Subordination of Claims in Bankruptcy

Subordination of claims in bankruptcy. About ten years ago, an interesting phenomenon appeared in Russian legal practice, known as "subordination of creditors' claims". In simple terms, it means moving a creditor's claims to a more remote queue, or even barring them entirely from sharing in the bankruptcy estate. This article examines the reasons and grounds for it, the possible consequences, and the courts' positions.

How subordination emerged

The process of subordinating claims arose in bankruptcy cases, sparked by the active discontent of outside claimants who discovered that parties interdependent with the debtor were "entering" the register of claims.

The Insolvency (Bankruptcy) Law does not directly establish any mechanism for separating the priority of claims based on the relationship between creditors and the bankrupt. At the same time, its article 2 excludes from the category of bankruptcy creditors the debtor's founders/participants in respect of obligations arising from such participation. This gap led to numerous objections by claimants against affiliated creditors joining the case, and practice began to form.

The turning point in case law

A first serious milestone was the Ruling of the Supreme Court's Economic Disputes Chamber of 06.08.2015 No. 302-ЭС15-3973. Here the Court sided with a creditor whom the lower courts had refused to include in the register. A participant of an LLC with a 70% stake had made interest-free loans to the company. The lower courts treated this as intra-corporate relations — obligations not admitted to receivership. But the Supreme Court held otherwise.

Analysing the Bankruptcy Law together with LLC legislation, the Court found that legal entities have not only rights but duties towards their participants (distribution of profit, property on liquidation, buy-out of a share, participation in meetings). Where such duties are improperly performed, founders may address both property and non-property claims to the company. It follows that obligations of the debtor towards its participants arising from participation are not just any duties, but only those corresponding to the participants' corporate rights. Relations built within a civil-law construction (here, a loan) participate in receivership on general grounds. Connectedness through participation does not by itself prove that the relations are exclusively corporate.

The 2020 Supreme Court Review

The principal achievement in this field is the Review of case law on establishing, in bankruptcy procedures, the claims of persons controlling the debtor and affiliated with it (approved by the Supreme Court Presidium on 29.01.2020). Its main theses include:

• The burden of proving good faith is placed on persons interconnected with the debtor. If the court or other creditors have reasonable doubts, a presumption of the sham nature of transactions between the bankrupt and its affiliated creditor is triggered.

• Where a loan was, in substance, a way of financing the company in a crisis in place of a capital contribution, the affiliated creditor's claim is subordinated — satisfied only after all outside creditors.

Example. In case No. А35-4752/2017 (Ruling of the Central District Commercial Court of 17.04.2023), several companies owned and run by close relatives carried out a series of property transfers without real payment. In the ensuing bankruptcy, the whole group of related companies sought to enter the register, but failed to rebut that the debt arose from a sham transaction.

What this means for lenders and affiliated creditors

For outside creditors, subordination is a shield: it prevents insiders and affiliated lenders from diluting the estate by "loading" the register with intra-group claims. For those who lend to their own companies, it is a warning: financing a company in crisis through loans, rather than capital, risks having the claim pushed behind all outside creditors — or barred as a sham. The line is discretionary and fact-specific, and turns on whether the funding was genuine arm's-length lending or disguised equity support.

Related materials

• Suspicious transactions in bankruptcy

• Subsidiary liability of beneficiaries