Significant Amendments to Federal Law On Insolvency (Bankruptcy) Relating to Employee Status

15.07.2015

Legal update No 522

Goltsblat BLP advises that, on 29 June 2015, the President of the Russian Federation signed Federal Law No. 186-ZF "On Amending Certain Legislative Acts of the Russian Federation".

The Law introduces amendments to a number of legislative acts: the Civil Code of the Russian Federation, the Federal Law "On Insolvency (Bankruptcy)" (the "Law") and the Federal Law "On Enforcement Proceedings”, some of which are significant . Certain financial and credit institution bankruptcy specifics are also covered by the Law.

Previously, the main threat to businesses came from active creditors and tax authorities, whereas the legislators have now decided to equip debtors' employees with quite serious leverage mechanisms to use with their management. Coupled with earlier amendments, this potentially complicates protection of businesses against hostile creditors.

According to these amendments (the listed ones being the most significant in our opinion):

  1. Employees (including former ones) are now, for the first time, entitled to seek bankruptcy of their employers through an arbitration court (article 11 of the amended Law), whereas individuals to whom salary arrears were owed did not previously enjoy such a right. Furthermore, the legislators have also made it possible for employees to combine their claims and file joint petitions for bankruptcy of a debtor (clause 5, article 39 of the amended Law).
  2. Employees’ right to apply to an arbitration court to open a bankruptcy case on their own initiative must be confirmed by a court decision ordering recovery of funds (article 7 of the new version of the Law). It should be mentioned that the procedural legislation allows this decision to be obtained within a relatively short period. Please note that where a bankruptcy case has already been initiated, the preferential procedure (not requiring a court decision) is retained for including claims for severance payment or salaries to individuals that work or worked under employment contracts.
  3. Debts to employees must now be taken into account by the debtor's management in identifying signs of the company's bankruptcy (article 3 and 4 of the new version of the Law).
  4. If a bankruptcy case is instigated against a debtor on the basis of a petition from an employee and then its assets turn out not to suffice to pay court and other mandatory costs relating to the bankruptcy case (such as the administrator’s fees), the Law expressly releases the initiator from the obligation to cover these costs (clause 3, article 59 of the new version of the Law).
  5. The Law establishes a procedure, previously lacking, for electing and re-electing a representative of the debtor's employees for the bankruptcy proceedings (article 12.1 of the new version of the Law). Such a representative’s services may now be paid at the debtor's expense (clause 11, article 12.1 of the new version of the Law). Businesses should be aware that, in conjunction with the other provisions of the Law, the amendments not only formalise the way such a representative should be elected but, in our opinion, also establish some economic and organisational preconditions for duly qualified debtor employee representatives acting independently, as it were, of the employer’s will to appear on the legal market.
  6. The order of priority is specified for repaying current arrears to the debtor's employees that were (or continue) in employment when the bankruptcy petition is accepted. These claims will now be paid as a second priority and any other claims of the same priority will be excluded in order to prevent abuse by managers, insolvency administrators and other persons.
  7. Debtor employee representatives, employees and former employees may, in certain cases, file requests for secondary liability to be imposed on the debtor's controlling persons, including the director (clause 5, article 10 of the new version of the Law).
  8. The amendments expressly envisage the insolvency administrator's duty to identify, within the scope of a bankruptcy case, breaches of the obligation to file the debtor’s petition to an arbitration court and to take steps to hold the guilty person liable (let us recall that this relates to secondary liability of this person for the bankrupt party’s debts);
  9. The founders of (or participants in) a credit institution or a third party (or parties) may, at any time once the institution is declared bankrupt and before the receivership proceedings are completed, provide sufficient funds to cover discharge of the latter’s obligations.

The general rule is that the above amendments will take effect 90 days after their official publication, but the Law also stipulates certain enactment specifics for proceedings initiated and continuing at a certain stage.

As a result, these amendments clearly demonstrate the legislators’ intent to give the strongest protection to the weakest category of creditor, i.e., the debtor's employees, by arming them with a range of powerful tools.

Companies should note that the new opportunities afforded to employees might be used by bad faith parties for purposes totally different from repayment of debts to employees. For instance, they could use the current legislation to obtain a prompt decision to recover salary arrears and then initiate bankruptcy proceedings, specifying an insolvency administrator who will support them thus causing a chain reaction with other creditors lodging claims and bankruptcy petitions.

In order to prevent such abuse, debtors-employers and their managers should now monitor the status of their debts not only to business partners but also employees. Should any difficulties or complications arise in protecting a business against bad faith parties, we recommend using qualified lawyers to assist.

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