New legal positions of the Russian Supreme Court regarding creditors exercising their rights in bankruptcy cases

Pepeliaev Group draws your attention to the new legal positions the Russian Supreme Court has formed concerning foreclosure in bankruptcy cases involving individuals and the exercise of creditors’ other rights.

On 25 December 2018 the Plenum of the Russian Supreme Court (the “Supreme Court”) adopted Resolution No. 48 “On certain issues relating to specific features of the bankruptcy estate being formed and distributed in bankruptcy cases involving individuals” (“Resolution No. 48”). The specified resolution clarifies the issues relating to foreclosure on the debtor’s sole dwelling and the issues of how an individual’s bankruptcy estate is formed and distributed, including spouses’ common obligations.

On 26 December 2018 the Presidium of the Supreme Court published an overview summarising the case law regarding the invalidation of decisions of meetings and committees of creditors in bankruptcy proceedings (the “Overview”) and additions to the overview of case law relating to authorised bodies participating in bankruptcy cases and to the bankruptcy procedures applicable in such cases (the “Addition to the Overview”).

Please find below the most important clarifications of the Supreme Court and the approaches developed in the case law.

If the debtor has several residential premises, the court grants execution immunity to one of such residential premises at its own discretion.

In clause 3 of Resolution No. 48 the Supreme Court has put an end to disputes over granting execution immunity (article 446 of the Russian Civil Procedure Code) if the debtor owns several residential premises.

Now, which residential premises are not subject to foreclosure is determined by the court at its own discretion and not selected by the debtor. When determining such residential premises the court must be guided by both the need to satisfy the creditors’ claims and by the need to protect the constitutional right to a dwelling of the debtor and of the debtor’s family members including minors, the elderly, and disabled persons depending on the debtor and by the need to provide the specified persons with normal living conditions and guarantees of their social and economic rights.

A pledgee of the sole residential premises that misses the deadline for filing an application for the claim to be determined loses its priority right

The specified position has been designed to balance the interests of creditors and debtors preventing the debtor from abusing his/her right and for the ownership of the most “upmarket” residential premises to be retained. The Supreme Court has refrained from expressing a position relating to the situation in which the sole residential premises of the debtor are premises whose characteristics definitely exceed those of premises that are reasonably sufficient for the need of a dwelling to be met. It looks like the Supreme Court has left this issue to be decided by the legislature at its own discretion (draft law ID 01/05/11-16/00059339 developed by the Russian Ministry of Justice).

The Supreme Court has clarified that if the pledgee under a mortgage of the sole residential premises fails to file an application for the status of the pledge to be determined or misses the deadline for his, a pledgee may not expect its claim to be settled by means of the pledged item. Such a claim will be entered in the register as a claim not secured by a pledge. In addition, the residential premises will not be considered to be premises that are not included in the bankruptcy estate as property which may not be foreclosed. The right of pledge to such premises will no longer exist after the property is sold.

When the creditors’ claims are entered in the register, the pledgee under the mortgage must immediately file a claim for the status of a pledge to be determined. Otherwise, a risk arises that not only will the security be lost, but also that the debtor’s bankruptcy estate will significantly reduce owing to it being impossible to foreclose the sole residential premises. Such an approach encourages creditors to actively protect their rights and protects against a creditor abusing his/her/its rights.

Creditors’ claims regarding spouses’ common obligations may also be settled at the expense of the bankrupt spouse’s share

Because Resolution No. 48 was adopted, the clarifications of the Supreme Court[1] that spouses’ common property could not be included in the bankruptcy estate are no longer relevant. Now the share of the debtor’s spouse may be used in order to settle claims of creditors regarding the spouses’ common obligations.

The following priority has been set for creditors’ claims to be settled in the case of the bankruptcy of an individual who is the co-owner of common property:

• first of all, at the expense of the debtor’s personal property and his/her share in the spouses’ common property;
• then, the funds that fall to the share of the debtor’s spouse are used for settling the creditors’ (unsettled) claims regarding the common obligations;
• the remaining funds that fall within the share of the debtor’s spouse are transferred to the spouse.

A creditor may initiate recognition of the obligations of the debtor and his/her spouse as common obligations not only when the claim is established in the bankruptcy case, but also after that. In both cases, the court must enlist the debtor’s spouse to take part in the consideration of the application.

The new approach of the Supreme Court significantly increases the creditors’ chances of having their claims upheld, substantially simplifies the foreclosure procedure with regard to such popular types of common obligations as a common loan or joint suretyship, and will also reduce the number of cases of spouses abusing their rights.

The debtor’s spouse may appeal to the court of general jurisdiction claiming to have the spouses’ common property divided before such property is sold in the bankruptcy proceedings, and to have the shares in the property determined

The Supreme Court has confirmed the right of the debtor’s spouse (ex-spouse) to initiate, outside of a case concerning the bankruptcy of the latter, the division of the common property before such property is sold in the procedure of disposing of the debtor’s property if he/she believes that disposing of such property “does not take into account the lawful interest of the spouse in question and/or the interests of the persons depending on him/her which deserve attention, including the interests of minor children”. The Supreme Court has pointed out that such a claim is to be considered by the court of general jurisdiction with the jurisdiction rules being observed.

The financial administrator and the creditors who have filed claims in the bankruptcy case may participate as third parties in the consideration of a case concerning the division of the common property and concerning the determination of the shares.

The Supreme Court has confirmed the worst fears by “dividing” the process of foreclosure of the debtor individual’s property between the two branches of judicial power. If the courts of general jurisdiction consider independent disputes over the composition of the debtor’s bankruptcy estate, debtors and their spouses obtain ample opportunities to abuse their rights, in particular by dragging out the bankruptcy procedure. Simultaneously, the general effectiveness of the bankruptcy significantly decreases.

The possibility of a joint bankruptcy procedure for spouses

This is the first occasion on which the court of the highest level has confirmed the possibility of a court joining together two cases on the spouses’ insolvency under the rules of article 130 of the Russian Commercial Procedure Code, with the financial administrator being appointed from the case that was initiated first.

After the two cases are joined together, the creditors may hold a general meeting to determine a candidate for the position of another receiver or another self-regulating organisation. When the cases are joined together, the financial administrator keeps a separate register of creditors’ claims with regard to the spouses’ common obligations and registers of creditors’ claims with regard to the personal obligations of each of the spouses. The amount obtained from the sale of the personal property of one of the spouses may not be used for discharging the personal obligations of the other spouse.

The specified mechanism of “family bankruptcy” appears to be effective from the standpoint of creditors’ interests since it significantly simplifies the sale of the common property of both spouses. We recommend that creditors file, as soon as possible, a motion with the court to join together spouses’ (including ex-spouses’) bankruptcy cases.

The possibility of challenging the transactions of the debtor’s spouse relating to the disposal of common property

The Supreme Court has confirmed the possibility of challenging in bankruptcy cases transactions that were concluded not only by the debtor, but also by his/her spouse. In the latter case the transactions may be challenged on the grounds that such transactions violate the rights and lawful interests of the creditors (articles 61.2 and 61.3 of the Law on bankruptcy; articles 10, 168, 170 and 174.1(1) of the Russian Civil Code).

With regard to challenging the decisions of the creditors’ meeting the Supreme Court has established the following approaches used by the courts that extend the creditors’ rights

• The creditors’ meeting may cancel a previously taken decision of its own, including by taking other decisions regarding similar issues.

Decisions previously taken may be cancelled if such cancellation does not have any signs of an abuse of a right and if it took place before the cancelled decision “had legal effect in business”. A particular example of a previous decision being cancelled by the taking of a new decision with regard to a similar issue is the situation when a new candidate for the position of the receiver is selected before the court approves the previous candidate.

• Failure to give notice of the creditors’ meeting is a material violation which entails the invalidation of decisions of the creditors’ meeting even if the creditor who has not been notified cannot influence the voting.

At the same time, publishing information about an upcoming creditors’ meeting in the Unified Federal Bankruptcy Register is recognised as due notification.

The candidate for the position of the receiver may not be approved if such candidate was proposed by an applicant who is a creditor affiliated with the debtor

The specified approach has been developed by case law taking into consideration article 37(5) of the Law on bankruptcy establishing the procedure for appointing the provisional administrator at random when the debtor himself/herself files the application. Since the debtor and the affiliates of the debtor share a common interest which is different from the interest of other creditors, according to the Supreme Court, the provisions of the specified article are applicable by analogy to the affiliates.

The court also emphasised that such approach is applicable not only to the formal affiliates of the debtor, but also to persons which may give mandatory instructions to the debtor or otherwise determine the debtor’s actions.

The approach the Supreme Court has formulated significantly complicates the carrying out of controlled bankruptcies. In this connection, we recommend taking into account the risk that it may be impossible to appoint a receiver proposed by an applicant who is a creditor when the strategy of the debtor’s bankruptcy is developed.

What to think about and what to do

The Supreme Court has provided clarifications and summarised the case law with regard to a number of pressing issues relating to a “family” bankruptcy by providing more opportunities to the creditors, on the one hand, and by making an extremely unsuccessful attempt to ensure that the rights of the debtors’ spouses are ensured by referring individual independent disputes to the courts of general jurisdiction. Unfortunately, the destructive competition between the two branches of judicial power, taking the example of bankruptcy cases, remains a topical issue.

The clarifications in Resolution No. 48 of the Plenum of the Supreme Court and the summary of the case law have once more demonstrated the aim of limiting the rights of affiliates and an informal approach to determining whether the affiliates and the debtor are related.

We recommend taking a detailed look at the legal positions developed by the Supreme Court. According to our experience in supporting bankruptcy cases, knowing insufficient information about the changes in the case law causes errors when the strategy for working with distressed debts is developed, errors when determining the prospects and the timeframes of foreclosure, as well as the understatement of the risks of negative implications.

Help from your adviser

Pepeliaev Group's experts possess extensive experience of success in protecting the interests of creditors and of other categories of persons involved in the procedures applicable in bankruptcy cases. Our lawyers also provide qualified legal assistance in cases relating to the bankruptcy of individuals complicated by the issues of forming the bankruptcy estate at the expense of the share of the debtor’s spouse.