Russia - The Strategic View - Corporate Restructuring 2016
        

Artem Kukin reviews recent amendments which represent a significant step forward in dealing with problematic loopholes and inconsistencies in the restructuring legislation of Russia.

Contributing firm

1. What trends, in terms of activity levels, affected industries or investor focus, have you seen in the restructuring and insolvency market in your jurisdiction over the last 12 months?

In view of the conflict between the West and Russia over its alleged involvement in the Ukraine crisis, the sharp decline in oil prices and the sanctions on Russia imposed by the U.S. and the European Union, internal economic challenges, political turmoil and depreciation of the ruble, Russian companies have been affected both by a reduction in their ability to attract overseas funding and a substantial increase in costs of attracting funding in general.  These events have a significant impact on the ability of Russian companies to repay their debts.  The amount of overdue corporate and consumer loans has reached its highest peak over the last decade.  In order to recover financially troubled borrowers’ debt, creditors may restructure the borrower’s indebtedness or file an application for their bankruptcy.

Times of economic distress are propitious for legislative reform.  Transparent and consistent bankruptcy regulation is a key element of fluid market economy and a necessary tool for dealing with distressed business.  The legislation regulating the insolvency in Russia was amended at the end of December 2014.  These amendments have a strong impact on the market and represent a significant step forward in dealing with major loopholes and inconsistencies in The Federal Law No. 127-FZ “On insolvency (bankruptcy)” of 26 October 2002 (the “Bankruptcy Law”, which is the principal law on insolvency in Russia).  The practice of the application of the amendments has not yet been sufficiently developed.

Restructuring and insolvency are the major topics in Russia during 2015 and beyond.  Restructuring represents the most viable alternative to formal bankruptcy procedures.  Instead of improving the likelihood, speed and amount of recovery for creditors, bankruptcy proceedings may have the effect of eroding the value of assets out of which creditors expect to be paid.  Creditors are often loath to go to courts to order debtor’s liquidation when it is already too late to revive business.

Until now, the bankruptcy regime in Russia has only applied to legal entities and individuals registered as entrepreneurs.  The changes to the Bankruptcy Law introduced the long-awaited regulation of bankruptcy of individuals, which has certain impact on consumer credits.  The bankrupt individual will be deemed released from all payment obligations towards debtor’s creditors upon completion of settlements within the bankruptcy proceedings.

The amendments to the Bankruptcy Law allow banks to file a petition for bankruptcy without the preliminary court’s ruling with respect to their debt.  This amendment has simplified the procedure for banks to initiate bankruptcy in comparison to other creditors.

2. What is the market view on prospects for the coming year?

The GDP of Russia contracted by 1.8 per cent in 2014 and by 4.5 per cent in 2015 (Economic Outlook No. 1220-1221, “The insolvency U-turn” September-October 2015, published at www.eulerhermes.com).  At the same time, Russian’s overall consumption level did not drop.  The more competitive exchange rate, increasing external demand, stabilisation of financial conditions, recent ruble appreciation and public wage indexation will help recovery in 2016 and cause the rate of inflation to decline rapidly over the next two years.  The cost of borrowing has slowly decreased as, in October 2015, the Central Bank of Russia (CBR) decreased the refinancing rate to 11 per cent (this was 17 per cent at the end 2014).

All these events, as well as the threat of possible further sanctions, led to a decrease in firms’ revenues and an increase of unpaid transactions; foreign banks are looking at Russia with a more critical eye now.

It remains unclear the extent to which macroeconomic and geopolitical events will impact the level of restructuring and insolvency in 2016.  According to the statistics published by Euler Hermes, the number of corporate insolvency cases in 2016 will rise by 4 per cent (Economic Outlook No. 1207, “Insolvency World Cup 2014: Who will score fewer insolvencies?” May 2014, published at www.eulerhermes.com).  In 2015, the number of insolvency cases has grown by 30 per cent (Economic Outlook No. 1220-1221, “The insolvency U-turn” September-October 2015, published at www.eulerhermes.com).  During 2015, we observe an increasing number of disputes involving debts collected from individuals acting as sureties and from pledges.  Legal entities are prominent in failing to meet their obligations towards banks.  We predict that in 2016 there will be no change in the number of the above-mentioned disputes.

3. What are the key tools available in your jurisdiction to achieve a corporate restructuring – are they primarily formal, court-driven processes, or are informal out-of-court restructurings possible? Do you feel that the tools you have available are effective in terms of providing speedy, fair and predictable outcomes?

There is no procedure called “corporate restructuring”, but restructuring may be achieved either through financial rehabilitation and external administration plans, settlement or sanation.

The recent Amendments to the Bankruptcy Law have introduced a basic procedure for the bankruptcy of individuals called “debt restructuring”.  During that procedure, a restructuring plan, under which debt is restructured, may be approved by creditors.

A company Chef Executive Officer is obliged to send notification to shareholders about the risks of bankruptcy proceedings after he has learned of such proceedings.  Shareholders are obliged to take all necessary preventive measures to ensure that the entity does not become bankrupt; including the primarily formal tool for restructuring, called sanation, which is a pre-trial step and not a bankruptcy procedure. At that stage the debtor’s creditors, as well as the third parties, are allowed to inject capital to debtor.

There are varieties of informal out-of-court restructurings:

  • Refinancing.  Creditors provide additional financing to the debtor in order to refinance debtors’ indebtedness.
  • Renegotiation.  If creditors do not want to refinance the debtor, they can amend terms of the existing loan in order to restructure debt and include in the agreement the following terms:
    • Temporary relief from making payments.
    • Postponement of the repayment date or other changes to the payment schedule.
    • Release from financial or other covenants.
    • Agreement by creditors not to exercise certain rights or remedies and others.
  • Debt-for-Equity Swaps and Equity Financing.  Creditors obtain an equity stake in the debtor as a part of an exchange of existing debtor’s shares or the newly issued shares for forgiveness or in connection with new money being invested into the debtor.

 

There are the following court-driven processes tools of restructuring:

  • Shutting down unprofitable production facilities.
  • Selling parts of debtor’s property.
  • Increasing debtor’s chapter capital.
  • Issuance of additional shares.
  • Selling debtor’s business as a going concern.
  • Replacing debtor’s assets and others. 

 

After the initiation of bankruptcy, there are enough tools of restructuring to receive a speedy, fair and predictable positive outcome.  However, restructuring which is taken place before bankruptcy may be challenged as “suspicious” or “preferential” transaction.

4. In terms of intercreditor dynamics, where does the balance of power lie as between shareholders and creditors, and as between senior lenders and junior/mezzanine lenders? In particular, how do valuation disputes between different stakeholders tend to play out?

The Bankruptcy Law does not provide for the debtor’s and creditors’ ability to enter into subordination or other ranking arrangements.

Pursuant to the Amendments to the Civil Code of Russia, a concept of an intercreditor agreement has been introduced, which permits a contractually agreed order between the creditors owing obligations of the same kind for recovery of claims.  This agreement may contain provisions concerning the order of priority for the satisfaction of claims or concerning non-proportional distribution of such claims.

Shareholders with their loans to the debtor are treated as other creditors.  In case of bankruptcy, their claims rank together with other creditors’ claims.

As a general rule, under intercreditor agreements a junior creditor may not satisfy its rights until a debt to a senior creditor is paid in full.

The recent Amendments point out the regime relating to pledges which are held by multiply pledgees, including when pledges are of equal ranking (“pari passu”) or rank at different levels of seniority.  Seniority is linked to the time when the relevant pledge is created and may be altered by agreement between creditors.

As the regime of bankruptcy procedures has not been changed to reflect the above-mentioned amendments, intercreditor agreements are unlikely to be recognised in bankruptcy.  The court and bankruptcy manager will repay creditors according to statutory order of priorities.

During the bankruptcy procedures, except liquidation, the shareholders reserve the right to approve decisions on selling the debtor’s business as a going concern, replacing his assets and the issuance the additional shares.  The price of valuation of a debtor’s business as a going concern and his assets is set up by a decision of creditors’ meeting on the basis of the market value determined by the report of an independent appraiser engaged by the bankruptcy manager.  That market value is advisory but not mandatory.  If the debtor’s shareholders or one of the creditors do not agree with the valuation, they can appeal the decision of the creditors’ meeting in which that valuation was approved.  Only the debtor’s shareholders can set the offering price of additional shares.

5. Have there been any changes in the capital structures of companies based in your jurisdiction over recent years caused by the retreat of banks from loan origination?  In particular, have you found that capital structures now increasingly comprise debt governed by different laws (such as New York law governed high yield bonds)? If so, how do you expect these changes to impact on restructurings in the future?

During 2014 and at the beginning of 2015, foreign banks reported sharp falls in their Russian exposure; therefore, it is expected that foreign banks will continue to retreat next year.  The repayment of foreign currency loans has become more expensive.  This has caused a problem for Russian banks and companies to meet their foreign currency payment obligations and has weakened their capital structure.  This situation has led to the falling of lending growth.  During 2015, the number of domestic banks dropped from 923 to 834, which reflects one of the biggest reductions in a decade.

The Government tried to prop up economy though stabilising the banking sector and maintaining exchange rate stability.  State investment plays a key role in the Russian economy.  To achieve these goals, the CBR intervened to manage the ruble’s decline.  Moreover, because domestic banks are a key funding source for Russian companies, the CBR and the Ministry of Finance introduced a range of liquidity, asset purchase and recapitalisation schemes to the banking sector.  Russian banks are moderately leveraged and well capitalised.  As a result, they should be able to resist financial sanctions relatively well.

The Government set facilities to help large companies who had become unable to rollover their large external debts from foreign banks.  These companies were strategically important for the economy, especially in cases where foreign creditors would receive a claim on the shares of these if they defaulted.

There is special regulation on the restructuring and bankruptcy of banks and strategically important companies.  There is no special regulation on bankruptcy procedures of companies with state participation in it.

6. Is there significant activity on the part of distressed debt funds in your jurisdiction? How successful have they been in entering the market, and how much has market practice (or law) evolved in response? If funds have not successfully entered the market, can you identify reasons why?

The possibility to form a hedge fund, which can invest in distressed debt, appeared in Russia in 2008, when changes were made to legislation on investment funds.  As it follows from the information published online (http://pif.investmentfunds.ru.), there are no Russian hedge funds.

There is still a great interest from foreign investors in the Russian market; according to hedgeweek (http://www.hedgeweek.com/2015/05/29/224163/russian-hedge-funds-surge-oil-rouble-gains), in the second quarter of 2015, all types of funds were investing in Russia and posted strong gains.  In these difficult times, Russia is the main focus as all assets are selling at a very low percentage of par value.  Many investors are eager to put money into them.  If the once-distressed company emerges from bankruptcy as a viable company, that once-distressed debt will sell for a considerably higher price.  In the first half of 2015, over 13 per cent of all debtors emerged from bankruptcy (according to the statistics of the Supreme Court of Russia, there were 59,923 bankruptcy cases, from which 7,514 debtors emerged).

Since the end of 2014, there has been significant activity on the part of distressed debt funds in Russia.  During this period of time, a new English hedge fund called Promeritum Investment Management LLP has bought the debts of Mechel – a coking coal producer and steelmaker – before the day of inclusion of this company in the list of state strategic companies.  Promeritum also bought the debts of Sberbank, VTB and VEB before these banks got financial support from the state.  After acquisition, the debts rose in price and offered potentially high-percentage returns.  This example shows that foreign distressed debt funds are successfully entered into in the Russian market.

7. Are there any unusual features of your insolvency or restructuring law that an external investor should be aware of (such as equitable subordination, or substantive consolidation)?

Here we point out the unusual features of restructuring and bankruptcy:

  • Limitations on enforcing creditor’s claims and rights:
    • Suspending creditors’ rights

      Once bankruptcy proceedings are commenced, the Bankruptcy Law imposes a stay on all creditors’ claims.  Creditors’ claims may be presented in accordance with the order of priorities prescribed by law.  The exception is current claims, which arise after the bankruptcy proceedings commence.  Such claims are satisfied outside the statutory order of priorities.  Claims secured by collateral over the debtor’s assets are settled ahead of all claims out of the proceeds from the sale of such collateral.

 

    • Clawback risks

      Following the initiation of insolvency, within a certain period of time prior or after the investor’s transactions with the debtor, the transactions may be challenged as suspicious or preferential;

 

    • Right to participate in the first meeting

      A creditor must submit his claims for registration within 30 calendar days from the date of publication of the notice of commencement of supervision.  If a creditor does not file its claim at that time, he will lose the right to participate in the first creditors’ meeting.

 

  • Limitations on protecting debtor’s going concern value
    • Lack of stay on trade creditors terminating contract

      From the date of commencement of external administration, the bankruptcy manager may terminate contracts.  When the debtor enters into bankruptcy, he may no longer be able to rely on business counterparties.

 

    • Absence of shareholder cram-down

      There is no possibility to coerce shareholders to accept the arrangement, which requires their consent.  The shareholders can refrain from providing the relevant consent, making their lack of consent an obstacle for creditors to recover value.

 

    • Long period of time for exit from bankruptcy

      Bankruptcy proceedings can be protracted, increasing the cost of the process.

 

8. Are there any proposals for reform of the legal framework that governs insolvency and restructurings in your jurisdiction?

On 24 July 2014 the Government adopted the Decree No. 1385-r, in which there was described a plan of action for the improvement of the institutions of bankruptcy and restructuring.  This plan contains the following main directions for the reformation of such institutions and should be in place by the end of 2016:

  • Improvements to the supervision and financial rehabilitation, changes in order of satisfaction of current creditors’ claims and costs of the bankruptcy procedures.  Such improvement aims to reduce the duration of bankruptcy procedures and increase the size of the bankruptcy estate.
  • Development of the procedure of selling the property of the debtor in order to increase the bankruptcy estate.
  • The protection of pledged creditors’ rights should be strengthened.
    • Development of the mechanism of imposing the liability on a company’s management, shareholders and other persons who have the right to give binding instructions to the company.  

 

The current legislation concerning liability has become quite cumbersome and the court practice about it is unpredictable.  There is a need to simplify that mechanism.

9. If it was up to you, what changes would you make?

We would like to make the following changes:

  • It would be more appropriate to initiate the bankruptcy of the legal entity when the debt is no less than 500,000 rubles (today it is 300,000 rubles) and the insolvency of an individual when the debt is less than 300,000 rubles (today it is 500,000 rubles).  The current amount of the debt for individuals to initiate bankruptcy is too high, a more appropriate amount which could signify financial difficulty is 300,000 rubles; while for legal entities the amount of 300,000 rubles is not sufficient to be recognised as bankruptcy.
  • The current legislation does not contain rules dealing with international insolvencies, but it will be useful if the Russian court will have jurisdiction to rule on cross-border insolvencies and the rules governing the examination of these cases.

 

Adding rules that allow general Debt-for-Equity Swaps during the bankruptcy procedures.  The current legislation allows to do so outside the bankruptcy.

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The Strategic View - Corporate Restructuring

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