Zakaznoe bankrotstvo (Russia)

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Zakaznoe bankrotstvo
Location: Russian Federation
Russia map.png
Author: Yuko Adachi
Affiliation: Sophia University

 Original text by Yuko Adachi  

In general, bankruptcy proceedings usually function as a mechanism for liquidating or rescuing distressed companies, and protecting creditors’ rights. However, in post-Soviet Russia, bankruptcy proceedings have often served as a mechanism to enable hostile takeovers, or as a means of attacking a rival company (see entry on reiderstvo in this volume). The manipulation of bankruptcy proceedings is known as zakaznoe bankrotstvto, which literally means ‘bankruptcy to order’: zakaznoe is the adjectival form of the noun zakaz, which means an order, contract or commission. Zakaznoe bankrotstvto is made possible through the exploitation of legal weaknesses and informal networks. One expert noted in 2004 that, ‘[b]ankruptcies ‘to order’ have become a major business, often combining strategies for exploiting weaknesses in the law with political intervention and outright corruption’ (Tompson 2004: 1[1]).


The practice became widespread in the late 1990s and was closely linked to the Federal law ‘On insolvency (bankruptcy)’ of 1998 (henceforth ‘the bankruptcy law’). The number of bankruptcy cases soared after the 1998 law came into force, rising from 4,200 in January 1998, to 15,200 in January 2000, and 52,500 in January 2002 (Simachev 2003[2]). According to the Federal Service for Financial Rehabilitation (FSFO), which had been responsible for supervising bankruptcy proceedings, in approximately 30 per cent of cases creditors were more interested in bringing about a change of ownership in a particular company than in recovering the debt (Golovachev 2001[3]).


One of the most high profile cases of zakaznoe bankrotstvto was that of Chernogorneft, a subsidiary of the oil company Sidanko, which was artificially bankrupted in 1999 by Tyumen Oil Company (TNK), another major Russian oil company at the time. TNK acquired debts from Chernogorneft’s creditors, and instigated bankruptcy proceedings to obtain control over the company. BP Amoco (which had paid $571 million USD for a 10 per cent share of Sidanko in 1997) along with other foreign shareholders found themselves squeezed out, and accused TNK of intimidating judges and journalists to pull off the successful raid (The Economist 1999[4]).


The main reason the 1998 version of the bankruptcy law triggered the practice of zakaznoe bankrotstvo is that it set a very low threshold for filing a bankruptcy suit. For example, a bankruptcy proceeding could be initiated against a company if the outstanding debts exceeded an amount 500 times the minimum wage (i.e. a relatively small sum in the context of corporate finance), and if the company failed to meet payment obligations within three months of the due date. In addition to overdue debts, bankruptcy proceedings could be started on the basis of tax arrears or unpaid utility bills. The 1998 law was intended to rectify the defects of the 1992 law, which allowed debtor companies to continue accumulating debts and unpaid bills. However, the 1998 law set the threshold so low that not only truly insolvent companies but also those capable of servicing debts were forced into bankruptcy (Volkov 2004[5], Tavernise 2000[6]).


Another weakness of the 1998 bankruptcy law was that it granted court-appointed (temporary and external) administrators considerable power over bankruptcy proceedings. Once bankruptcy proceedings were started, a temporary administrator took charge of the debtor company. The creditors who had filed the application for the initiation of bankruptcy proceedings often influenced temporary administrator appointments, effectively installing someone to serve their own interests rather than the interests of the company subject to the bankruptcy proceedings. For example, in the aforementioned Chernogorneft case, the administrator was allegedly allied to TNK (Economist 1999[7]). The temporary administrator had the authority to grant or withhold approval for many of the transactions carried out by incumbent managers, including disposal of assets or taking out of loans. They also had the power to control creditors' registers, which enabled them to exclude or undervalue the claims of some legitimate but ‘undesirable’ creditors, and to inflate the claims of others. In addition, the temporary administrator was responsible for organising the first creditors’ meeting where it was decided whether to appoint an external administrator, or whether company liquidation and asset disposal should be initiated immediately. If the decision favoured external administration, then the external administrator candidate would be decided at this meeting (Oda 2001[8], Tompson 2004[9], Volkov 2004[10]). The external administrator, who was given substantial authority, would then take over the management of the entire bankruptcy process, with the director of the debtor company removed from post and the power of the incumbent manager terminated. The external administrator had the power to make changes to the company's management, to dispose of company assets, and to take control of the debtor company's financial flow (Volkov 2004[11]).


When launching a hostile takeover or an attack against a bankrupt debtor, the key to success was obtaining as much debt as possible as a creditor and then appointing ‘one’s own’ (svoi) person as bankruptcy administrator. Through this bankruptcy administrator, a creditor could control the entire procedure. If a creditor could manage to appoint a closely connected administrator, bankruptcy was a cheaper and sometimes more reliable means of company takeover than obtaining shares in that company (Bashkinskas 2000[12], Afanasiev 1998[13]). For this practice to succeed, the initiating party was required to coordinate and mobilise an informal network of various actors such as external administrators, courts, the regional governor, the regional representative of the FSFO, law enforcement agencies, etc. (Novaya gazeta 2000[14]). Also, some alliance was required between the court-appointed bankruptcy administrator and the judges, as well as some political intervention for its enforcement. The cooperation of - or at least non-interference from - regional authorities was important in bankruptcy proceedings, since arbitration courts were often dependent on the regional authorities.


The 1998 bankruptcy law was amended in 2002 in an attempt to bring to an end the excesses of zakaznoe bankrotstvo. The amendment raised the threshold to initiate bankruptcy and made it more difficult for creditors to apply for bankruptcy proceedings. Moreover, the powers granted to bankruptcy administrators, which had been seriously abused through the practice of zakaznoe bankrotstvo, were also substantially curbed. For example, the administrator’s power to dispose of debtors’ assets was brought under the strict control of the creditors’ meeting (Oda 2007[15]). Following the 2002 amendment, the previously typical phenomenon of using or ‘ordering’ a particular administrator in launching zakaznoe bankrotsvo became less common (Iukhnin 2006[16]).


Although the practice of zakaznoe bankrotsvo has decreased following the 2002 amendment of the bankruptcy law, it has not been eliminated altogether. For example, the tactic was used in the mid- to late-2000s to bring about the de facto privatisation of state-owned vodka producers. One example concerns the vodka factory Yarich, which in 2006 (when it was owned by the federal state alcohol holding company Rosspirtprom) took out a ten million rouble bank loan, with its property as the guarantee. The debt was purchased by the trading house SDS-Alko in April 2009, which then demanded its repayment. When Yarich was unable to repay, SDS-Alko took out a court action for the bankruptcy of Yarich. A few months later a new company began operating at the Yarich site, owned by SDS-Alko. The case was described by national newspaper Vedomosti as ‘a clear example of how bankruptcy is becoming an instrument of privatisation’ (Bailey 2016[17] (forthcoming)).


In terms of linguistic usage, it seems that the term zakaznoe bankrotstvo has become less common since the early 2000s. This may be partly due to the practice itself becoming less widespread since the bankruptcy law was tightened up in 2002, but also due to the term reiderstvo gaining wider currency from this time (Sagova 2012[18] , Sakwa 2011[19]). Reiderstvo is a broader concept than zakaznoe bankrotstvo, with its meaning encompassing a range of informal tactics used to execute hostile takeovers. Zakaznoe bankrotstvo is one of those tactics, but others can include the use of contacts in the judiciary, in state agencies (who can, for example, impose fines or revoke licences), and even physical force and violence.

References and Bibliography

  1. Adachi, Y. 2010. Building Big Business in Russia: The impact of informal corporate governance practices, London and New York: Routledge.
  2. Volkov, A., Gurova T., and Titov. V. 1999. ‘Sanitary i marodery’, Ekspert, 1 March.
  3. Volkov, A., and Sivakov, D. 1999.

‘Tekhnologiia absoliutnoi vlasti’, Ekspert, 21 June.

Notes

  1. Tompson, W. 2004. ‘Reforming Russian Bankruptcy Law’, Briefing Note, Royal Institute of International Affairs, August.
  2. Simachev, Iu. ‘Institut nesostoiatel’nosti:osnovnye tendenntsii v primenenii i slozhivshaiasia “struktura sprosa”- vzgliad ekonomista’, in Razvitie sprosa na pravovoe regulirovanie korporativnogo upravleniia v chastnom sektore, Moscow: Moskovskii obschestvennyi nauchnyi fond, 2003.
  3. Golovachev, V. 2001. ‘Interview with T. Treifilova’, Trud-7, 23-29 August, http://bankr.ru/doc/75.
  4. The Economist. 1999. ‘Rules of War’, 4 December.
  5. Volkov, V. 2004. ‘The Selective Use of State Capacity in Russia’s Economy: Property disputes and enterprise takeovers’, in J. Kornai, B. Rothstein, and S. Rose-Ackerman (eds), Creating Social Trust in Post-Socialist Transition, New York: Palgrave.
  6. Tavernise, S. 2000. ‘Using Bankruptcy as a Takeover Tool’, New York Times, 7 October.
  7. The Economist. 1999. ‘Rules of War’, 4 December.
  8. Oda, H. 2001. Russian Commercial Law, Hague: Kluwer.
  9. Tompson, W. 2004. ‘Reforming Russian Bankruptcy Law’, Briefing Note, Royal Institute of International Affairs, August.
  10. Volkov, V. 2004. ‘The Selective Use of State Capacity in Russia’s Economy: Property disputes and enterprise takeovers’, in J. Kornai, B. Rothstein, and S. Rose-Ackerman (eds), Creating Social Trust in Post-Socialist Transition, New York: Palgrave.
  11. Volkov, V. 2004. ‘The Selective Use of State Capacity in Russia’s Economy: Property disputes and enterprise takeovers’, in J. Kornai, B. Rothstein, and S. Rose-Ackerman (eds), Creating Social Trust in Post-Socialist Transition, New York: Palgrave.
  12. Bashkinskas, V. 2000. ‘Bespredel bespredela’, Ekonomika i zhizn’, 9 December.
  13. Afanasiev, V. 1998. ‘Beskonfliktnyi zakhvat’, Ekspert, 21 December.
  14. Novaya gazeta. 2000. ‘Zakaznoe “bankrotstvo”’, No. 66, 11 September.
  15. Oda, H. 2007. Russian Commercial Law, Second Revised Edition, Leiden: Martinus Nijhoff.
  16. Iukhin, A. 2006. `Tipologiia “zakaznykh bankrotsv”’, Imushchestvennye otnosheniia v Rossiiskoi Federatsii, N1(52).
  17. Bailey, A. L. 2016. Alcohol and Politics in Russia: Policy and Corruption Under Putin (London: IB Tauris)
  18. Sagova, A. 2012. ‘Genezis reiderstva kak sotsial’no-pravavogo iavlneniia’, Biznes v zakone, N1.
  19. Sakwa, R. 2011. ‘Raiding in Russia’, Russian Analytical Digest, No. 105.