Oda Russian Commercial Law 2007-1

it. The pledger was obliged to notify all the subsequent pledgees of the existing pledges. For non-compliance with this requirement, the pledger was to be held liable. The Civil Code has a similar arrangement (Art.342), but whether this has any practical meaning is questionable.

Subsequent creditors are protected only if there is a proper system of registration which the person who intends to create security can refer to for information on prior security.

A Japanese company EIP initiated an action against a limited liability company MBT and a regional bank asking the court to acknowledge the contract of pledge of immovables concluded between the MBT and the bank on September 13, 1996 to be invalid.

Asaresultofatri-partitecontract,concludedbetween1993and1995,EIPprovided aloantothecompanyGreenlineExpressforconstructingahotelinKhabarovsk.MBT, asthepossessorofthehotel,wastotransfertherighttopossessandusethehoteltoEIP in the case of default by Greenline Express. On May 1, 1996 and February 18, 1997, MBT which had assumed the debt of Greenline Express, concluded a contract with EIP to the effect that MBT transfer the title to the hotel in the case of default.

However, MBT had concluded a loan agreement with the bank on September 4, 1996 and a contract of pledge on the hotel with the bank on September 13, the same year. EIP sued MBT and the bank to have this agreement recognised as null and void. The ground for this action was the failure on the part of the MBT to indicate the possessor of the assets, and to disclose the EIP debt owed by MBT.

Both the appellate instance and the cassation instance judges rejected the claim, but acknowledged that EIP had pledge on the hotel.

The Supreme Commercial Court found that the lower courts recognised the right of pledge of EIP on the hotel and concluded that the pledge by the bank was inferior to the pledge by EIP without suf cient grounds. In this case, Russian Law is applicable, since the status of immovables should be determined by the law of the location of the property. Russian law sets certain requirements as to the content of the pledge agreement. The contract takes effect only by registration.

The Court reversed the case to examine whether these requirements were met by the parties.21

The 1998 Law on Hypothec has some provisions on subsequent hypothecs. The creation of a subsequent hypothec is allowed only when it is not prohibited by prior hypothec agreements. If, despite the prohibition, a subsequent hypothec is created, the court may declare subsequent hypothecs null and void. This applies regardless of whether the subsequent pledgee was aware of the prior hypothec

21Decision of the Presidium of the Supreme Commercial Court, December 14, 1999, Case 5534/98.

or not (Art.43, para.3). Most signi cantly, it provides that subsequent hypothecs can be registered and that the priority of hypothec is determined by the order of registration (ibid., para.1).

However, for other properties such as motorcars, or construction machinery, there is no protection as in the case with a hypothec, since registration is not a prerequisite for the effect of a pledge.

If a subsequent hypothecary creditor applies for enforcement, then, prior creditors may also apply, regardless of whether the claim is due or not.

6)Transfer of Collaterals

The Civil Code provides that the pledger may assign the collateral, offer it for lease, for gratuitous use, and by other means dispose of it, as long as it is not against the law or contract, or does not emanate from the nature of the pledge, but only with the consent of the pledgee. Agreements which restrict this right of the pledger are null and void (Art.346, para.2). There is a different arrangement regarding an encumbrance on the collateral in the Law on Hypothec as below.

In cases where the title to the collateral is transferred to a third party, the pledge remains with the property. The person who obtained the title replaces the pledger and becomes liable for the debt (Art.353, para.1).

While the Civil Code is silent on the effect of disposal of the collateral without the consent of the pledgee, the Law on Hypothec has a provisions on this matter. Thus, if the collateral was assigned without the consent of the pledgee, the pledgee has a choice of:

i)avoiding the transaction between the pledger and the third party, or

ii)accelerating the performance of the claim and seizing the collateral regardless of whom the collateral belongs to.

If the third party who obtained the collateral had known, or should have known that the assignment was effected without the consent of the pledger, the third party is liable to the pledgee jointly with the pledger for the non-performance of the obligation, but within the value of the collateral (Art.39).

The Civil Code allows the pledger to offer the collateral for lease, or gratuitous use of a third party in principle, but only with the consent of the pledgee. The Law on Hypothec differs from the Code in this respect. Under this Law, unless otherwise provided by a Federal law or contract, the pledger may lease the collateral, offer it for temporary use with compensation and create servitude without the consent of the pledgee. The period of such encumbrance should not exceed the period of the claim secured by the pledge (Art.40, para.1). These

Firstly, a real security right is not always enforceable when the debtor has defaulted. The Code provides for a moratorium for the pledger. Upon the request of the pledger, the court may postpone the public sale for up to one year (Art.350, para.2).According to a commentary, this applies in cases where, for example, the pledger had pledged his only property, such as accommodation. The pledger is to be given a chance to repay the debt before his property is foreclosed.23 Naturally, this is a great disadvantage to creditors.

Secondly, the Law on Hypothec provides that with regards to obligations which require periodic payments, the collateral can be seized only in cases where there was a systematic breach of terms in repayment by the debtor, i.e. where the repayment was not made in compliance with the date of repayment three times in 12 months unless otherwise provided in the contract (Art.50, para.2).

Finally, there is the mandatory requirement of recourse to court procedure and public sale.

The Civil Code distinguishes between the enforcement of immovables and movables. In the case of movables which have already been transferred to the pledgee, unless the law provides otherwise, the parties may agree not to use court proceedings for seizure. Concerning immovables, the Civil Code provides that satisfaction of the claim without recourse to the court is allowed only on the basis of a notarised contract concluded after the default (Art.349, para.1). Otherwise, the creditor has to go through court procedure. Furthermore, the Code also provides that such an arrangement to bypass the court can be invalidated by the court upon the petition of an interested party, whose right was affected by such an agreement. Interested parties in this context means secured lenders of a senior rank, or the owner of the collateral. An example is when the price of the collateral was incorrectly determined.24

According to the resolution of the Plenum of the Supreme Court and the Supreme Commercial Court, a clause in the contract of pledge which provides for the right of the creditor to take possession of the collateral immediately and directly is null and void.25 Such arrangements used to be common.26

The preference for court procedure is clearly based upon social policy considerations. Proponents of this approach maintain that with notarised agreements concluded in advance, at the time the document is formulated, the existence and validity of the secured claim as well as the possibility of recovering the claim by other means are not ascertained, and therefore, it entails a risk for the debtors.

23Braginskii and Vitrianskii, supra, p.431.

24Ibid., pp.429-430. Sadikov ed., supra, p.841.

25Item 46, Joint Decision of the Plenums of the Supreme Court and the Supreme Commercial Court No.6/8, July 1, 1996.

26A.A.Vishnevskii, Zalogovoe pravo, Moscow 1995, p.87.

Particularly at a time when the consumer credit industry is ourishing and citizens are pledging their ats which are their sole property, it is “unethical” to let creditors foreclose the property without recourse to court.27

This antipathy against enforcement without recourse to the court is also evident in the 1997 Law on Civil Enforcement. Previously, under the Code of Civil Procedure, along with court judgements and arbitral awards, notarised agreements of enforcement were listed as one of the grounds for enforcement. However, the 1997 Law on Civil Enforcement considerably limited the use of the notarised agreement, only allowing it to be used in alimony cases. In fact, this approach had already been clear in the 1992 Provisional Statute on Pledge, which was prepared by the Institute of Private Law in Moscow. Later, this Institute played a major role in preparing the Civil Code.

A further problem for the creditor is that the realisation of the collateral has to go through a public sale (publichnyi torg). The Civil Code provides that the pledged property is to be realised by public sale as provided by the procedural law (Art.350, para.1). The possibility of sale on a commission basis is excluded.28

The reason why public sale was made mandatory in the Civil Code is presumably because this way, instances such as pledgees taking advantage of commissioned sale, and acquiring the property at an unfairly low price, can be avoided. There has to be an element of competition in order to keep the sales price higher. The arrangement seems to be primarily based upon the policy to protect the debtor/pledger. As one commentator pointed out, “under no circumstances can the pledgee automatically become the owner of the pledged property”.29 Another commentator stated that “this rule protects the interest of the weaker party, since it ensures that the collateral is sold at market price”.30 The 1998 Law on Hypothec has a similar provision (Art.56, para.1). While the Code is silent as to the agency which handles public sale, the Law provides that it is the agency which is entrusted with the enforcement of court judgments that is to handle public sale (Art.57, para.1).

According to the Law on Hypothec, the procedure starts with the announcement of a public sale, at least one month before the sale. The starting price is declared at this stage. Those who intend to take part are obliged to place a deposit of up to 5% of the value of the property on sale. At the sale, only those who take part in the sale and those who are entitled to use the property or have a real

27Braginskii and Vitrianskii, supra, p.532.

28O.N.Braginskii ed., Nauchno-prakticheskii komentarii k chasti pervoi Grazhdanskogo Kodeksa, second edition, Moscow 1996, p.303.

29Ibid., p.304.

30Sadikov ed., supra, p.843.

right to the property may be present. The bidder who bid the highest price is the winner. This person must pay the price within ve days of the sale. Within ve days of the payment, the successful bidder concludes a sales contract with the organiser (Art.57).

There is some confusion regarding the concept of public sale. In addition to publichnyi torg, the Code refers to torg. Torg takes two forms; auction (auktsion) and tender bid (konkurs) (Art.447, para.4). The distinction between them is that in an auction, the highest bidder in price wins, while in a tender, “the most suitable person to solve the task” or the bidder “who made the best offer” wins.31 In other words, the price is not decisive in a tender bid. Presumably, as can be seen from the fact that the tender bid is utilised in the privatisation process for the sale of state enterprises, the tender bid may be intended to be used in the realisation of collaterals such as enterprises.

The Law on Hypothec juxtaposes public sale with auction. It has a separate provision on auction in addition to public sale. It provides that by agreement of the pledge and the pledger, a specialised organisation can be selected. This organisation is in a contractual relationship with the pledgee and acts in the name of the pledgee. The auction is, as a rule, conducted in public (Art.59, para.1).32

Thus, the Law on Hypothec, which is the latest law in this eld, has maintained the principle of mandatory public sale of the pledged property, but expanded the concept to include auctions by specialised organisations. It should be remembered that at the time of the preparation of the Civil Code, the possibility of commercial organisations being involved in auctions was already acknowledged.33 On the other hand, it has been made clear that the hypothecated property is to be realised within the framework of the civil enforcement procedure regulated by the Law on Civil Enforcement.34

This requirement of mandatory court involvement and public sale is inevitably time consuming and costly, and is therefore being criticised in Russia as “a completely inconvenient arrangement which apparently does not meet the needs of contemporary times”.35

Another problem with the mandatory public sale is that it is obviously not suited to pledges on claims. The 1992 Law on Pledge devoted a chapter to pledges on rights. It provided that objects of a pledge could be the right to

31Ibid., supra, p.998. B.A.Zavidov, Analiza zaloga v grazhdanskom prave. Moscow 1999, p.73.

32L.A.Novoselova, Publichnye torgi v ramkakh ispolnitel’nogo proizvodstva, Moscow 2006, pp. 18-19.

33Braginskii ed., supra, p.303.

34Novoseleva, supra, p.19.

35Sviridenko, supra, p.74.

possess and use property including the right to lease, and other rights (claims) emanating from obligations, as well as other proprietary rights (Art.54). This means that claims can be pledged in the same manner as proprietary rights, such as intellectual property rights.

If a public sale is mandatory, problems arise with the realisation of a pledge on rights. There is no problem in realising them by public sale or auction, if the given right is embodied in securities, for example, if company shares or bonds were pledged. However, if it is a simple money claim, such a claim is normally unsuitable for auction.

Let us assume that A has a claim against B. B, in turn, has a claim against C. B pledges his claim against C as a security for his debt to A. According to the present Russian Law,Acannot realise the claim other than by public sale or auction. It is unrealistic to think of a “market” for such claims unless debtor C is a major company. A possible solution is to let A exercise the right of B vis à vis C, i.e. let A replace B as a creditor within the scope of A’s claim by court order.

However, under the current law, even a claim against an individual has to be sold at auction or public sale, which does not seem to be rational.

The requirement of a mandatory public sale is justi ed by the fact that it ensures that the collateral will be realised at a fair price. However, the pledgee substituting the pledger in a claim by court procedure will not harm the pledger, since the pledgee substitutes the pledger only to the extent of his claim against the pledger, and the amount of this claim is already xed. There is no more possibility of unfairness to the pledger here than in a public sale.

9)Real Security Rights and Insolvency Procedure

Russian commentators agree that the nature of a pledge lies in the right to have a claim satis ed out of the proceeds from the pledged property in priority to other creditors. However, this is not necessarily the case under Russian Law.

The rst Insolvency law in the Russian Federation was enacted in 1992. This Law excluded secured property from the bankruptcy estate. The 1992 Law was replaced by a new Insolvency Law in 1998. In contrast with the 1992 Law, the 1998 Law as well as the current 2002 Law do not exclude the pledged property from the bankruptcy estate.

Secured claims do have priority to unsecured claims, but are inferior to two other categories of claims. One is the claim for compensation arising from damage caused to the life and health of people, and the other is the claim for wages and retirement payments. These claims, particularly the rst category, can be substantial if there was e.g. environmental damage caused by the pledger.

The justi cation for not excluding secured claims from the bankruptcy estate is primarily that a pledge is not a real right, but a right in personam.

What is more, the Civil Code provides in a chapter on bank accounts that in cases where the amount in the bank account is not suf cient to satisfy all the claims, tort claims are of the rst rank, followed by wages and retirement payments, and then, by tax and other mandatory payments. Money claims come after tax payments, and moreover, there is no distinction here between secured and unsecured claims (Art.855).

3ATYPICAL SECURITY RIGHTS

As mentioned above, the procedure for the enforcement of a pledge is rigid because of mandatory public sale requirements and does not meet the need of creditors who prefer quick, inexpensive and less complicated enforcement.

As one commentator put it, “because of restrictions imposed by the laws, a pledge does not give creditors in most cases con dence of speedy and full satisfaction of the claim through seizure of the pledged property”.36 Another commentator found “essential shortcomings of the pledge system” in that:

...the system, in a majority of cases, does not give creditors con dence in full and prompt satisfaction of the claim, since court procedure, which requires cost and time, is mandatory for enforcement.37

This author suggested that because of these shortcomings, in order to avoid risk, banks should conclude an agreement to have the title to the property combined with an agreement of reverse sale.

In some jurisdictions where speedy, uncostly, and uncomplicated enforcement of security rights is not available, eventually, alternative methods of security have developed. This is also the case with Russia.

In practice, varieties of transactions are being used as alternative means of securing obligations. Parties often resort to novation, or substitute performance (otstupnoe). They agree in advance to terminate the contract and conclude another agreement, which, in effect, is an agreement to transfer the title of the property to the pledgee. However, novation is accompanied by a risk of litigation by interested parties such as other creditors, since as the original transaction has been terminated and replaced by a new agreement, whatever priority they had

36G.Adamovich, “O nekotorykh sposobakh obespecheniia kreditnykh obiazatel’stv, KhiP, 1996 No.9, p.41.

37M.Chirkova, “Otsenka zaloga kak sposoba obespecheniia vozvratnosti kredita”, VVAS RF, 1998 No.8, p.38.