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Bankruptcy After Coronavirus: What’s Next

Date of publication: 2 June 2020

Dmitry Konstantinov, Сounsel, Head of Insolvency and Financial Restructuring in Russia

Source: Vedomosti

Alongside with post-crisis recovery, the reform shall be a tough trial for the system.

Once the coronavirus pandemic is taken over, Russian market shall be exposed not only to the many-fold growth of bankruptcy cases, but also the large-scale reform of the bankruptcy legislation proper. Rehabilitation of debtors instead of their liquidation, randomized selection of the official receivers and availability of bankruptcy mechanisms for private individuals – these key milestones of the reform have been announced before the crisis even stroke. But shall the reform be adjusted in view of the pandemic and when shall it actually start?

Every new crisis arouses panic and is accompanied with proclamations like “the world has changed forever”, but following just a couple of months after the apocalypse began these strong emotions would normally only be shared by our colleagues in bankruptcy receivership, who are sorting out the remnants of failedc businesses. Other people would go to the newly opened restaurants and stores that welcome them at the locations of their less successful predecessors. But the bankruptcy laws bear signs of each particular crisis – these have all induced the reform. Suffice it to think back of special procedure applicable to the bank’s bankruptcy that emerged after the crisis of 1998 and a chapter in the bankruptcy law on challenging of transactions that was adopted following the crisis of 2008.

Further changes to Russian bankruptcy legislation were on agenda long before the pandemic hit. The draft of bankruptcy legislation reform, prepared by the Ministry of economic development was, perhaps, one of the most noticeable in recent months (although changes to this legislation are discussed and implemented with unfailing regularity). All subsequent steps are worth discussing with a careful eye to this policy document. Probably the most expected reform pertains to all-round use of rehabilitation procedures for bankruptcy instead of liquidation ones. As such, initiatives by the Ministry of economic development in this regard (termination of the admittedly pointless and sometimes harmful observation procedure and clearer delineation of the remaining procedures) look more than sound, but alas, there is still little hope for revolution for the time being anyway. Even the most sophisticated bankruptcy law would not extend financing to the business that does not have any money to pay back to its creditors, nor shall it provide the opportunity for a restaurant that closed because of the coronavirus pandemic to clear debts before its landlord, bank, suppliers and fiscal authorities. That is why forced termination of part of the debtor’s liabilities to the disadvantage of the creditors’ interests remains the only alternative option to liquidation by this time, while such beneficences may not be massively practicable, because they deal a blow at the creditors’ solvency – including fiscal authorities, whose interests may in no case be infringed in Russia.

Transition to wide-spread use of rehabilitation procedures, specifically at the time of large-scale bankruptcies, may prove twice as difficult to perform.

Firstly, there shall hardly be any investors around, who would be eager to put their money into restructuring of a distressed business, or there shall be few. That is, even a potentially profitable business that could raise funding from third parties at the bankruptcy stage or before the formal procedure is launched and undergo rehabilitation relatively easily, shall most likely be liquidated in crisis period.

Secondly, increased load on any system makes implementation of changes, especially so far-going, considerably more difficult. The new procedures that are not yet known both to the court and the official receivers, are unlikely to be successfully implemented against the many-fold increase in number of bankruptcy cases. At many courts, the load on judges who majored in bankruptcy was too high even before the crisis (combined with the reform). Judges at Moscow courts of arbitration now cannot afford to allocate more than 10 minutes of their time to consider a single case. If the scenario under discussion becomes a reality and the number of bankruptcy cases shall increase 2-fold, then the time allocated to consider a case would be obviously reduced to, say, five minutes, which the court shall be in a position to spend in order to apply the laws that it is not familiar with, not even having the appropriate law enforcement practices at hand.

It is worth mentioning that restructuring is considerably more complicated as compared to liquidation and requires a way tighter engagement on judge’s part – similarly to a heart surgery that requires more time and effort on the part of surgeons than autopsy of a passed patient who did not make it to his life-saving surgery.

In fact, legislator’s best intentions may well crash against the realities of arbitration courts, but not only that. The second fundamentally important stakeholder of the process – official receivers – may also fail to support the reform. It looks like the professional community of the official receivers is not happy about the forthcoming changes at all. As a result, we are most likely to survive the currently unfolding crisis under conditions of liquidation-biased bankruptcy, but after it is over, there is still hope for the broader use of rehabilitation procedures.

Unfortunately, the position that official receivers now find themselves in has proven to be the Gordian knot of Russian bankruptcy proceedings a while ago. The key principle of financing their work is entitlement to a small monthly remuneration (or even a flat fee, if they handle bankruptcy of a private individual) and percent-based remuneration following the deliverables of the conducted bankruptcy procedures. Seemingly a completely reasonable approach, but it quite rarely works the way it was designed – as a rule, only in those proceedings, where debtors have enough assets to get a third-party investor interested in financing them (there is hardly any official receiver who is able to do this single-handedly). That is why bankruptcy proceedings are normally financed by either some of the debtor’s creditors or his shareholders, who get full control of both the debtor’s and the receiver’s property. The outcome is wholly predictable – an average bankruptcy proceeding nowadays looks not like a civilized process, in which legal interests of all participants are taken into account, but rather like a primal clash, in which the strongest and the most insidious creditor wins.

Among other things, the latest amendments to the bankruptcy law suggest a change in the existing state of things by entrusting the selection of receiver to a randomized computer algorithm, as well as by slightly modifying the remuneration allocation procedure. Official receivers have already reacted to these suggestions – and in a very sharp manner. Their objections may easily be attributed to the fear of losing the profits they retrieve from unscrupulous beneficiaries of bankruptcy proceedings. Undoubtedly, disgraceful things around the controlled bankruptcies must be curbed. Therefore, one cannot but agree with suggestion of a computer algorithm as a method of selecting the receiver candidacy – at least for as long as Russian courts would not, for various reasons, be ready to appoint the receivers knowingly and on the arm’s length basis at their own discretion. But if we do not take into account financial interests of the official receivers (wherever they appear to be legal, unquestionably), we may end up in a situation where there shall simply not be anyone available to conduct both liquidation and rehabilitations proceedings. So far, this dilemma remains unresolved, therefore the authorities may suddenly be taken hostage by the official receivers – if the latter decide to boycott conducting these procedures amidst a large-scale bankruptcy process.

Bankruptcy of private individuals is another massive aspect of the reform. The law on changes to bankruptcy legislation in this part has already been adopted by the State Duma in the first reading. Here the consensus is about bankruptcy to become available to a variety of individuals that have found themselves to be financially troubled. It is suggested to facilitate applicable procedures (and, accordingly, to make them more affordable), to cut on bureaucratic formalities, which are required in order to liberate the bankrupt citizens from their debts. Before recent events this draft of law seemed to be useful for the creditors as well, but in the situation when the percentage of insolvent borrowers may grow by an order of magnitude, facilitated bankruptcy of debtors under consumer loans may drag down both microfinance and lending businesses. In case of default, repayment under such loans is unlikely anyway, that is why it is rather a question of time – how soon shall the credit finance companies be required to reflect losses on their balance sheet and (potentially) go bankrupt themselves. This part of the bankruptcy legislation reform is the closest to completion, but it may appear disadvantageous for large banks – accordingly, it shall be suspended.

In any case, after the restrictions imposed on business activities are lifted, the main puzzle for bankruptcy industry shall be whether the main part of legislation reform would start after the economic crisis ends (which may take 1,5–2 years, in the estimate of previous years) or the government would try to shape the game by new rules straight ahead. We are likely to discover this in the coming summer already.

So far, we got the moratorium imposed on bankruptcies.