The Russian Ministry of Economic Development has put forward a bill amending Federal Law No. 127-FZ dated October 26, 2002 On Insolvency (Bankruptcy) (further the “the Bankruptcy Law”) by adding Article 61.3-1 expressly specifying that it would be possible to challenge several transactions (a set of consecutive fictitious or sham transactions) completed to withdraw debtors’ assets in bankruptcy cases (Bill published on regulation.gov.ru).

Purpose of this amendment

Sometimes, managers and/or shareholders of companies subject to bankruptcy proceedings start withdrawing assets from their company before such proceedings. Funds are withdrawn in the pre-bankruptcy period by concluding several consecutive transactions having the same common unlawful purpose. In such case, it would indeed be ineffective to challenge each transaction made by the debtor separately. In addition, the fact that there is a vested interest in terminating the proceedings (such as, for example, being a party to a transaction with the party being liquidated) may make it difficult to invalidate a separate transaction. The purpose of being able to challenge a set of transactions made by debtors as part of a single dispute in a bankruptcy case is to ensure procedural economy as well as the prompt return of debtors’ withdrawn assets to the bankruptcy estate to satisfy creditors’ claims.

Although this is not expressly specified in the Bankruptcy Law, it is currently possible to challenge several transactions made by debtors as a single transaction. However, the lack of clear criteria for the relatedness of transactions makes it difficult for creditors and bankruptcy managers to prove such relatedness. Providing in the Bankruptcy Law not only for the possibility of challenging all the transactions made by debtors altogether, but also for the conditions for challenging transactions will reduce the share of judicial discretion in deciding whether the disputed transactions are a single related transaction, and creditors and bankruptcy managers will have clear criteria for challenging such transactions.

Conditions for challenging a set of transactions

The bill provides that several transactions (a set of consecutive fictitious or sham transactions) may be invalidated by a commercial court as a single related transaction if the purpose of such transactions was:

  • Damaging to the property rights of the debtor’s creditors;
  • Giving preference to one of the creditors over other creditors;
  • Covering up the conclusion and the difficulty in challenging a transaction that may be challenged on the grounds specified in the Bankruptcy Law (Articles 61.2 and 61.3);
  • Creating the appearance of validity of property disposal, of the good faith of property acquisition;
  • Making it difficult in applying the consequences of the invalidity of such transaction and making bilateral restitution impossible.

Such purpose may be evidenced by one or more of the following circumstances:

  • The transactions were completed within a short period of time;
  • The transactions were conclude with no sound economic justification;
  • The transactions significantly differed from those previously concluded by the same entities (e.g. in terms of size or purpose);
  • The parties to the transactions did not conclude any other transactions or engage in other economic activity before or after their completion;
  • The parties to the transactions are related parties (affiliates);
  • The price of each subsequent transaction differed from the previous one by no more than five percent;
  • As a result of the transactions, all or a substantial part of the disposed property (transferred funds) under the transactions was consolidated in the ownership of one entity;
  • The same entity acted as a party to separate transactions thereby constituting a single related transaction.

The bill contains provisions aimed at protecting parties that did not know and should not have known that they acquired property under a related transaction. The consequences of invalidating a related transaction cannot be applied to such parties. The interests of bona fide acquirers are protected by not invalidating certain parts of a related transaction if the completion of the related transaction was possible without including the part to which the bona fide entity is a party.

The bill regulates in sufficient detail the procedure for considering applications for invalidating a related transaction. Such application can be submitted by anyone authorized to challenge debtor transactions.

Any entity that is a party to one of the transactions constituting a disputed related transaction is recognized as a party to the related transaction. A claim for return of disposed property, recovery of funds, or value of disposed property may be presented to any entity recognized as a party to the related transaction, including the latest recipient of property (funds). Any entities recognized as parties to related transaction will be involved in the consideration of the application. The absence of any of the parties to one of the transactions or other circumstances that would be grounds for terminating proceedings if the transaction were contested separately should not preclude the examination of application for invalidating a related transaction. So, the liquidation of a legal entity that participated in the transaction at any stage does not prevent challenging the entire chain of transactions. When considering the application, the court may, based on the bankruptcy manager’s petition, demand information about the property (including account transactions) of the entities involved in such transactions.

We believe that the adoption of this bill would have a positive effect on the interests of creditors and will make it possible to effectively overcome abuses by debtors. Our lawyers look forward to advising you and providing support on bankruptcy issues and risk optimization.

Bankruptcy Dispute resolution