Earlier this month, the CEO of Russian oil giant OAO NK Yukos announced
that an emergency shareholders meeting next month will consider a
bankruptcy filing. Authorities have hit the country's largest oil
producer with billions of dollars in tax claims. CEO Steven Theede told
reporters recently that the company received a new bill for $10
billion, rendering Yukos insolvent. The Kremlin last year jailed Yukos
founder and controlling shareholder Mikhail Khodorkovsky on charges of
fraud and tax evasion. The government has made no secret of its desire
to grab and sell off Yukos assets.
A bankruptcy filing, however, could complicate matters considerably. It
would freeze all pending court action. The Russian government couldn't
seize Yukos assets for back taxes. And those tax claims? Under current
Russian law, the federal tax authorities are considered unsecured
creditors, so those claims are subordinate to those of secured
creditors. And it remains uncertain what kind of say tax authorities
would have on a creditors' committee, which appoints a bankruptcy
manager that's akin to a receiver or a trustee in the U.S.
The Yukos case is being closely watched, even though, by some
estimates, nine out of 10 bankruptcies in Russia involve small
companies. Yukos is an important test of the workings of the nation's
bankruptcy regulations not only because of its size but "because it
will be carried out in public," a Moscow-based lawyer says.
The Yukos situation comes at a time when the Russian government wants
to show its own people and the world at large that commercial and legal
safeguards are in place. The nation's often-squalid business reputation
has been born of a down-and-dirty transition after the fall of
communism to a market economy. And in three attempts in the past decade
to forge a stable and fair bankruptcy code, Russia has yet to succeed,
even though it acknowledges such laws are the backbone of a functional
economic system. To be sure, a working bankruptcy code is seen as
necessary for everything from increased investment to a lower cost of
Russia is still struggling to come up with a bankruptcy regime that
works. There are reports that a fourth round of legislation is in the
drafting stage. In October the Economic Development and Trade Ministry
proposed making fictitious, intentional bankruptcies a "grave crime,"
punishable by up to six years' imprisonment. Even many critics now
acknowledge that the framework for commercial bankruptcy is nearly in
The great disconnect in Russia hasn't been the code itself, however, it's been the execution of it.
"The laws are quite sensible," says Garegin Tosunyan, president of the
Association of Russian Banksas well as the head of the Centre of
Financial and Banking Law at the Institute of State and Law of the
Russian Academy of Sciences. "[But] there's no implementation."
Since the fall of the Soviet Union, bankruptcy in Russia has been
misconceived, misused and abused. In the late 1990s, it became a
powerful tool, not of creditor protection and debtor rehabilitation but
of corporate theft and judicial corruption. A Moscow police official
charged earlier this year that as much as half of the country's
bankruptcies were fictitious.
Lawyers cite small improvements in the court system that occur much
farther from the public glare. But again, it's more a matter of curbing
abuse rather than completing a successful workout.
"Over the last five years, the situation has been improving somewhat,"
says Alexander Temkin, senior manager of PricewaterhouseCoopers in
Russia. "The share of abuse has lessened."
And while there are signs of progress, cynics still abound. "Bankruptcy
remains the preferred mechanism for redistributing property," wrote
Mikhail Delyagin, the economic adviser to Russian Prime Minister
Mikhail Kasyanov, in a scathing newspaper column in September. Delyagin
called bankruptcy "a double-edged sword of economic terror."
A major problem in Russia is the lack of uniformity in how bankruptcies
are handled. "If it's a purely business matter, with no politics or
other influence involved, yes, it's getting better. But if there's some
kind of other [thing] in the equation, unfortunately, it's not," says
Vasilisa Strizh, a Moscow-based partner at LeBoeuf, Lamb, Greene &
MacRae LLP. "Practice differs from region to region, court to court,
business to business." Nor has there been a notable bankruptcy success
story in Russia, which is something the Yukos situation could help
remedy. While abuse has been curtailed, professionals are hard put to
cite a single case where a major company is being successfully
restructured within the court. Temkin, for one, has witnessed more
out-of-court restructurings than before. He also sees a continued
reliance on collateral and assets rather than on rehabilitation.
Creditors prefer to seize assets and sell them, he says, rather than
"working with shareholders and other stakeholders with an aim of
restructuring the company and seeing it repay the debt in full."
Who can blame them? If creditors such as the Russian tax authority that
are owed billions aren't assured of a seat at the bargaining table,
then what odds do small creditors face?
One case now under way in the Russian court system may help change
that. A construction company from the Urals region city of Perm two
years ago went bankrupt, and an external manager was appointed. In
March 2003, a Japanese trading company filed a $3 million claim on
unpaid bills for machinery and spare parts. The manager refused to
honor it. A lower court upheld that exclusion on the dubious grounds
that the trading company's power of attorney didn't conform to the 1961
Last month, however, a Russian appeals court ruling rejected that
interpretation and sent the case back to the arbitrage court, which is
presided over by local judges. If the claim is allowed, the Japanese
company becomes the largest creditor, with an ability to convene a
creditors' meeting and appoint a new bankruptcy manager.
"There's no assurance, but I believe we have really good chances of
success," says the Japanese company's attorney, Viatcheslav Khorov sky
of the Moscow office of Lovells. (Khorovsky declines to name his
He and other lawyers in Moscow believe that the further up the judicial
ladder a case goes, the more likely judges will make a reasoned
decision. "Eight hundred kilometers from Moscow, a judge is just not
prepared to apply laws that are dramatically changing year by year,
becoming much more sophisticated, much more complex," says Dmitri
Nikiforov, managing partner in the Moscow office of Debevoise &
Plimpton LLP. "Judges at the higher levels enjoy much better
compensation, much better respect. They are more professional and less
In the Russian judicial system, higher court judgments don't
necessarily become precedent. But some lawyers believe that the lower
court judges will adhere to appellate rulings just to protect
themselves. "Although the lower courts are not bound by these
decisions, they will follow them," Nikiforov says.
How the courts apply the laws becomes critical to a working system. "If
you look at transition economies, the laws on the books don't matter at
all if enforcement is poor," says Ekaterina Zhuravskaya, an economist
at the Moscow-based Centre for Economic and Financial Research.
Russian legislators made an initial stab at bankruptcy-related
regulations in late 1992, just months after the Soviet Union fell. The
law simply didn't work. Companies could easily escape, no matter how
debt-ridden and insolvent they were.
Loopholes abounded. According to the regulations, for example, a
company's debts had to exceed the total book value of its assets before
bankruptcy could be initiated. To avoid bankruptcy, all a manager had
to do, according to a detailed economic study on bankruptcy co-authored
by Zhuravskaya, was issue worthless debt to his company at a high face
value, thus increasing the nominal asset value.
In 1995, bankruptcy proceedings were initiated against some 1,100
companies, according to Zhuravskaya's study. But liquidation was
ordered in less than half of these. Outside managers were named in just
The country's 1998 financial crisis illustrated the dangers of poor
supervision. Six of the top 10 banks went bankrupt. The entire country
suffered. The ruble was devalued. Investment stopped. Money fled. "It
was a nightmare," says Pavel Gourine, who heads corporate and
investment banking for Austria's Raiffeisen Zentralbank Ã-sterreich AG
But because the bankruptcy code masked commercial weaknesses, the 1998
defaults were largely bank-related. Highly indebted corporations didn't
fall, at least not then.
Just weeks before the August 1998 financial crisis hit, legislators
enacted a revised commercial bankruptcy regime. This time, the pendulum
swung the other way.
Bankruptcy became ridiculously easy to initiate. According to
Zhuravskaya's study, some 11,000 companies went bankrupt in 1999, 10
times the number in 1995. A creditor could file a bankruptcy petition
against a company if owed a debt of $5,000 or more that was only three
months overdue. (In Russia at the time, 90-day arrears were the rule,
not the exception.)
The law gave wide authority to local judges in the arbitrage courts to
appoint a company manager, who was licensed by the states within
Russia, not by the federal government. These local judges decided
whether the enterprise would be liquidated. A judge could overrule
The law of unintended consequences came roaring to life. Crooked
managers, dishonest competitors and plain old-fashioned commercial scam
artists scored easily. Thousands of companies went bankrupt, but few
were actually restructured. Instead, bankruptcy became a favored
By ceding authority to poorly paid, inexperienced, pliant and easily
manipulated judges, the system was tailor-made for abuse. Corrupt
regional governors controlled the local courts. These powerful figures
often acted as puppeteers of bankrupt company managers, especially
since many incumbent executives bribed their way into remaining in
control and not restructuring their companies. They stopped paying
their debts. Company assets simply disappeared.
Under the law, the federal government could do little to intervene.
Federal tax authorities were given no rights and had no stake in making
the system work. They weren't even recognized as creditors.
The whole system, in fact, held legitimate creditors at bay. Judges
could exclude some debts and allow others. "Until you are registered,
you can't do anything, literally anything," says Anna Proshina, a
Moscow-based associate with law firm CMS Cameron McKenna.
She describes one American bank client that had a major claim against a
bankrupt Russian bank. After more than six months, the bank's external
manager, the Russian equivalent to a bankruptcy trustee, continued to
refuse to honor the debt. The American bank finally gave up.
"Managers used all sorts of methods to decline claims," Proshina says. "The goal was not to let anyone get close to the assets."
Zhuravskaya describes how managers were required to send out notices to
creditors. But since all that was required under the law was to confirm
an envelope was sent, managers dispatched empty envelopes.
It wasn't just the company managers who gained, however. Outside
commercial interests could buy up cheap corporate debt. They could then
hijack the process, force otherwise healthy companies into bankruptcy
and, by pressuring arbitrage judges, put their own agents into the
companies as managers. These managers would run up debts, then sell
assets in sweetheart deals to their bosses for little or no money.
In the late 1990s, this became a favored method of seizing everything
from factories to apartment buildings in Russia. In a press conference
early this year, a senior police investigator, Anton Golyshev, called
fraudulent bankruptcy "a disease if not yet an epidemic."
The courts moved at a snail's pace. Government investigators weren't
much faster. Only recently have authorities taken action on abuses
perpetrated under the old law. Often it's a matter of too little, too
For example, a judge put Primorsky territory fishing company
Dalmoreprodukt into bankruptcy in July 2002. Yet it took until earlier
this year for police investigators to announce criminal actions against
the former management. According to an Itar-Tass dispatch, police
accused the management of "premeditated criminal bankruptcy." But it
was too late Ã¢â¬" managers sold 100 Dalmoreprodukt ships in private
deals, transferring almost $23 million offshore.
Foreign investors got caught up as well. One of Russia's
highest-profile and complex bankruptcy cases involved oil production
company Chernogorneft, a subsidiary of Sidanco, in whichBP Amoco had
invested $571 million in 1997 for a 10% stake. In September 1998, an
arbitrage judge declared Chernogorneft bankrupt. This followed the
purchase by competitor Tyumen Oil Co. of some Chernogorneft credit
notes, then a demand by Tyumen Oil that Chernogorneft pay up.
Without shareholder approval, the judge appointed an external manager
who had worked for Tyumen Oil's parent. His actions were so blatantly
prejudicial to the company and shareholders that his license was
eventually terminated by federal authorities, although a judge allowed
him to continue auctioning off assets.
Two things followed. Tyumen Oil began to buy up credits and pressure
other shareholders for proxies. At the same time, the manager cut sales
and diverted oil supplies from Sidanco to two Tyumen affiliates at
prices, Chernogorneft shareholders alleged, that were far below those
the market would bear.
According to NoreX Petroleum Ltd., a Canadian company that held a
majority interest in a joint venture with Cherno gorneft, the bankrupt
company had assets worth anywhere from $1 billion to $2 billion. But
the external manager set a maximum bid for the assets of $200 million.
The manager excluded Sidanco from the bidding process and ignored an
offer from BP Amoco to pay off the entire indebtedness. Tyumen Oil won
the auction with a bid of only $172 million.
Tyumen Oil, which is controlled by Russia's Alfa Group Consortium,
eventually returned some of the assets of Chernogorneft to Sidanco, but
only after BP Amoco and the U.S. Export-Import Bank, which had
underwritten a loan to Sidanco, pressured it to do so. (BP plc is now a
50% owner of Sidanco.)
But NoreX claims many Chernogorneft shareholders weren't so lucky. They
were never repaid, asserts NoreX, which alone is owed more than $500
million for its share in an oil production joint venture it had with
Tyumen Oil called Yugraneft Corp. NoreX argues that Tyumen Oil now owns
In February 2002, NoreX filed a racketeering charge in a New York
federal court against Tyumen Oil and various subsidiaries and officers.
It was dismissed last year based on jurisdictional issues and is now
"What's really sad is that this was done on a large scale by very
clever people," says Phil Murray, NoreX's president. "But this kind of
corruption filters down from the very big to the very small."
In theory, such abuse is far harder to engage in these days because
there are specific provisions to counter debtor, creditor and external
manager abuse. That's because two years ago, in October 2002,
legislators enacted a new bankruptcy code that required a more detailed
and defined process, leaving less room for abuses, one lawyer says.
"The new law plugged some loopholes," the lawyer notes. "Unfortunately,
not the entire lot."
For example, professionals say that while the most recent law cuts down
on the ease of fictitious bankruptcies, it's still too early to tell
whether the system can actually work to rehabilitate companies in need.
Still, debtors now have the right to participate in bankruptcy hearings
from the beginning. This prevents surprise bankruptcies, where debtors
suddenly discover they're in receivership after the papers have been
Shareholders now can also participate in proceedings, although they still have no voting rights.
Creditors' committees, meanwhile, can now demand an external manager.
And these managers must be more professional and less prone to
corruption than they were before. Among their qualifications must be an
economics degree, at least two years' managerial experience and
membership in one of the self-regulated organizations formed to provide
bankruptcy managers. Creditors choose the organization, which offers
Both the debtor and the committee also have been given the right to
object to a candidate. And while an arbitrage judge technically
appoints the manager, "the manager, to a large extent, is controlled by
creditors," CMS Cameron's Proshina says.
The current Russian bankruptcy code is actually modeled on European
common law. A creditor owed as little as 100,000 rubles ($3,500) can
petition the court for a "debt judgment." Judgments take from three to
12 months before a final hearing is held to determine whether the
judgment order becomes final. If so, a court bailiff attempts to
enforce the judgment against the debtor's bank accounts and other
property. If a bailiff is unable to do so within 30 days, a creditor
can apply to put the debtor into formal insolvency proceedings.
A debtor can also initiate voluntary insolvency proceedings. In that
case, an arbitrage court judge must approve the application, then
appoint a temporary manager. During this time, management continues to
operate the company but can't sell assets, obtain loans or assign
rights without the temporary manager's approval.
At this point, creditors meet to set up a committee. Credit size and
security determine not only the pecking order for recovery but also who
gets clout within the committee.
In fact, Russian law now recognizes subordinated loans, a shift from
when the courts made no distinction between senior and subordinated
debt. It also recognizes the claims of the Russian tax authorities.
As a result of the separation of claims, a creditors' meeting is
"extremely important," Proshina says. It can decide whether to
distribute debtor assets to creditors, depending on priority claims, or
restructure them under court supervision via a "financial
rehabilitation," which is allowed for a maximum of two years.
In addition, the committee can demand a new external manager. While
managers are self-regulated, they do have to be licensed by the federal
government. External managers are powerful figures. They can dismiss
executives, close facilities, sell property and negotiate debt
restructuring with creditors. External managers are appointed for a
maximum of two years.
At any time during this process, the debtor may seek what is called an
"amicable agreement" to reorganize (in the U.S., this likely would be a
consensual plan). All secured creditors must approve the plan, as well
as a majority of all creditors. The arbitrage court must also approve
such a plan.
If that sounds very American, it probably is. After all, while
patterned after English common law, the Russian bankruptcy code has
borrowed a thing or two from the U.S.
Witness the Russians' rules against fraudulent preference. A manager
can unwind payments to creditors made six months or less before filing
(under U.S. law, it's 90 days).
Because of a new emphasis on continued operation and rehabilitation,
the current regime is considered extremely debtor friendly. "One of the
purposes of the law is to provide business communities with additional
tools to rehabilitate and, if possible, return to normal business,"
Lovells' Khorovsky says.
That, at least, is the hope. Moscow-based professionals emphasize that
the law may be 2 years old but the current bankruptcy regime remains in
its infancy. They also caution that the realities of business in Russia
are considerably messier than the neatness of the law.
Determining ownership, for example, can be an impossible task. Even the
country's largest parent companies are held by Cypriot or British
Virgin Island corporations, which are, in turn, held by Gibraltar
nominees. "You try to go after the owners, and you find 27 offshore
companies," says one American business executive with longtime
experience in Russia. "How can you track that?"
The answer for lenders is caution, RZB's Gourine says. "Know your
client, try to learn who the real owners of the companies are, what
their track record is, what their business strategies are," he says.
Security is also key. "It's very rare to lend money on an unsecured
basis," Gourine says. "The presence of collateral is not only a
possible source of repayment but also a way that allows creditors to be
on top of other creditors."
He and other bankers report an extremely low default rate. For JSB
OrgresBank, which caters to technology companies, "there has been no
single default of a corporate loan in the last five years," says its
chairman, Igor Kogan.
But Gourine also warns that competition is heating up. The country's
total commercial loan portfolio is now about $100 billion. That may not
sound like much, but it's 2.5 times more than what it was in 2001. And
he fears that some banks will become less risk-averse.
In an effort to mitigate this risk, a new law that should go into
effect next year provides for independent credit bureaus. "The impact
of that is revolutionary," Kogan says, with some hyperbole. "It will
decrease significantly lending risks."
Other bankers caution against reading too much into the action. The law
provides for a clean-slate approach, so any data commercial banks have
on clients now won't be allowed to be collected.
The system "will take at least a couple years to be meaningful," says
Alexandre Kolochenko, who heads RZB's Russian retail operations. "The
devil is in the details."
That cautionary note extends to Russia's legal environment. "It has
dramatically improved from the beginning of the '90s to the middle '90s
to right now," Debevoise & Plimpton's Nikiforov says. "It's now a
matter of implementation and strict enforcement of the laws."
As the past has shown, however, that's much easier said than done.
Copyright 2004 The Deal, L.L.C.