law is entitled zakon o nesostoiatel’nosti (bankrotstve). It accommodates both the procedure aimed at the rehabilitation of the debtor as well as the procedure for liquidation. In the following, nesostoiatel’nost’will be translated as insolvency to cover the entire procedure under the current Law, while bankruptcy will be used in a narrower sense to cover the konkurs procedure, i.e. the liquidation procedure under the 2002 Law.

The history of insolvency legislation in Russia goes back to the 1800 Statute on Bankruptcy (ustav o bankrotakh). The enactment of a new law was discussed extensively in the Tsarist period and even a draft law based upon the German model was published, but it was not adopted as it was seen as an imitation of Western statutes’.

After the Revolution, in the planned economy which followed, the sole owner of enterprises was the state. Despite the façade of the enterprises being separate entities from the state and operating on their own balance sheet, loss-making enterprises were supported by the state, which was actually redistributing pro ts made by other enterprises. There was little need to have the assets of the debtorenterprise distributed among the creditors who were also state enterprises, or rehabilitating the enterprise on the latter’s initiative. These enterprises did not have many assets which could be disposed of in the rst place. Thus, there was no system to deal with insolvent enterprises under the socialist system.

In the process of transition to the market economy, the necessity for such a system as a prerequisite to the transition was acutely felt. In 1992, the Law on the Insolvency (Bankruptcy) of Enterprises was enacted. As was the case with other laws enacted in this early period, this Law, which had only 51 provisions,

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lacked consistency and internal logic.As one Russian commentator put it, it was “like a car which was dif cult to start, and once it starts, inadequately responds to the attempts to manipulate it and moves in all directions”.1

In reality, between 1993 and 1997, the Law was not widely applied. In 1993, there were only 74 bankruptcy cases, although the number increased in the next several years, but only up to 2,269 in 1997. One of the problems was that the triggering mechanism for the insolvency procedure was set by the excess of debts over the value of the assets, which was too complicated to calculate in practice. This made the position of creditors dif cult.2 The Law was also regarded to be too debtor-friendly. Furthermore, by the enactment of the Civil Code in 1995 which accommodated some provisions on bankruptcy in its General Part, many provisions of the 1992 Law were superseded by those of the Civil Code and some contradictions emerged.

Therefore, a new Law was prepared and was enacted as the Law on Insolvency in 1998.3 In the three-year process of preparing the new Law, the “best laws of the contemporary world”, the US Bankruptcy Code, the UK Insolvency Act, the German Insolvenzordnung and the French Law were extensively studied. The end result was that, from a Russian perspective, “in terms of the conceptual parameter, the new Russian Law can be placed at the same level as the US, German, English and French laws which regulate insolvency”.4

An important novelty in the 1998 Law was the triggering mechanism for the insolvency procedure. Instead of the excess of the debt over the assets, the 1998 Law resorted to the concept of incapability to pay in order to strengthen the position of creditors. Insolvency was de ned as the inability of the debtor to pay monetary debt in full and/or perform obligations for mandatory payment (taxes, levies, and other payments). For juridical persons, this was indicated by the fact that the debtor failed to satisfy a monetary claim or perform an obligation for mandatory payment for more than three months after the due date. There is a minimum requirement for the amount of debt, but it was only 500 times the minimum wage. This made the initiation of the procedure quite easy, but opened the way for abuses.

Shortly after the 1998 Law took effect, a “simpli ed procedure” of insolvency was introduced by a government decision (Decision No.476) in the light of the looming nancial crisis. This decision introduced the debt-equity swap through auction. However, the new system was criticised for creating a water-

1 V.V.Stepanov, Nesosoiatel’nost’v Rossii, Frantsii, Anglii, Germanii, Moscow 1999, p.139.

2Iu.Simachev, “Institut nesostoiatel’nosti v rossii: spros, osnovnye tendentsii i problemy raz-

vitiia”, VE 2003 No.4, pp.62-63.

3 SZ RF, 1998 No.2, item 222 [replaced by the 2002 Law].

4Stepanov., supra, pp.161-162.

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shed for abuses and insider dealing. Under this system, it was pointed out, managers of the debtor-organisation, in conjunction with speculators with nancial resources, would have a major role and compromise the auction.5 There were instances where irregularities were suspected.6 This procedure was eventually abolished.

Although the nancial crisis in 1998 should be taken into account, still, the increase in the number of application after the adoption of the 1998 Law was remarkable. While in 1997, only 5,687 applications reached the court, this increased to 12,781 in 1998, and in the following year, increased by 31%.7 There was a further increase to 24,874 in 2000, 55,934 in 2001, and 106,647 in 2002. However, the sharp increase in the number of application between 2000 and

– 2002 is said to be partly due to the application of the simpli ed insolvency procedure to dormant companies, rather than to the bankruptcy of operating companies.8

However, the bankruptcy procedure under the 1998 Law, which was designed to be creditor-friendly, was open to various abuses. As a result of this creditor-friendly system, the system became a source of con icts and resulted in the collapse of many solvent companies. It was pointed out that the initiation of the procedure in fact became an inexpensive alternative to hostile takeover, provided that there was a potential alliance between the administrator, judges and other of cials.9 Often creditors were not interested in the implementation of measures of nancial restoration of the company, but its bankruptcy and acquisition of its assets.10 In 2001, reportedly, 30% of insolvency cases were related to hostile enterprise takeovers and to the illegitimate redistribution of property.11

Takeovers under the guise of bankruptcy worked as follows. After collecting nancial information on the target company, the company which intends to carry out the takeover forges an alliance with the creditor of the target company or buys the debts through front companies. Sometimes, repayment of debt by the target company is inhibited. Then the bankruptcy procedure is initiated by a creditor, which is a front company of the raider. The key point is the appointment of the administrator who has actually been selected by the raider. The decision

5	Ibid., pp.163-164.
6	A.Radygin, “Sovstvennost’ i integratsionnye protsessy v korporativnom sektore”, VE, 2001
	May, pp.31-32.

7Rabota arbitrazhnogo suda RF v 1998 godu, 1999 godu, edited byAKDI, Ekonomika i zhizn’,

www.akdi.ru.

8 Simachev, supra, pp.68-69.

9Ibid., p.33.

10S.A.Karelina, Pravovoe regulirovanie nesostoiatel’nosti, bankrotstva, Moscow 2006, p.9.

11V.Volkov, “Hostile Enterprise Takeover: Russia’s Economy in 1998-2002”, Review of Central and East European Law, 2004, No.4, p.532.

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of the court, which is often obtained through a substantial bribe, will be duly enforced by this administrator.12 This proved to be true in the celebrated Sidanco case where a major oil production company was taken over by a rival company through manipulation of the insolvency law.

At government level, the perceived shortcomings of the bankruptcy system included:13

i) Breach of the rights of the debtor and their shareholders; ii) Violation of the right of the State as a creditor in tax claims;

iii) Exit of assets of the debtor in the interest of a speci c group of creditors in the course of external administration and bankruptcy (konkurs);

iv) Wide use of ctitious bankruptcy as an instrument of uncivilised takeover of property;

v) “Lack of transparency”, lax regulation of the insolvency procedure which allows the bankruptcy administrator and other participants in the procedure to abuse loopholes and the absence of an effective mechanism of pursuing the responsibility of unfaithful and inef cient administrators;

Because the 1998 Law led to widespread abuses, it was felt that the system needed a complete review, and in 2002, a new Law on Insolvency was adopted.

2THE LAW ON INSOLVENCY

The basic law which covers insolvency is the Law on Insolvency (bankruptcy) of 2002. The Civil Code also has some provisions on the insolvency of juridical persons. The problem is that the Civil Code and the Law on Insolvency do not always coincide. An important provision such as Article 64, para.1 of the Civil Code, which provides for the rank of creditors in the distribution of proceeds from the sale of assets, differs from the equivalent provision in the Law on Insolvency.

In addition to the Law on Insolvency, there are two separate laws. One is the Law on the Insolvency of Credit Organisations of 1999 and the other is the Law on the Special Measures on the Insolvency of the Subjects of Natural Monopolies in the Fuel-Energy Complex enacted in the same year.

The Law on Insolvency has adopted a “one stop shopping” system, instead of having a separate law for each type of procedure. Once the application for the recognition of the debtor as bankrupt has been accepted, after the observation procedure, different measures and proceedings can be applied.

12Ibid., p.533.

13Simachev, supra, p.63.

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These are:

i) Financial restoration (sanatsiia; Sanierung); ii) External administration;

iii) Bankruptcy proceedings; iv) Amicable settlement.

The Law is applicable to the insolvency of juridical persons as well as that of individuals. There is a separate chapter for the insolvency procedure involving individuals, including individual entrepreneurs. Concerning juridical persons, the Law extends to “all juridical persons, except for treasury enterprises, agencies (uchrezhdenie), political parties and religious organisations (Art.1, para.2). This does not exactly correspond to the provision of the Civil Code which excludes only treasury enterprises from bankruptcy (Art.65, para.1). It should be added that as agencies are excluded from the scope of the bankruptcy law, constituent entities of the Russian Federation as well as municipalities are not covered by this Law. The Budget Code partly deals with the insolvency of such entities.

The “symptom of bankruptcy” which triggers off the insolvency procedure is the incapability of the debtor to pay debts. Juridical persons are deemed to be incapable of performing monetary obligations and/or the obligation to make mandatory payments (e.g. taxes) if the performance is overdue by three months (Art.3). In a separate provision, the minimum amount of debt is set at 100 thousand roubles (Art.6, para.2). An additional requirement for creditors is that in order to le an application for the recognition of the debtor as bankrupt, a judgment of the court of general jurisdiction, commercial court, or an award of an arbitration tribunal which has taken effect and evidence that the enforcement document has been sent to the bailiff has to be attached (Art.39, para.2).

Such arrangements are intended to prevent abusive applications which were common under the 1998 Law.

In 1999, insolvency proceedings were initiated against Sidanco, the then fth largest oil company, by an unknown company. The amount of claim this company held was actually 0.1% of the total debt of the company. Proceedings were initiated against Sidanco’s production subsidiaries too. In relation to one of the subsidiaries, the creditor who led for recognition of insolvency had been offered payment, but reportedly, the court ignored it and went ahead with the proceedings.14

Reportedly a paradoxical situation was observed where enterprises which have suf cient assets were dragged into the insolvency procedure because there was a

14 East European Energy, 1999 September issue, pp.11-13.

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fair chance of their competitors taking control of these enterprises, while hopeless enterprises escaped the procedure because no one wanted to take control of such enterprises.

Therefore, it was proposed to require the initiator of the procedure to prove that there is no other way of recovering the debt than insolvency procedure.15 However, the new arrangement under the 2002 Law has actually gone to the other extreme and made applications extremely dif cult for creditors. This is demonstrated by a sharp fall in the number of application. In 2002, there were 106,647 applications for the commencement of the procedure. The Law came into force on December 2, 2002. In 2003, the number of application fell to 14,277. Although the fact that there was a “last minute rush” of applications in 2002 has to be taken into account, this is still a signi cant decrease.

Table 10 Insolvency cases handled by the commercial court: 2003-2006

	2003	2004	2005	2006
Accepted Cases	9,695	10,093	25,643	83,068
Financial	10	29	32	39
restoration
External	2,081	1,369	1,013	947
administration
Recognition as	17,081	9,390	13,963	76,447
bankrupt
Refusal of	688	163	308	737
recognition
as bankrupt
Settlement	170	150	84	106
Application for	3,213	2,162	1,506	2,625
the dismissal of
the administra-
tor
Insolvency	56,440	20,116	18,812	60,848
procedure
Completed
(www.arbitr.ru)

15 Radygin, supra, pp.32-33.

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3THE PROCEDURE

1)Initiation of the Procedure

The insolvency procedure is initiated by an application for the recognition of the debtor by the court as bankrupt. The commercial court has exclusive jurisdiction in bankruptcy cases, regardless of whether the debtor is a juridical person or an individual (Art.6, para.1). It should be noted that the Law explicitly provides that insolvency cases may not be handled by arbitration (Art.33, para.3).

The debtor, creditor, and “empowered bodies” are entitled to apply to court for the recognition of the debtor as bankrupt. “Empowered bodies” primarily means tax and pension agencies.Alarge portion of insolvency cases are initiated by the tax agency. In 2000, 43.7% of the cases were initiated by the tax agency, while 20% were initiated by creditors. The share of cases initiated by the tax agency actually was close to 70% in 2001.16 Obviously, the tax agency uses the insolvency procedure as an effective device for collecting unpaid taxes.17

Not only creditors, but debtors are entitled to apply for bankruptcy. The debtor is entitled to apply, if there are circumstances which clearly demonstrate that the debtor is not in a state to perform the obligation in time (Art.8, para.1). This means that even when the “indications of bankruptcy” as provided in Article 6 have not emerged, the debtor, foreseeing such a situation, is entitled to apply for bankruptcy.

The executive (the single executive body or the head of the collective executive body) of the debtor which is a juridical person is under an obligation to apply in cases where repayment to a creditor(s) results in the debtor’s impossibility to fully satisfy the other creditors’claim. This also applies in cases where a body of the debtor/juridical person which is empowered to adopt the decision of liquidation decided to apply to court, and when the seizure of properties by a creditor makes the economic activities of the debtor signi cantly dif cult, or impossible. The grounds for the mandatory application for the initiation of the procedure by the debtor have been expanded by the 2002 Law.Although it is not clear from the Law, the application of the executive body has to be preceded by the decision of the body, i.e. the board or the shareholders’meeting, to do so.18

The commercial court of the place of location of the debtor has jurisdiction over the insolvency case (Art.33, para.1).

16Simachev, supra, p.74.

17Supreme Commercial Court, “Rassmotrenie del o bankrotstve v 2000 godu’, www.akdi.ru. Information on the number of application by the tax agency is no longer available.

18Karelina, supra, p.51.