The Supreme Court will decide whether affiliation with a bankrupt through government structures lowers the priority of a creditor

The Supreme Court will decide whether it is possible to downgrade (subordinate) the claims of a creditor affiliated with the bankrupt through the municipality. In the dispute referred to the Economic College of the Supreme Court, the issue is that the administration of Ufa controls both the debtor and the creditor. As a general rule, debts to persons related to the debtor that arose during the period of his property crisis are repaid after independent creditors. But it is unclear whether this applies to cases where the beneficiary is a state or municipal entity. Lawyers note that there is no direct prohibition in the law, and consider it necessary to develop a systematic approach to this issue.

The Supreme Court will provide clarification on whether it is possible to subordinate a creditor if it is affiliated with the bankrupt through a public legal entity represented by a government authority.

The dispute arose within the framework of the bankruptcy of OJSC Sipaylovsky Housing Management of the Oktyabrsky District of the Urban District of the City of Ufa of the Republic of Bashkortostan (UZHH). This company was engaged in the management of apartment buildings in Ufa. Thermal energy and hot water were supplied to these houses by Bashkir Distribution Heat Networks LLC, to which UZHH owed money for the supplied resources. The right to claim this debt of the network was ceded in favor of Investment Agency JSC, which in September 2019 signed an agreement with the debtor on an installment plan for 49 years. But already in March 2020, at the initiative of another creditor, the court opened a bankruptcy case for UZH; in August, a monitoring procedure was introduced in the company, and in January 2021, external management (a rehabilitation procedure aimed at restoring the debtor’s solvency). The Investment Agency asked to include its requirements for 114.5 million rubles. in the third place of the register of creditors.

The republic’s arbitration court completely rejected the agency, considering that this was an unreasonable demand that violated the rights and interests of other creditors. The appeal and cassation decided differently: they admitted that the debt exists, but it should be repaid after all independent creditors included in the register. Court decisions note that the sole shareholder of the Investment Agency is the Department of Land and Property Relations of the Ufa Administration. At the same time, 74% of the shares of UZHH belong to the MUP, the owner of which is again the administration of Ufa. Thus, the city authorities control both the debtor and the creditor. By granting a deferment, the affiliated creditor provided the debtor, “in a state of property crisis,” with “compensatory financing,” which is the basis for the subordination of its claim, the decisions explain.

The investment agency appealed this to the Supreme Court, stating that the redemption of another creditor’s claim against the debtor and the provision of installment plans “were due to the need to solve socially significant problems in the housing and communal services sector, and not to the beneficial desire of the Ufa administration to participate in the distribution of all possible future management profits.” The case was transferred to the economic board, the meeting is scheduled for February 19.

“The issue of subordination of the claims of public legal entities affiliated with the debtor in judicial practice is ambiguous,” says David Kononov, head of the bankruptcy practice of Lemchik, Krupsky and Partners. “There is no single approach in practice,” admits Orchards adviser Vadim Borodkin. “But there is a tendency to not apply the rules of subordination to the claims of creditors affiliated with debtors through government bodies or public entities.”

Partner at Sotheby’s law firm Anton Krasnikov confirms that in the vast majority of cases, courts refuse to subordinate the claims of such creditors. This is motivated by the reference to paragraph 13 of the Supreme Council review, as well as “a reference to socially significant functions performed by companies in the authorized capital of which a public entity participates,” clarifies Mr. Krasnikov.

However, “it is premature to talk about the current unified approach in practice,” since the Supreme Court touched on the issues under discussion only in the mentioned review and “in relation to unitary enterprises, which, in principle, are usually created to assist in achieving public objectives,” emphasizes Anton Krasnikov. If the state or municipality creates business companies (JSC, LLC) to extract commercial benefits, then “it is wrong for them to assume the primacy of the public goals of their founders,” Mr. Krasnikov believes.

In general, this is a complex issue, says Mr. Borodkin, “since here public interests very clearly collide with the interests of private individuals.” According to Mr. Kononov, it is necessary to distinguish between situations when “the proposed deferment pursued the solution of socially significant problems” and when “there was pure additional financing of the debtor in the conditions of its crisis.” In the latter case, the lawyer believes, the debt must be subordinated, otherwise it “will definitely violate the rights of creditors not related to the debtor.” In the UZH case, the court must find out the goals of creating the Investment Agency, evaluate its activities before the redemption of the disputed debt and “its role in the economy of the region,” explains Anton Krasnikov.

Let us recall that in the amendments to the bankruptcy law being developed by the Ministry of Economy in Art. 19 it was proposed to directly exclude the Russian Federation, constituent entities of the Russian Federation and municipalities from the circle of persons interested in the debtor. This would make it possible not to apply the rules on subordination to public entities and the persons controlled by them and to stop disputes about this. In May 2021, the bill was submitted to the State Duma, but its consideration has stalled.

As a result, there is now no direct ban on the subordination of such creditors, so “attempts by lower courts to tailor the task to the answer run counter to the interests of commercial creditors, who are no less important for turnover, being taxpayers and employers,” points out Vadim Borodkin. “If preferences are created for “public” creditors, then they must be systematic, consistent and preferably enshrined at the legislative level,” the lawyer concludes.

Anna Zanina