Overview of the court practice of the Russian Supreme State Commercial (‘Arbitration’) Court (the “SAC”)

Overview of the court practice of the Russian Supreme State Commercial  (‘Arbitration’) Court (the “SAC”) in relation to applying bankruptcy legislation, published in the 1st quarter of 2013

Practice shows that one of the problems faced by purchasers of property of persons who have been declared bankrupt is establishing the proper tax agent to pay value-added tax (VAT). 

Federal Law No. 245-FZ dated 19 July 2011 has amended article 161 of the Russian Tax Code. Before this, the debtors themselves were tax agents in relation to the payment of VAT on a sale within Russia of the property and/or property rights of debtors who had been held bankrupt in accordance with Russian law. However, this meant that conflicts arose because there were specific rules in Federal Law No. 127-FZ dated 26 October 2002 ‘On insolvency (bankruptcy)’ (the “Bankruptcy Law”) and Federal Law No. 40-FZ dated 25 February 1999 ‘On the insolvency (bankruptcy) of credit institutions’ (the “Banking Insolvency Law”), which govern the order of priority under which current payments are to be made.

Resolution No. 11 of the Plenum of the SAC dated 25 January 2013 eliminates the conflicts that arose and clarifies the following:  

1. VAT received as part of the proceeds of sale of the property of a bankrupt (save for a credit institution) must be paid only after the current payments have been made in the first three classes in the order of priority.

2. VAT received as part of the proceeds of sale of the property of a bankrupt credit institution is not part of current payments and it must be paid using the debtor’s property that remains after the claims of registered creditors have been satisfied.

3. When a commercial (‘arbitration’) court declares bankrupt an individual with the status of an individual entrepreneur, or issues a decision for receivership proceedings to commence, such person ceases to have the status of a VAT payer.

Having regard to the practice of applying bankruptcy legislation and to the above Resolution, we recommend that if there are conflicts between tax and bankruptcy legislation, the specific rules should be followed of the Federal Law ‘On insolvency (bankruptcy)’ and Federal Law ‘On the insolvency (bankruptcy) of credit institutions’. This includes in relation to the regime for paying VAT when bankrupts’ property is purchased.

The above Resolution is of interest from the standpoint of the sale, in a bankruptcy (insolvency) case, of socially significant facilities.

The interested parties challenged a sale and purchase contract for a debtor to sell socially significant facilities. The contract had been entered into via a public offer further to a failed bidding process.

In rejecting the claims, the first instance court proceeded on the basis of the provisions of article 139(4) of the Bankruptcy Law, which establish the procedure for a debtor’s property to be sold via a public offer if repeat bidding processes for the debtor’s property prove abortive. 

In overturning the first instance court’s decision, the appeal court pointed to the absence in the Bankruptcy Law of provisions stipulating that socially significant facilities may be sold by way of a public offer.

The cassation court supported the stance of the first instance court, rejecting the appeal court’s conclusions on the grounds that the rules of article 132(5) of the Law were wrongly interpreted. These rules provide for socially significant facilities to be transferred into the municipal ownership of the relevant municipal body if they are not sold under the procedure set by clause 4 of the above article. Taking the abortive nature of the repeated bidding processes into account as well as the terms and conditions of the sale and purchase agreement in relation to the designated use of the property in dispute, the cassation court concluded that there were no grounds for holding that such agreement was invalid.

Overturning the decisions of the first instance and cassation courts and leaving the appeal court’s resolution in force, the SAC stated that the rules of article 139 of the Federal Law ‘On insolvency (bankruptcy)’, which govern the procedure for selling property by way of a public offer, should not be applied in the case of socially important facilities. This is because article 132 of the same law establishes a specific regime for selling a debtor’s property that falls outside the bankruptcy estate.

In practice, difficulties are often caused by a failure to comply with the procedure for executing a power of attorney for the taking of certain procedural steps in an insolvency (bankruptcy) case.

The matter that was being assessed in this dispute was whether an application to be included in the register of creditors’ claims could be filed by a representative whose power of attorney contained no specific reference to a specific authority to conduct a bankruptcy case.

The first instance court’s ruling, which the appeal and cassation courts upheld, was that the application to be included in the register of creditors’ claims was not examined on the grounds that the representative had no right to conduct a bankruptcy case.

In overturning the court decisions and referring the creditor’s application to be reheard, the SAC relied on the following. 

The authority to conduct a bankruptcy case should be specifically stipulated in a power of attorney; a power of attorney to conduct cases in state commercial (‘arbitration’) courts which does not contain such a stipulation does not grant the authority referred to.

However, a creditor’s claim under the procedure of article 71 or 100 of the Bankruptcy Law may be signed and presented by a person who has a general power of attorney to conduct the creditor’s cases in state commercial (‘arbitration’) courts with the right to sign a statement of claim (article 62(2) of the Russian Arbitration Procedure Code). Moreover, according to articles 37(1)(2), 40(2) and 150(2)(2) of the Bankruptcy Law, in a power of attorney to conduct a bankruptcy case, the representative’s rights must be specifically stipulated to sign an application for a debtor to be held bankrupt and to vote on concluding a settlement agreement.

When in a bankruptcy case a procedural document is received which is signed by a person who lacks the authority to conduct a bankruptcy case, it should be borne in mind that a person who has the properly documented powers to conduct such a case may at any time ratify procedural actions undertaken by an unauthorised person.

The matter being assessed in the context of the above Resolution was whether the restrictions provided for by article 295(2) of the Civil Code may be applied when determining the powers of a court-appointed administrator to dispose of the property of a debtor which is a state or municipally owned enterprise.

Having set aside all existing court decisions in the case, the Presidium upheld the claim of a purchaser of property challenging a supplemental agreement to a lease contract for such property which a municipality had entered into as owner of the debtor’s property during receivership proceedings. In doing so, the SAC relied on the following.

In clause 5 of information letter No. 20 of the Presidium of the SAC dated 7 August 1997 ‘An overview of the practice of state commercial (‘arbitration’) courts applying bankruptcy (insolvency) legislation’, it is explained that a court-appointed administrator’s powers to dispose of a debtor’s property are not restricted by the scope of the powers set for a CEO of the debtor company.

When the authority is determined of a court-appointed administrator to dispose of the property of a debtor which is a state or municipal enterprise, the restrictions stipulated by article 295(2) of the Civil Code are not applied.

In accordance with article 126(1) of the Bankruptcy Law, from the date on which a state commercial (‘arbitration’) court takes a decision to declare the debtor bankrupt and to initiate receivership proceedings, transactions which involve the debtor’s property being disposed of or entail its property being transferred to be used by third parties, are only permitted under the procedure established in chapter VII ‘Receivership proceedings’.

Since the owner of the leased property accepted a supplemental agreement to the lease contract in violation of the requirements of the Bankruptcy Law, such agreement was invalid. 

This Resolution displays the mechanism for preventing groundless claims of creditors from being included in the register. It takes the form of challenging the transaction on which the corresponding claim is based. Also important is the approach set out in the resolution for proving that the transaction has the nature of a sham transaction.

The decision of the first instance court, which was upheld by the appeal and cassation courts, declined to hold a supply contract to be invalid (a sham), citing that there was evidence of the supply in the form of waybills and that the debtor itself had acknowledged the debt.

Setting aside these decisions and referring the case to be reheard, the SAC stated the following.

A court, when examining a case to challenge a transaction that served as a ground for a defendant’s claims to be included in the register of creditors’ claims, must carry out a check based on arguments that the transaction showed signs of being a sham which was aimed at creating artificial debt of a creditor and on the facts of the case. In carrying out such a check, it must follow the principle of establishing sufficient evidence as to whether or not there is an actual relationship involving a supply. The purpose of the check is to establish whether or not there is a genuine basis for the debt that arose under the contract, and to ensure that unjustified claims are not included in the register. This is because, such claims being included entails a violation of the rights and lawful interests of creditors who have well grounded claims as well as the debtor and its shareholders (members).

If there is credible evidence of it being impossible to deliver a specified volume of goods, the burden of proving the opposite rests with the defendant, but the defendants did not refute the claimant’s arguments by way of presenting the relevant evidence.

In relation to a dispute regarding having a transaction declared a sham, it cannot be prejudicial to verify, in the context of examining whether claims are well grounded in a bankruptcy case, that the waybills supplied comply with the provisions of the Law on accounting and that the debtor acknowledged a debt. 

In view of the legal position set out in Resolution No. 2751/10 of the Presidium of the SAC dated 8 June 2010, the courts should have taken into account that a bankruptcy case had been initiated in relation to the debtor. Therefore, to take a decision regarding the case at hand would directly affect the rights and obligations of the parties to the bankruptcy case.

In cases to challenge sham transactions, a statement of falsification in relation to whether the signatures on documents are genuine does not achieve these aims, since when parties consummate a transaction solely for the sake of appearance, they execute all documents properly. However, they do not strive to create genuine legal consequences.

Therefore when examining whether the supply contract and the documents confirming the transfer of the goods were a sham, the court should not have limited its check to whether the copies of the documents met the formal requirements established by the law. When waybills are challenged, account should be taken of both other source accounting documents and other evidence.

The Resolution is also of interest from the standpoint of assessing a claimant’s interest, under substantive law, in having the claims upheld. As the Presidium of the SAC noted, the courts did not comply with the provisions of article 67 of the Russian Civil Code and article 8 of Federal Law No. 14-FZ dated 8 February 1998 ‘On limited liability companies’ when those courts concluded that the claimant lacked interest, based on the lack of evidence that the debtor had sufficient property that was to be distributed among the members of the debtor to be liquidated.