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. Last Updated: 07/27/2016

BUSINESS AND THE LAW: Details on Credit Support Law

The use of credit support in volatile markets has become increasingly important as parties seek to reduce their credit exposure.

Credit support is provided to ensure that assets will be available to satisfy the obligations of parties under derivative contracts if there is an early termination. If a party defaults, the creditor may recover all or some of its claims from the debtor's pledged property or from a third party (if credit support was provided by this third party).

The Civil Code of Russia of 1995 provides several convenient instruments for securing financial obligations. Primarily these include pledges, surety and bank guarantees, as well as reservation of title, penalty and others.

The Civil Code, however, left several gaps in credit support regulation that became obvious during the three years of court practice since the adoption of the code. In February, the Supreme Arbitration Court published its second summary of court cases, discussing the recent court practice and providing the interpretation of credit support regulations as they apply to pledges, surety and bank guarantees. Although the court's case summaries are not considered official sources of law, they are becoming increasingly important in Russia's developing legal practice, because they provide greater legal certainty in business transactions through guidance as to how Russian courts will interpret the law.

Most litigation has been concerned with the nature of the property being pledged. The Supreme Court maintains that only pledges of "immovable" property, such as real estate, must be registered with a notary. Pledges of "movable" property, such as stocks or bonds, do not have to be registered with a notary; however, they must be registered with a registrar or a custodian if they are in a nondocumentary format. Movable property, in any case, must be specifically identified (or be capable of being specifically identified in the future) and must not be fungible.

The second group of cases concerns foreclosure and the realization of pledges. According to the general rule of the Civil Code, a pledge may be foreclosed only through a court proceeding. The courts, however, have been carving out certain exceptions concerning foreclosure of pledges of movable property. For example, money held in a bank account may not be the subject of a pledge, because "noncash" money cannot be sold at a public auction in the case of default, as is required by the Civil Code. As with pledges, the Supreme Arbitration Court cases on surety, the obligation of one person guaranteed by another, can be grouped into two categories: formation and enforcement.

The court maintains that a surety agreement will be deemed to satisfy the requirement of a written contract if it is concluded between a creditor and a surety provider and if it refers to and incorporates (by reference) the underlying debt (including an obligation under a derivatives contract). While the underlying obligation must be identified with maximum specificity, it need not be concluded before the surety agreement. The surety agreement may specify its own duration and reduce the scope of the surety provider's liability, which is limited by the amount of the underlying debt. Finally, the court has concluded that the party providing the surety may neither argue that the debtor lacked the capacity to assume the underlying debt or a financial obligation, nor that the surety provider's liability is automatically terminated if the underlying obligation is materially changed.

Unlike a surety, according to the Civil Code, a bank guarantee is independent from underlying obligation and remains enforceable after termination of underlying obligations or after a declaration that the underlying obligation is void.

A bank guarantee must be issued for an identified term and, unless otherwise specified in a guarantee, the guarantor does not have to be informed that the beneficiary has accepted the guarantee. The Supreme Court has held that although the bank guarantee must be issued by the bank guarantor in written form, the absence of a written agreement between the guarantor and the debtor (or the beneficiary) does not invalidate the guarantee, because a bank guarantee is a unilateral written obligation of the guarantor.

Peter Malyshev is an associate in the securities practice of Baker & McKenzie's Moscow office.