A Landmark Judgment on the Bankruptcy of Foreign Companies in Russia

Dmitrii Pekarnikov*

Introduction

On February 8, 2024, an event occurred in the regulation of cross-border bankruptcy in the Russian Federation that can be directly called revolutionary. The Supreme Court of the Russian Federation directly recognized the possibility of opening bankruptcy proceedings against foreign companies in the Russian’s courts. In this ruling, the court listed in detail the criteria under which such proceedings are possible and in what forms they can take place.

Why is this judgment so important?

Firstly, although formally there is no case law in Russia, the Supreme Court of the Russian Federation, with its judgments on specific cases, as well as abstract explanations, indicates the guidelines that lower courts are guided by when handing down their judgments.

Secondly, over the previous decades, attempts were made to initiate bankruptcy proceedings against foreign companies in the Russian’s courts, as a last chance to collect debts to Russian creditors. But invariably, for decades, the courts refused to do this, citing the provision of the Federal Law “On Insolvency (Bankruptcy) in the Russian Federation” (“hereinafter the Code”). This provision establishes that only an individual or legal entity registered in the Russian Federation can be declared insolvent (bankrupt) in the Russian Federation.

Thus, the ruling of the Supreme Court of the Russian Federation in the Westwalk case changes the previous judicial practice regarding the bankruptcy of foreign companies in Russia by 180 degrees.

Thirdly, it should be noted that the bankruptcy legislation of the Russian Federation almost completely lacks rules governing cross-border bankruptcy. The Code contains only the rule that foreign companies can participate in bankruptcy cases in the Russian Federation as creditors (but not debtors!). The Supreme Court of the Russian Federation gave this norm a broad interpretation.

We can say that the Supreme Court of the Russian Federation went beyond its powers and actually replaced the legislator. A draft law on the regulation of cross-border bankruptcy in the Russian Federation was developed in 2011, but has not yet been adopted by the Parliament.

The Supreme Court of the Russian Federation often gives a broader interpretation of the law than can be understood by simple reading. Therefore, when analyzing provisions on the legislation of the Russian Federation, the position of the Supreme Court on the issue in question is to be attached great importance.

What did the Supreme Court of the Russian Federation rule in this particular case?

The court, in its judgment, applied the concept of cross-border bankruptcy established in the UNCITRAL Model Law on Cross-Border Insolvency (1997). The Supreme Court thus indicated to lower courts the following procedure when the courts receive applications to declare debtors registered outside the Russian Federation insolvent.

First of all, when considering a bankruptcy petition of a debtor, the courts of first instance must find the existence of a close connection between the debtor and the Russian Federation. Examples of such a connection could be economic activity on the territory of Russia; location of a governing body, branch or representative office of a foreign company on the territory of Russia; location of assets of a foreign company in Russia; the presence of the majority of the foreign company’s creditors in Russia. The list is not exhaustive.

The lack of registration of a foreign entity in Russia is no longer an obstacle to initiating bankruptcy proceedings and transferring powers to manage a foreign company to a special manager approved by the court.

In this case, it is necessary to take into account the allocation of the burden of proof between the parties to the process, taking into account their capabilities. It is enough for the applicant to confirm the existence of circumstances that prove, in his opinion, the close connection of the debtor with the Russian Federation, after which the burden of proving the opposite passes to the defendant, who can refute it.

If a close connection of the debtor with the Russian Federation is discovered, the court must decide whether the debtor’s Center of Main Interests (COMI) is located in Russia. If the debtor’s COMI is in Russia, the courts should initiate main bankruptcy proceedings, which should have an effect on all other jurisdictions. Such a bankruptcy procedure is of an extraterritorial nature and applies to all of the debtor’s property, regardless of its location, including outside the Russian Federation.

If the debtor’s COMI is located outside of Russia, then the courts initiate secondary proceedings. Such secondary proceedings apply only to the assets of a foreign company located in Russia, and only creditors associated with the activities of a foreign company in the Russian Federation participate in it.

Since in Russia it is possible to declare an individual insolvent, lower courts will be able to take this judgment as a model when considering applications for bankruptcy of individuals.

How might this affect foreign companies doing business in Russia in general and Turkish companies in particular?

This judgment of the Supreme Court of the Russian Federation changes the rules regarding the collection of debts from foreign companies operating in Russia.

Now, if there are debts of a foreign company, not only enforcement proceedings can be initiated against such a debtor, but also bankruptcy proceedings as well. Bankruptcy proceedings have a wider range of debt collection and property collection tools. During bankruptcy proceedings, it is possible, for example, to assess the fairness of transferring of debtor’s property, including payments. Also, if dishonest behavior of the company’s managers is detected, courts may hold them vicariously liable for the company’s debts remaining unpaid. That being said, it should be noted that there are quite strict standards in Russia that allow to collect unpaid debts from company managers after the bankruptcy of the company.

Examples of initiating bankruptcy cases against foreign companies that have assets in the Russian Federation already exist, including against Turkish companies. Thus, already in February 2024, the Eleventh Arbitration Court of Appeal confirmed the legality of the initiation by the Arbitration Court of the Republic of Tatarstan of secondary bankruptcy proceedings in relation to the property of a Turkish company located in Russia.

Of course, doubts remain regarding the extraterritorial effect of Russian courts’ judgments. The Russian Federation does not have international treaties with any country allowing the recognition of judicial acts of courts in bankruptcy cases. Thus, recognition of such judicial acts in other countries will occur on the basis of reciprocity. However, bankruptcy cases of a foreign company in the Russian Federation may have an impact on transactions for the transfer of assets located in Russia, previously owned by a foreign debtor. If such transactions are declared invalid in a bankruptcy case, such assets may be seized from the acquirer of the assets to satisfy the claims of creditors of the foreign company.

Conclusion

Thus, after the above judgment of the Supreme Court of the Russian Federation, foreign companies, including Turkish ones, operating in Russia should take into account the following. If debts are not paid in Russia, they may be subject to bankruptcy proceedings in Russia, even if they did not register a Russian legal entity.

Bankruptcy will be carried out in accordance with the principles set out by the UNCITRAL Model Law on Cross-Border Insolvency (1997), although there are no provisions for this in Russian law.

If the Russian court considers that the COMI of the foreign company was located in Russia, then the main bankruptcy procedure will be initiated. This could have legal consequences for foreign companies around the world. If the company’s COMI was located outside of Russia, the Russian court will initiate a secondary bankruptcy procedure, which will only affect the assets of the foreign company in Russia.

* Lawyer; graduate student, Koç University Law School