Counterparty’s insolvency risks for creditors of state and municipal unitary enterprises

Pepeliaev Group advises of specific aspects of how claims of creditors of state enterprises are satisfied at the expense of the debtor’s rights to a land plot.

The Russian Supreme Court disallowed inclusion into a bankruptcy estate and disposal of a leasehold to a land plot held by an insolvent state unitary enterprise. The Supreme Court’s Board for Economic Disputes issued its Ruling dated 17 March 2021 in bankruptcy case No. A40-150393/2014. The essence of the dispute was as follows.

Receivership proceedings were initiated against a federal state unitary enterprise. The debtor was the lessee of five land plots owned by a public-law entity. The receiver applied to a state commercial court seeking to obtain approval of the plan for selling the leasehold to the land plots at an auction.

The receiver’s application was sustained by the ruling of the first instance court which was upheld by the courts of appeal and of cassation. The judgments were challenged before the Supreme Court by the Federal Agency for State Property Management acting as a governmental body exercising the functions involving managing federal property.

The Board for Economic Disputes sided with the Federal Agency, having reversed the judgments of lower courts and thereby disallowed the leasehold from being included into the bankruptcy estate.

Legal grounds of the dispute

The key legal issue was resolving the conflict between general and specific legal provisions: article 18(2)(2) of the Federal Law “On state and municipal unitary enterprises” regarding the leasehold to public-owned land plots being sold at an auction in an insolvency case, and article 131 of the Federal Law “On insolvency (bankruptcy)” regarding the property included in the bankruptcy estate.

Article 18(2)(2) of the Federal Law “On state and municipal unitary enterprises” prohibits a state or a municipal unitary enterprise from reassigning a land plot leased from a public owner, which may lead to a decision prohibiting the transfer of the leasehold at an auction during the receivership proceedings.

Citing that subject to article 131 of the Federal Law “On insolvency (bankruptcy)” all debtor’s property should be included in the bankruptcy estate, including its property rights, the Supreme Court made quite an opposite conclusion that the leasehold could not be included in the bankruptcy estate of the state unitary enterprise.

To sum up, the Supreme Court’s Board for Economic Disputes resolved the dispute, contrary to the special legal provision, based on article 18(2)(2) of the Federal Law “On state and municipal unitary enterprises”, having disallowed for the leasehold to be included in the bankruptcy estate.

Political and legal relevance

It would be a stretch to call balanced the Supreme Court’s position in the dispute we comment on. The issue of low protection of interests of creditors of state and municipal unitary enterprises has occasionally emerged in the court practice and has been in the focus of the Russian Constitutional Court' attention. In some cases, the Constitutional Court sided with creditors, taking into account the specific goals of receivership proceedings and the need for striking a balance between public-law and private interests.

Considering the current environment in which the enterprise operates, a prohibition on transferring a lessee’s rights and obligations can be aimed at preventing potential abuse by the management of a state-owned enterprise and, therefore, indirectly preventing plunder of public property, as well as preventing a state-owned enterprise from obtaining anti-competitive advantages over other market players.

The provisions of legislation on bankruptcy are principally aimed at satisfying creditors’ claims in the most proportionate way possible. Having regard to the above, the prohibition on disposing of the leasehold to a land plot at an auction within the framework of receivership proceedings prevents attaining the goals of the institution of bankruptcy.

What to think about and what to do

Therefore, in practical terms, persons who enter into legal relationships with state (municipal) unitary enterprises should wisely assess the risks of insolvency of the counterparty and take into account the likelihood of the leasehold to a land plot being excluded from the bankruptcy estate in case of a bankruptcy.

Hence, close attention should be paid to the provisions of contracts which provide for deferred payments by the counterparty. We recommend considering obtaining security for the other party’s obligations, as a security creditor has a pre-emptive right to have all its claims satisfied over unsecured creditors who have been also included in the register of claims. Before making a decision on entering into a transaction, it is advisable to assess the risks in terms of a legal regime applicable to the assets and the potential bankruptcy of the counterparties.

Help from your adviser

Pepeliaev Group's lawyers are ready to assist in assessing circumstances and facts as they apply to each specific case, and in developing a position with regard to the most reasonable conduct depending on the situation. We will also provide any legal support, including in resolving disputes, in negotiations with counterparties, state and local authorities, and in assessing the land, town planning and bankruptcy risks in the current crisis.

We are ready to provide comprehensive legal support within litigations in courts of all levels, including on issues connected with formalising and assigning leasehold, as well as in bankruptcy cases.

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