Important Changes to Russian Law
Russian law is facing considerable changes. Amendments to be introduced to the Russian Civil Code, which is the most fundamental piece of Russian legislation relating to business operations, aim to facilitate the use of some legal instruments in the cross-border transactions previously officially unknown in Russia. The proposed amendments are the result of Russian law’s adoption of many Western legal concepts commonly used overseas in both corporate and financial transactions including syndicated lending, structured finance, asset and project finance.
The amendments cover a wide range of legal issues which are previously untested in Russian courts, but sometimes used in practice (for example, warranties and representations). They also introduce a number of legal instruments, which will bring Russia’s legal environment closer to that of Western developed jurisprudence.
New banking concepts
Regarding banking transaction, certain important changes will be made to the system Russian bank accounts. This will facilitate use of Russian banks when structuring financial deals that were previously channelled through Western financial institutions.
For example, previously Russian law was not familiar with the concept of escrow accounts. The general rule under Russian banking regulations was based on the fundamental principle that a client is entitled to close its bank account at any time, and any agreements stating otherwise were not enforceable. Therefore, any arrangements relating to the bank accounts opened in the Russian banks were not reliable.
The amendments to the Civil Code introduce a concept of escrow account, which is similar to that existing in the West. An escrow mechanism allows the parties to block the funds until certain contractual obligations are performed. Under the Russian banking law escrow arrangement it is not the parties but the bank, in which the escrow account is opened, that controls the performance of the obligations. Such a mechanism may be a reliable instrument for Western investors, once an escrow is opened in a local subsidiary of an esteemed Western bank, since this bank will be in charge of the funds transfer. It should be also noted that not only money, but any asset, including securities, may be put under an escrow regime.
Russian law will recognise a new concept of a ‘joint account’, which may be used as a sort of security, or at least will be a comfort for foreign creditors. Unlike the previous one-client-one-account approach, soon it will be possible to have a single account be owned, and more importantly controlled, by two clients. This, for example, includes a debtor and a creditor, as per their agreement. However, one disadvantage of joint accounts is that each of the accountholders may withdraw from the arrangements at any time without the other holder’s consent. Needless to say, the possibility of this diminishes the mechanism’s attractiveness.
Lack of a Russian equivalent of a pledge over a bank account was, in the past, one of the biggest disadvantages of Russian law. This was the main reason why any arrangements involving account pledges were normally put in place outside Russia. Instead of an account pledge, Russian legal practice developed the account debiting rights concept. This allowed the creditor to debit funds on the debtor’s bank account without the accountholder’s consent. This legal instrument was far form perfect in practice, and in no circumstances could it be treated as security under Russian law.
The amendments to the Russian Civil Code introduce a new concept called a ‘pledge account’. This is a special type of a bank account opened for the purpose of a pledge, even if no money has been credited to this account. Such an account should be separated from other accounts opened by the debtor. The pledgee may be both the account bank and a third party.
The agreement on account pledges may refer to the fixed sum credited to the account being pledged. In this event, the pledgor must keep, as a minimum, amount on its pledge bank account. Strictly speaking, in this event this amount will be deemed to be pledged. The account pledge agreement is subject to recording by the bank in which the pledge account is opened. The bank keeps the record of such accounts, and the pledge is effective once the bank records it.
Unless otherwise specified in the agreement, the pledgor may debit the pledge account. However, it cannot do so in respect of the pledged fixed amount specified in the agreement, or once the pledgee notifies the bank of the pledgor’s default. If the bank debits the account in breach of this rule, the pledgor and the bank are jointly and severally liable to the pledgee.
The enforcement of the pledge of account is performed by a direct payment of the sum on the pledge account to the pledgee to be made upon a court decision or otherwise.
Pledge of rights
The proposed amendments to the Civil Code introduce a detailed mechanism for the pledge of rights. This concept has not been developed under Russian law and, therefore, is very rarely used in practice. The amendments allow a pledge of existing and future rights, partial rights, and non-matured rights – the parties will have great flexibility in structuring the scope of rights to be pledged.
Generally, the pledgor is not obliged to obtain its debtor’s consent for such a pledge. If an agreement between them prohibits the assignment, the pledge of rights will still be valid and effective, but the pledgor will be liable to its debtor for entering into the pledge without its debtor’s consent. The pledgor must therefore inform its debtor about the pledge, otherwise the creditor may accelerate the debt.
Depending on the wording of the agreement on the pledge of rights, the debtor of the pledgor shall pay either to the pledgor or directly to the pledgee. If the payment is made to the pledgor, it must transfer the revenue to its creditor (pledgee) unless the pledge agreement states otherwise. The agreement may state that the revenue due to the pledgor will be credited to its pledge account. Breach of this obligation may be a ground for acceleration of the debt.
The pledge of rights may be enforced either through court proceedings or without court involvement by means of assignment of the rights to the creditor (pledgee). Such assignment cancels the debt (or its relevant part).
Syndicated lending
Traditionally, syndicated lending is not widely used among Russian banks and Russian borrowers, although it has been recently reported on a number of pure Russian syndications. Lack of relevant, developed legislation has been named as one of the problems restricting the growth of syndications under Russian law. Syndicated lenders faced particular difficulties structuring their security in Russia since, like many other continental jurisdictions, Russian law is not familiar with the concept of a security trustee. This gave rise to a number of legal queries, particularly regarding sharing, managing, registering or enforcing Russian law security of a debt to several creditors, for example syndicated lenders.
The amendments to the Civil Code aim to facilitate dealing with security owned by a number of creditors. They introduce the concept of co-pledgees and, more importantly, allow them to enter into agreements governing their management of the security. The Civil Code will refer to the concept of ‘security management’, which allows the parties to nominate one of the creditors, or even a third party, to act as a manager of the security. This approach is close to the English law concept of security trustee. The security manager will act in the interest of all other creditors, it will be a party to a pledge agreement on behalf of other creditors, and the agreement may provide for management fees to be paid by other creditors to the manager. It is important to note that the pledges owned by the security manager do not form its bankruptcy pool of assets. If the pledge is enforced, the security manager will distribute the relevant assets (or proceeds) to all creditors on a pro rata basis.
However, the security manager’s power may be limited by the agreement. For example, if the agreement specifies, it may not take certain actions without the consent of other creditors.
Conditions precedent
Historically, Russian law was not familiar with the concept of a condition precedent. In terms of bank lending, the present wording of the Civil Code refers only to one possibility where a bank may refuse to lend, namely, if the bank believes that the loan will not be repaid. Failure to comply with what is understood in the West as a condition precedent, is not technically a ground for refusing to lend under Russian law. It was argued that lending under a condition precedent may be viewed as a conditional transaction, as it is understood in Russian law. However Russian court practice does not, as a rule, recognise conditions being dependent on the actions of the parties. This leads to uncertainty with enforceability of the Western concept of conditions precedent, despite being used widely in cross-boarder transactions involving Russian companies.
The proposed amendments to the Civil Code introduce a concept of ‘conditional performance of obligation’. If applied properly, it may be structured as a typical condition precedent, for example in banking lending where a bank undertakes to lend only if certain conditions are met. This may also mean that other clauses of the facility agreement, particularly those related to payment of the bank’s fees, are effective. However, it is advisable that this effect is clearly specified in the agreement.
Many other new legal concepts will be introduced by the amendments. Needless to say that even once they are adopted as law, it will take a while for Russian bankers, lawyers and judges to test them. However, once they are confirmed by court practice, the Russian legal system will be much more attractive for Western investors. It will provide proper legal protection of investors’ rights, and will be viewed as a developed legal system closer to that of jurisdictions with which such investors are familiar.
