Controlling Assets During Bankruptcy

An examination of the most significant changes in legislation over the last six months makes it clear that the purpose of most amendments has been an attempt to bring existing regulations into line with the new economic situation. The crisis has made it urgently necessary to amend laws in many areas. The Federal Law on Insolvency (Bankruptcy) is no exception, and the latest amendments, of December 30, 2008, have had significant resonance in the legal community, and been received with varying opinions.

One of the most important amendments to the Law on Insolvency is the provision of more detailed regulation of arbitration administrators, who play a key role in bankruptcy proceedings. In particular, arbitration administrators are able to call meetings of creditors, submit various applications to the arbitration court, engage other parties by contract to perform certain aspects of the bankruptcy proceedings and pay them at the expense of the debtor. Furthermore, the arbitration administrator is required to take action to protect the debtor's property, to analyze its financial standing and results of its activities, maintain a register of claims and creditors, uncover evidence of intentional or sham bankruptcies, etc.

In the final stage of bankruptcy -- winding up -- the receiver assumes the powers of the CEO and management bodies of the debtor, including the power to dispose of its property. Clearly, the arbitration administrator is a key figure in ensuring control over the debtor's assets, and is, to a considerable degree, responsible for the outcome of the bankruptcy proceedings and satisfaction of the creditors.

The law provides additional material incentives for administrators to perform well, and the new amendments make the receiver's remuneration dependent on full satisfaction of creditor claims. For example, if more than 75 percent of creditor claims are satisfied, the arbitration administrator is entitled to 7 percent of the satisfied claims, and if less than 25 percent of creditor claims are satisfied the remuneration is 3 percent of the satisfied claims.

At the same time, practice shows that certain abuses by arbitration administrations are not uncommon. Many practitioners know of situations in which a significant volume of the debtor's assets simply "disappears" in the course of bankruptcy, depriving creditors of the ability to recover at least part of their debt. These cases have led some lawyers to eloquently describe arbitration administrators as "responsible for meteorites in the atmosphere," which burn away as they get closer to Earth. This makes efforts by parties with opposing interests to appoint a preferred candidate entirely understandable.

Before the most recent amendments to the Law on Insolvency (Bankruptcy), the parties in the bankruptcy proceedings had far less opportunity to appoint a specific person as bankruptcy administrator. The appointment procedure was previously as follows. When filing the bankruptcy application with the Arbitration Court, the debtor or creditor stated the name and address of the self-regulating organization from which the arbitration court should appoint the temporary administrator. The said organization was required to submit a list of three candidates, of which the debtor and the applicant could reject one each. The arbitration court would then appoint the remaining candidate.

The new rules enable the applicant to nominate a specific candidate as arbitration administrator, who the arbitration court will appoint provided there are no obstacles to doing so. Therefore, the party that initiates the bankruptcy case and submits its preferred candidate will be in a privileged position.

At the same time as these amendments to the procedure for appointing the arbitration administrator, legislators also added additional safeguards for the interests of creditors, including a simplified procedure for removing the arbitration administrator, improved oversight by self-regulating organizations of arbitration administrators, and limitations on expenses compensated out of the debtor's property.

The approach to the activities of arbitration administrators, until recently treated as entrepreneurial, that is, primarily intended to be profitable, has also changed. This change in treatment of activities relating to the disposal of the debtor's assets is worthy of support, however, only practical application of the new Law will show whether the amendments are effective. The current economic situation suggests it will not take long to develop extensive practice in this area.