Law Leaves Private Debtors Naked

As consumer lending, formation of credit bureaus and credit histories are progressing in Russia, a strong bankruptcy system seems to be the missing piece of the jigsaw.

Suspicion that bankruptcy is simply an excuse for debtors to avoid their obligations is slowly giving way to understanding the role of insolvency in a market economy, and Russia's current bankruptcy law says that individuals, along with companies, can go through bankruptcy procedures. However, the practice proves otherwise and personal bankruptcy remains a foreign concept, experts say.

Since 1992, Russia has seen three bankruptcy laws passed, with the latest having gone into effect in 2002. But, according to Alexei Tolokonnikov, an attorney with Freshfields Bruckhaus Deringer, the legislation is contradictory.

"The new law appears to contradict a number of other laws. Some believe it contradicts the Civil Code," he said, adding that it has yet to be tested in the courts.

"Individuals as such cannot file for bankruptcy [in Russia]," said Alexander Ivanov, a partner with the MINFIN consulting group.

This means that people who have debts are deprived of the mechanisms that would empower them to solve their problems, Ivanov added.

There still is a traditional misconception around the issue of personal bankruptcy largely associated with the 1990s, when bankruptcy was used arbitrarily and served as the main instrument of property redistribution.

Russia needs to raise awareness on the subject of personal bankruptcy because "people should understand that it is not bad," said Andrei Yegorov, a counselor with the Supreme Arbitration Court. Without well-developed bankruptcy legislation, "consumer loans are dangerous," he added.

Consumer lending has been steadily on the rise in Russia. According to the Central Bank, as of Sept. 1 personal ruble loans totaled 411.3 billion rubles, an increase from 14.4 billion rubles in 1999.

Yet experts say consumers have not had time to pile up debt on a mass scale.

"Russian consumers do not generally carry a lot of consumer debt," said Michael Malloy, the head of the corporate commercial group of Gowlings International in Moscow. "People do not generally carry payment cards, and those that do have debit cards rather than credit cards, so they do not build up large credit card balances."

Other types of borrowing are still in their early stages so it is too early to tell how over-extended consumers will resolve their debts, he added.

Debt collection agencies "occasionally poke their heads out," but "the cost of collection is much higher in Russia," said Jamie Firestone, a Moscow-based lawyer with Firestone Duncan. While in the United States debt collection can involve mostly "nickel-and-dime stuff" such as telephone bills, in Russia "you just switch telephone companies."

Collection agencies in Russia usually kick in when larger sums are at stake, he added.

Credit histories, both positive and negative, will eventually enable creditors to differentiate consumers. That, in turn, will boost consumer lending by banks, stores and other financial institutions. Credit bureaus have recently started making an appearance in Russia. In September, Interfax set up a joint credit bureau with Experian, the largest Western watchdog agency.

"At some point, Russian legislation will have to deal with personal bankruptcy," Firestone said.

Meanwhile, bankruptcy law for companies is becoming more rehabilitative by giving legal entities the mechanisms to withstand financial pressure and get back into business.

Either the company or its creditors can initiate bankruptcy proceedings and there are no differences in the law's treatment of local and foreign businesses operating in Russia when it comes to filing for bankruptcy, Firestone said.

An insolvent company initiates bankruptcy proceedings, which may lead to its liquidation, by filing a petition with the court. It will have to present evidence of its inability to meet its debts and to pay tax, and in short prove it is genuinely on the verge of bankruptcy.

"Unfortunately, some people play a shell game with companies, leaving creditors holding the bag," Malloy said.

The consequences of the commencement of liquidation initiated by the debtor are similar to those of the commencement of a liquidation initiated by creditors.

The debtor and its creditors, according to Tolokonnikov, may also agree on the conditions for the settlement of debts in a composition and thus terminate bankruptcy proceedings. A paper written jointly by Tolokonnikov on insolvency and restructuring in Russia, as well as many other jurisdictions worldwide, is available online at Gettingthedealthrough.com.

While foreign individuals are not liable for bankruptcy in Russia, individual entrepreneurs registered with the tax authorities are. Furthermore, as of Dec. 31, 2004, expatriates registered as entrepreneurs have to have a residency permit in Russia, Firestone said. "And not many have it."