Bankruptcy of Legal Entities

The concept and signs of corporate bankruptcy. Supervision, receivership, and selected issues in applying the Insolvency (Bankruptcy) Law. The principal legislative act on bankruptcy is Federal Law No. 127-FZ of 26 October 2002 "On Insolvency (Bankruptcy)". It is the main source of rules on all procedures, signs, and consequences of bankruptcy. The Law defines insolvency as a commercial court's recognition of a person's inability to satisfy in full monetary claims, claims for severance pay or wages, or to perform the duty to pay mandatory payments.

Signs of bankruptcy

The first characteristic lies in the definition itself — the specific types of debt whose existence allows a legal entity to be treated as insolvent. The second key sign: not every delay in discharging monetary obligations indicates insolvency, but only one exceeding three months from the date the obligations should have been performed.

A bankruptcy petition may be filed by the debtor in respect of itself, or by its creditors. For the debtor's director, filing a petition is mandatory where, among other things: repaying one creditor would make it impossible to settle with the others; the debtor meets the conditions of insolvency or insufficiency of assets; or wages or severance pay have been owed to employees for more than three months.

Procedures in corporate bankruptcy

Bankruptcy cases involving legal entities are complex and multi-stage. The law provides four main procedures: supervision (observation), financial rehabilitation, external administration, and receivership (competitive proceedings). A case may also be concluded by an amicable settlement.

In practice, cases rarely pass through every stage. Most involve supervision and receivership, without the need or possibility of introducing the other procedures. Each procedure is introduced by a ruling of the commercial court on the basis of a decision of the creditors' meeting — after the court has analysed the specific circumstances — and entails particular legal consequences.

The supervision (observation) stage

Supervision is introduced by the commercial court after examining the bankruptcy petition, where confirmed signs of insolvency exist. The debtor's director and other management bodies continue to perform their functions. However, the central figure in this procedure is the interim manager, appointed by the court, who must safeguard the debtor's property, analyse its financial condition, identify the holders of obligations, compile the register of their claims, and convene and conduct the first creditors' meeting.

Consequences of introducing supervision include:

• All monetary claims against the debtor (except current payments) may be brought only within the bankruptcy case; existing debt-recovery proceedings may be suspended at a creditor's request.

• Enforcement proceedings are suspended; attachments and other restrictions on the debtor's property are lifted, with certain exceptions.

• A participant's share cannot be carved out on withdrawal, nor the actual value of a share paid out, nor the debtor's issued shares acquired.

• Set-offs of counterclaims are not carried out if this breaches the order of priority for satisfying creditors' claims.

• Dividends, income on shares, and distribution of profit among participants are not allowed.

• Financial sanctions for non-performance of monetary obligations do not accrue.

• Transactions disposing of property whose book value exceeds 5% of the debtor's assets require the interim manager's consent, as do loans, guarantees and sureties, assignment of claims, and transfer of debt.

Why the register matters

The core of any bankruptcy for a creditor is inclusion in the register of creditors' claims and the priority of that claim. Being in the register — and in the right queue — determines whether and how much a creditor recovers. Much of the litigation within a bankruptcy case is, in effect, a fight over the register: challenging other creditors' claims, subordinating affiliated claims, and defending one's own position.

What this means for international creditors

Foreign creditors facing an insolvent Russian counterparty should act early: monitor for signs of insolvency, file claims within the statutory windows, and secure a place in the register. Passivity is costly — claims filed late fall behind, and assets may be diverted before the estate is formed. Alongside inclusion in the register, creditors can pursue the challenge of suspicious transactions and the subsidiary liability of controlling persons.

Related materials

• Suspicious transactions in bankruptcy

• Subsidiary liability of beneficiaries