Lowering the priority of claims of interested creditors in bankruptcy

Lowering the priority of claims of interested creditors in bankruptcy

Controlled bankruptcy, where the affiliates of the bankrupt debtor appoint a liquidator and determine the fate of voting within the framework of bankruptcy proceedings, is one of the dangers awaiting the debtor’s independent creditors. In controlled bankruptcies, no small part goes to the practice of accumulating real debts in the hands of the debtor’s affiliates, including where the founder had extended loans to the debtor company, which eventually formed the major part of creditor claims in bankruptcy.

Let’s assume a company called Romashka LLC (the bankrupt debtor to be) took out a bank loan. It failed to repay the loan itself, but the loan was repaid in its stead by its affiliated company owned by the spouse of Romashka LLC’s founder. Generally, this would mean that Romashka LLC would get a new lender, whose claims would qualify for inclusion in the bankruptcy register. Such a lender can either fully control the bankruptcy procedure if it holds the majority of votes, or simply claim a significant share of the bankruptcy estate.

Another version of this scheme can be seen where an affiliate gives a guarantee for the debtor. In this case, after the guarantor repays the debtor’s debt, it has a right of recourse (a claim) to the debtor. Similarly to the situation described above, it can control the bankruptcy proceedings or claim a share of the bankruptcy estate.

This is the “standard” or the general approach. At the first sight, there is every reason to include such creditors into the register.

However, in certain circumstances, after hearing the arguments of the independent creditors, the courts begin to wonder whether the affiliates in such cases are acting in bad faith, and whether it is necessary to look into the circumstances and the reasons that caused the new lender to choose to satisfy such a debt.

Such circumstances may include the lack of active actions on the part of the new creditor, who is entitled to demand payment from the debtor, for a long time prior to the bankruptcy proceedings and the intensification of its efforts only in the course of bankruptcy. Among other characteristics one can name the lack of documents supporting the payment by the new creditor.

In a series of recent cases (Mikheyev’s bankruptcy) tried by the Supreme Court of the Russian Federation, those exact issues were the ones the Court addressed.1 All three lower instances of courts included the claims of affiliates into the register of creditors’ claims. The Supreme Court, however, remanded the case for a new trial, indicating that the courts should investigate the circumstances of the new creditor’s assumption of the debt and ascertain whether he had any intention to repay that debt without consideration. Indeed, in that case he would not have a claim against the debtor, and he would not qualify for inclusion into the register.

This series of cases was studied by the participants of the Bankruptcy Club, whose meeting was held on May 11, 2017 at the Chamber of Commerce and Industry of the Russian Federation under the auspices of the Research Centre of Private Law named after S.S. Alekseev.

The majority of participants agreed that the Bankruptcy Law does not provide for a possibility of lowering the creditor’s ranking (i.e., inclusion of the creditor’s claim into “lower” priority claims), as practiced in a number of foreign jurisdictions. At the same time, not all participants of the discussion were sure that the mechanism of (blunt) refusal to include such creditors into the register is favorable for the current state of development of the Russian judicial practice.

In any event, the very fact that the Supreme Court has suggested conducting a deeper assessment of the circumstances of the case and identifying whether the debtor’s affiliates acted in good faith, should encourage independent creditors.

The meeting of the Bankruptcy Club discussed other important practical issues as well: namely, whether the security (e.g., a guarantee, an independent (bank) guarantee or a pledge), which ceased due to the performance of the principal obligation, but remains suspended, should be restored, where the transaction for the performance of such a principle obligation is challenged. For instance, whether the surety should be restored if the transfer of funds for repayment of the loan is challenged.

The meeting of the Bankruptcy Club was attended by a partner of the “Mosgo & Partners” law firm, Anton Shamatonov.

1See, e.g., the Ruling of the Judicial Chamber for Economic Disputes dated March 30, 2017 No. 306-ES16-17647 (1) (, as well as No. 306-ES16-17647 (2), No. 306-ES16-17647 (6), and No. 306-ES16-17647 (7).

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© Mosgo & Partners. Moscow, 2017.

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