What is financial recovery and why it does not work in Russia?

Konstantin Zautrennikov, the leading lawyer of “Prospectasi” company, prepared a detailed material about the features of financial recovery for “Rusbankrot” website. When this concept is introduced, what measures should be taken for its introduction and why this procedure is so rare in Russia?

About the concept 

 Financial recovery - a procedure, used in a bankruptcy case against a debtor in order to restore his or her solvency and pay off the debt in accordance with the debt repayment schedule (Article 2 of the Bankruptcy Law).  Financial recovery, along with the external management and a settlement agreement, are bankruptcy rehabilitation procedures, i.e.  situations in which, upon the completion of bankruptcy procedure, the debtor restores his solvency, settles accounts with creditors and continues to function as a business unit.

Rehabilitation procedures are opposed to the liquidation procedures. When the bankruptcy process ends with the liquidation of the debtor as a legal entity - its property is sold at auction in order to repay the claims of creditors.  In current Russian legislation, such liquidation procedure is bankruptcy proceedings.

When is the financial recovery procedure introduced?

The introduction of financial recovery is possible after the observation stage, when the debtor has not been declared insolvent by the court yet, but has revealed signs of insolvency that could be overcome in the course of financial recovery.  A distinctive feature of financial recovery, in comparison with other procedures, applicable in a bankruptcy case, is that the powers of the management bodies of a legal entity are retained, when the restrictions are placed on the disposal of the property of a legal entity by an administrative manager.

 Financial recovery is introduced by the arbitration court on the basis of the decision of the first meeting of creditors (Clause 1, Article 80 of the Bankruptcy Law).  The founders of the debtor, the owners of the property of the debtor - the unitary enterprise, or third parties may apply to the first meeting of creditors with a request for the introduction of financial rehabilitation.

Financial Recovery Commitments

 According to the paragraph 3 of the Article 80 of the Bankruptcy Law, the decision on the introduction of financial recovery should indicate the period of financial recovery, as well as contain the schedule of the debt repayment, approved by the court.  Simultaneously with the introduction of financial recovery, the arbitration court approves the administrative manager.

According to the paragraph 79 of the Bankruptcy Law, the performance by a debtor of obligations in accordance with the debt repayment schedule can be secured by a pledge (mortgage), an independent guarantee, a state or municipal guarantee, as well as in other ways that do not contradict the Federal Law.  In the absence of ensuring of the fulfillment of the debtor’s obligations in accordance with the debt repayment schedule, a financial recovery plan is developed.

Financial recovery plan

The financial recovery plan, prepared by the founders (participants) of the debtor and the owner of the property of the debtor, is approved by the meeting of creditors. The debt repayment schedule is signed by the person, authorized by the founders (participants) of the debtor (Article 84 of the Bankruptcy Law).

The introduction of the financial recovery provides for a number of consequences for the debtor:  arrests and other restrictions on the disposal of the property of the debtor are removed, collection on the enforcement orders is suspended, charges and penalties are charged, claims on the debtor (with the exception of current payments) can be brought against the debtor only with the compliance of the requirements of the Bankruptcy Law, etc. (Article 81 of the Bankruptcy Law).

Financial recovery or bankruptcy?

Despite the fact that the text of the Bankruptcy Law repeatedly emphasizes the importance of implementing measures to prevent the insolvency (bankruptcy) of the debtor and  to restore his or her solvency, in practice, in the vast majority of cases, the bankruptcy procedure ends with the bankruptcy proceedings and the subsequent liquidation of the debtor.

As it follows from the statistics of the official website of the Federal Arbitration Courts of the Russian Federation, for the period from 2010 to 2013, the arbitration courts received 146,413 bankruptcy cases. The financial recovery procedure was carried out 344 times. At the same time, another rehabilitation procedure - external management - was carried out much more often, 3,619 times, to be precise.

It is worth noting that the number of financial recovery procedures, terminated due to the debt repayment, did not exceed 7.4% of all the cases of introducing financial recovery.

Why is the financial recovery unpopular?

In our opinion, the main reason for the rare application of the financial recovery procedure and its low effectiveness, first of all, is the late appeal to the court to declare the debtor’s bankruptcy.

As the experience of the Russian judicial arbitration practice shows, a petition for declaring a debtor bankrupt is filed only when other measures to collect the debt have been exhausted and the most liquid assets have left the debtor's possession. Thus, by the time a bankruptcy case is initiated, the debtor usually lacks property that allows him to conduct core business efficiently, the total amount of debt to creditors significantly exceeds the value of the business itself and, as a result, restoration of the debtor’s solvency is impossible and is not necessary for its owners and creditors.

Unfortunately, in spite of not declaring the priority of rehabilitation procedures in the Bankruptcy Law, the notion that bankruptcy is the actual liquidation of a business prevails in the Russian legal consciousness; the debtor enterprise is a priori insolvent, and the sole task of creditors and business owners is to satisfy their requirements.

According to this, participants in a civil turnover have a negative attitude to the prospect of bankruptcy and do not consider it (in particular, the financial recovery process) as a way to overcome the financial crisis. They seek to delay the opening of the bankruptcy proceedings as much as possible, which makes it impossible to subsequently restore the solvency of the debtor.

Nevertheless, there are precedents for the positive application of the practice of financial recovery in the experience of Russian legal proceedings. For example, in the case No.  A79-2849/2010, examined by the Arbitration Court of the Chuvash Republic, a financial rehabilitation was introduced for a developer for a period of twenty months in relation to the developer company, and a schedule for debt repayment was approved.

As a result of the financial recovery procedure, it was possible to restore the solvency of the debtor, and to repay the claims of creditors. During the bankruptcy procedure, the company managed to complete the construction of the residential complex and put it into operation, as well as to transfer the apartments to the participants in shared construction. After the completion of the bankruptcy procedure, the company continued to work.