…and other related aspects of related corporate law
Relevant to Paper F4 (RUS)
This article goes into more detailed knowledge than is expected from Paper F4 candidates. Please read the Syllabus and Study Guide in order to familiarise yourself with the learning objectives for this paper.
This article provides a brief overview of recent amendments made to the corporate and business law legislation of the Russian Federation. Drastic changes were implemented to the Civil Code (The Civil Code of the Russian Federation: Part I No.51 ‑ FZ, 30 November 1994; Part II No.14 ‑ FZ, 26 January 1996; Part III No.146 ‑ FZ, 26 November 2001; Part IV No.230 ‑ FZ, 24 November 2006), the law on pledge (The Law of the Russian Federation No.2872 ‑ 1 On Pledge, 29 May 1992), the law on mortgage (The Federal Law of the Russian Federation No.102 ‑ FZ, On Mortgage, 16 July 1998), and the Bankruptcy Law (The Federal Law of the Russian Federation No.127 ‑ FZ, On Insolvency (Bankruptcy), 26 October 2002) under Federal Law No. 306 FZ, 30 December 2008.
These amendments directly affect the relationship between a lender and a borrower, as a pledge is generally a subsidiary obligation in credit relations. The need to sell a debtor’s property only arises when a debtor cannot fulfil their obligations under the main (credit) agreement.
Article 348 of the Civil Code now provides that in both a pledge contract and afterwards (in the case of non‑fulfillment of obligations secured by the pledge) the ability to sell the pledged property (and to set a price) is possible without recourse to the court. If the pledger (the debtor – the person providing the pledge) is a ‘natural person’, or the pledge is of real estate (ie a mortgage) such agreements must be notarised.
Also, in situations where periodic payments are due, the systematic infringement of payment terms (occurring more than three times within 12 months) will result in the seizure of the pledged property. Even if the pledger does not fulfil their agreed obligations on the seizure of the pledged property, a special execution may be based on a notarised endorsement.
The pledgee (the creditor) must inform the pledger on the initiation of the recovery procedure without recourse to court.
In certain cases (eg selling of securities) an independent appraiser, invited by both parties, must evaluate the mortgaged property.
Execution by court decision
A court decision to levy an execution on the object of a pledge can only take place in certain circumstances, including the following:
- With the consent or permission of the other person or body, required for the conclusion of the contract on the pledge of property of the individual.
- When the object of the pledge is property of considerable historic, artistic or other cultural value for society.
- If the pledger is absent and is impossible to locate.
- When the object of the pledge is residential accommodation belonging to a natural person under the right of ownership.
- When the pledge contract does not stipulate the order on levy execution on the pledged property.
A claim for levying execution on the pledged property may be rejected by the court if the violation, committed by the debtor (with respect to the obligation secured by the pledge), is utterly insignificant.
This is when the sum of the overdue obligation is worth less than 5% of the value of the subject of the pledge, and the overdue period is less than three months.
For this reason, the amount of the pledger’s claim is obviously disproportionate to the cost of the pledged property.
Sale of pledged property
A sale of pledged property is executed by open auction in the order established by the procedural legislation (The Civil Procedural Code of the Russian Federation No.138 ‑ FZ, 14 November 2002), unless otherwise provided for by law.
The initial selling price of a pledged property, from which the bidding starts, is 80% of its market valuation as determined by an independent appraiser, unless otherwise provided for by the pledge agreement.
The pledged property is sold to the highest bidder.
Right of pledgee
If the auction is declared as having failed, the pledgee has the right, by an agreement with the pledger concluded within one month from the date of the auction, to acquire the pledged property and to offset the sale price by the amount of his claims, secured against the pledge. The rules of a sale and purchase contract apply to such an agreement.
At a re‑auction, the initial selling price is 15% lower than that at the first auction.
If the re‑auction is also declared as having failed, the pledgee has the right to keep the pledged property, appraised at a value not less than 10% below its initial selling price at the first auction.
If the pledgee does not avail himself of this right within one month from the date of declaring the re-auction as having failed, the contract of pledge is terminated.
If the amount realised from the pledged property is insufficient to cover the claims, the pledgee has the right (in the absence of any other provisions in the law or in the contract) to demand the shortfall from other property of the debtor, but without the right of priority based on pledge.
If the amount realised exceeds the claims secured by the pledge, the excess must be returned to the pledger within 10 days from the date of due payment by the purchaser.
Right to terminate sale
The debtor and the pledger (if the pledge is provided by a third party) have the right, at any time before the sale of the pledged object, to terminate the sale by fulfilling the obligation secured by pledge. An agreement restricting this right is insignificant (The Civil Code, Article 350.7).
The debtor has the right to petition for delay of the sale for up to one year.
In case of bankruptcy, the debtor’s bankruptcy estate includes all property available as at the date the receivership is initiated, and any revealed during receivership proceedings, except for:
- those properties, the sale of which is prohibited by law
- exclusive rights, including rights to engage in specific types of the debtor’s activity
- residential premises, pre-school institutions and public facilities.
After inventory and appraisal, the property of the bankruptcy estate is sold at auction or by bidding, unless another procedure has been established by the creditors’ meeting or the committee.
Any property the sale of which requires special permit is sold by closed bidding.
Property not sold by the first bidding is submitted for re-bidding or sold without bidding. A bankruptcy estate consists of two parts:
- All of the debtor’s assets indicated in their balance sheet or similar documents, as at the date of the receiver’s appointment.
- Property revealed during the receivership.
Not all of the debtor’s property is included in the bankruptcy estate, only that on which recovery is sought. The following property in the possession of, but not legally owned by the debtor, is excluded from the bankruptcy estate:
- Leased property or property in the safe keeping of the debtor.
- Personal property of the employees of the enterprise, but not of the founders of the legal entity.
Priority in satisfaction
Article 134 of the Bankruptcy Law stipulates the following order of priority when satisfying creditors’ claims, according to the Register of creditors’ claims:
i) legal costs and the arbitrage manager’s fees
ii) debts on salaries and dismissal payments
iii) current maintenance expenses
iv) other claims on liabilities which emerged during the bankruptcy procedures.
- Settlements with creditors of each priority are only conducted after full settlement has been made to the creditors of the preceding priority. Within each priority, creditors are satisfied according to the following turns:
• First turn – claims of individuals for payments for harm caused to life and health.
• Second turn – discharge pay and labour remuneration under labour contracts.
• Third turn – all other creditors: obligatory payments to the budget and non-budgetary funds and settlements with creditors on the remaining civil law obligations.
If claims of creditors on current payments belong to the same turn they are satisfied in chronological order.
Pledged property is exempted from the estate. Seventy per cent of the money raised after realisation of the pledged property is directed to the creditor whose rights are secured by the pledged property.
If there is money left after selling off the pledged property, 20% is directed to the special banking account of the debtor for settlements with first and second turns, and the rest is for reimbursement of court expenses and arbitrage manager’s fees. If the creditor secured under pledge is a bankruptcy creditor, they receive 80% of the money raised after realisation of the pledged property. If there is money left after selling off the pledged property, 15% is directed to the special banking account of the debtor for settlements with first and second turns, and the rest is for reimbursement of court expenses and arbitrage manager’s fees.
The receiver is obliged to eliminate all the debtor’s existing bank accounts other than the sole bank account used to satisfy the claims of the debtor’s creditors. The funds in this account are replenished by the proceeds from public sales of the debtor’s property (and, failing that, through private contracts) and by collection of the debtor’s accounts receivable.
If the debtor has insufficient funds to cover creditors’ claims of a single priority, the remaining funds are allocated pro rata to the amount of creditors’ claims.
If a claim is submitted after the settlements had been started, and this claim has a higher priority compared to the priority of claims currently being settled, settlements should be postponed until the claim with a higher priority is repaid.
Claims made after the Register of claims has been closed have the lowest priority and should be settled only if there is debtor’s property remaining. This includes:
- arbitrage manager’s fees presented after closing of the Register of claims, and
- claims on obligatory payments arising after opening of the receivership notwithstanding the term of their presentation (The Ruling of the Federal Arbitrazh Court of Moscow, Circuit No.KG ‑ A40/9322 ‑ 05, 9 November 2005).
If claims were not settled due to insufficient funds, they are deemed cancelled. Creditors may claim from the third parties, if the debtor’s property has been obtained illegally.
When dealing with any debtor property remaining after full settlements with creditors of all priorities, if creditors refuse to take the property for execution of obligations before them, the property goes to the local self‑government bodies of the Russian Federation where the debtor is located.
If the debtor’s property is insufficient to settle the arbitrage manager’s remuneration, such expenses in the part not covered by the debtor’s property, is reimbursed by the creditor claimant (The Ruling of the Presidium of the High Arbitrazh Court No. 6007/08, 13 November 2008).
The current procedure regarding the sale of a debtor’s property reflects the current market situation when, due to the global economic crisis, many businesses cannot execute their obligations.
Dr Anna Shashkova is a visiting lecturer at ATC in Russia, professor of law at the Moscow State University for International Relations (MGIMO), and lawyer of the Moscow Region Bar Association