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. Last Updated: 07/27/2016

Bankruptcy Laws Endanger Healthy Companies

NOVOKUZNETSK, Western Siberia — The Novokuznetsk Aluminum Plant turns out 276,000 metric tons of metal a year, over 10 percent of Russia's total production and enough to build more than 3,500 Boeing 747s.

It makes a profit on every ton by selling its ingots abroad for foreign currency after processing the metal in Russia, where workers' wages and supplies are priced in rubles far below world cost.

Nonetheless, in January, a local court, prodded by the regional governor, declared the company bankrupt and named a new set of managers. It is now controlled by a former competitor, one that has cultivated a relationship with the governor.

As Novokuznetsk Aluminum's fortunes demonstrate, bankruptcy in Russia often has more to do with politics than it does with balance sheets. A two-year-old bankruptcy law lets debts of as little as $5,000 topple companies worth millions, if the bills go unpaid for three months.

In a country where even the government routinely runs months behind in paying wages, this means that most companies are candidates for receivership. The number of bankruptcies has soared 150 percent in two years.

All over the country, local politicians and business tycoons have latched onto the bankruptcy law to effectively seize valuable companies at a fraction of their market value, critics say. Powerful local politicians start the process by opening the door to a predator business group and pressing judges to put the target company into bankruptcy and name one of the predator's own employees to manage it. Through these managers, called receivers, the process is most often abused, critics said.

"In a developed economy, bankruptcy is a process that eliminates enterprises that aren't effective, but in Russia it doesn't work like that," said Pyotr Karpov, the former deputy head of the Federal Bankruptcy Service. "Bankruptcy here has absolutely no relation to how economically effective a company is or to the amount of its debts.

"The law thinks in a Western way," he said, "but the creditors think only of how to use bankruptcy to grab the company."

Probably the best-known example is the BP Amoco investment of $500 million in the Sidanko oil company. A rival business group pushed Sidanko's most valuable subsidiaries into bankruptcy last year after acquiring their debts from other creditors. The rival group, Tyumen Oil Co., used the process to snap up those subsidiaries at bargain prices, eviscerating BP Amoco's investment.

BP Amoco, based in London, eventually recouped a part of its investment, but only after enlisting the U.S. government to threaten a key loan to Russia.

Russia rewrote its bankruptcy statute two years ago to try to correct problems caused by a 1992 law approved soon after the collapse of the former Soviet Union's centrally planned economic system. That law let companies accumulate debts with impunity and resulted in a tangle of unpaid bills that choked the economy.

The new law addressed that problem, critics said, but created others by setting too low a threshold for bankruptcies and allowing local politicians too much control over the process.

Almost 11,000 companies entered bankruptcy last year, compared with 4,300 in 1997, before the new law was passed, according to research published by the Center for Economic Policy Research, a private London-based institution. Most of these companies were liquidated to pay creditors. But more than 10 percent — most often big companies — were put into receivership, with their debts frozen and cash flows put in the hands of court-appointed managers.

The law lets healthy companies fall into bankruptcy almost as often as sick ones, the researchers found. Because the amount of debt required to start the process is so small, Russia's bankruptcy process has yet to begin separating truly insolvent companies from those that can pay their debts.

Yekaterina Zhuravskaya, an economist at the Center for Economic and Financial Research in Moscow and a coauthor of the Center for Economic Research study, found that domestic companies under external management were usually no worse, and sometimes much better, at servicing their debts before being put into bankruptcy than were companies not pushed into receivership. There is no economic reason these companies are being bankrupted when the others, which are worse, are not, she said.

In the Kemerovo region of Siberia, where Novokuznetsk Aluminum is located, the aluminum plant is not the only enterprise in the hands of a receiver. Local authorities have used bankruptcy to unseat the owners of all the largest enterprises.

Formally, the local electric utility started the aluminum company's bankruptcy. The state-controlled utility company said that the smelter was $54 million behind in payments for electricity. Novokuznetsk Aluminum said it owed far less.

The company declined to give its net worth, but a former manager said it sold $414 million worth of metal last year. Politics, however, pushed the bankruptcy through, and the region's powerful governor, Aman Tuleyev, does not hide his own role.

"We had to change the owners," Tuleyev said in an interview, waving his hand in his spacious office in the region's capital, Kemerovo. He described the previous owners, the Zhivilo brothers, as con men.

If the bankruptcy served the needs of the governor, it did not help the aluminum company's largest creditor. The electric utility became a victim of the process it had started when the court-appointed receiver, Sergei Chernyshov, challenged the very debt that had driven the aluminum plant into bankruptcy. A court let him revalue the debt at about $1 million, less than 2 percent of what the creditor expected to collect.

Now a former competitor is consolidating control over Novokuznetsk Aluminum. Exports flow through companies affiliated with Russian Aluminum, the holding company that controls about 70 percent of the country's aluminum industry. Though Chernyshov said he was not connected to the group, the general director he recently hired came from one of Russian Aluminum's subsidiaries. A photograph of Russian Aluminum's chief executive, Oleg Deripaska, hangs on the new general director's wall.

"This was theft in broad daylight," said Mikhail Zhivilo, the former owner, in an interview earlier this year. "If it was the money they wanted, they could have just seized the supplies that were en route to the plant. They wanted the factory, and the only way to do this was through bankruptcy."

While Kemerovo regional authorities needed the electricity company's help to bankrupt the aluminum smelter, they have been able to intervene directly with larger enterprises in the region.

The new bankruptcy law enables local governments to prevent the closing of a city's main employer. Under the law, local governments can extend receiverships for companies with at least 5,000 employees to as long as 10 years, compared with 18 months for other concerns. Companies with more than 5,000 employees account for 41 percent of industrial production.