Jeff Browne and Ivan Kozhemiakov of Chadbourne & Parke look at how changes to Russia’s Civil Code will affect the pledge security regime

On July 1 2014 certain changes to the Russian Civil Code relating to the legal regime for taking pledge security came into force as part of Russia’s on-going reform of its civil legislation. The changes have implications for lenders taking security over certain types of collateral (e.g. contractual claims, bank accounts, and others) and are aimed at providing increased certainty to some of the options available for reducing credit risk.

A brief overview of some of the key changes is provided below.

1. Registration of movable property pledges

A new system of centralised registration of security interests over movable property has been introduced. Pledgors and pledgees of movable property (with the exception of some types of collateral which are subject to separate requirements) are entitled to deliver a notice on the creation of a security interest to a notary public. Upon receipt of such notice, the notary public is required to submit information about the security interest for inclusion in the register of notices on pledges of movable property (which is part of the unified information system of notaries operated pursuant to legislation on notaries).

Parties are incentivised use such registration possibility for two important reasons. First, because registered security interests take priority over unregistered security interests even where unregistered security interests were created earlier, although a transition period (until February 1 2015) during which previously-applicable priority rules continue to apply has been put in place).  Second, because of the risk of an automatic termination of the pledge upon the sale of the collateral to a "good faith purchaser", i.e. a purchaser who was not aware and should not have been aware of the fact that the property had been pledged.

2. Reduction in formalities for movable property pledges

There is no longer a requirement to specify the value (otsenka) of the pledged property in the pledge agreement itself as a pre-condition to its validity. Under the new rules the value (stoimost) of the collateral is determined by agreement between the parties. Further, unless otherwise provided by law, the starting price for the purposes of realisation of the collateral upon enforcement shall be either the value determined by an agreement between the parties or by a court order on enforcement.

There is also no longer a requirement to describe the nature, size and the term of the secured obligations in the pledge agreement as a pre-condition to its effectiveness and a reference to the underlying agreement, which contains the secured obligations, would be sufficient.

3. Enforcement rules

The previously applicable Law on Pledge (No. 2872-I, dated May 29 1992) has been repealed and provisions dealing with the enforcement of pledges into the Civil Code have been incorporated into the Civil Code. The rules have not been substantively altered in the process, but were refined to address some specific shortcomings.

For example, the rules now address the consequences of enforcement of a prior-ranking pledge.  Unless limited by agreement, the subsequent-ranking pledgee will be entitled to accelerate the underlying obligations and initiate enforcement of the subsequent-ranking pledge simultaneously with the enforcement of the prior-ranking pledge. However, if the subsequent-ranking pledgee fails to do so, the subsequent-ranking pledge will terminate (except where the collateral remaining after enforcement of the first-ranking pledge would be sufficient to cover the relevant secured obligations).

4. Security agent acting for multiple creditors

The concept of a “collateral management agreement” allowing multiple creditors to appoint a collateral manager to administer security over a single asset has been introduced. Russian law’s existing principles of agency (porucheniye) will apply to the collateral manager’s duties insofar as the new provisions do not cover the relevant issues.

Under a collateral management agreement, the creditors are bound to act through the collateral manager who, in turn, must act in the interests of all the creditors and each creditor would be a pledgee of record. It seems that in its current form the new concept would not provide significant additional certainty and flexibility to similar structures already familiar to the market and based on general statutory provisions.

5. Bank account pledge

The amendments introduce the concept of a pledge over rights to a special secured bank account (zalogovyi schet) in the form of a pledge of rights under the bank account agreement. Generally, the pledge would cover the whole amount standing to the credit of the account; alternatively, it is possible to stipulate that the pledge covers a fixed monetary amount below which the account balance should not decrease.

Prior to an enforcement event, the pledgor is entitled to use the right to use the funds standing to the credit of the secured account without restriction (or to the extent the balance exceeds a fixed limit), unless the pledge agreement provides otherwise. Following an enforcement event, (i) the bank is prohibited from performing any instructions from the pledgor that would result in the account balance falling below the amount of the secured obligations, and (ii) the pledgee may instruct the bank to debit the secured account in the pledgee's favour. Failure to comply would make the bank liable jointly and severally with the pledgor in the amount of the funds wrongfully debited from the secured account.

6. Security over contractual claims

The amendments permit both current and future claims, both under existing and future contracts, to be pledged.

Even where the underlying contract contains a prohibition on pledge, failure to notify the debtor under the underlying contract relating to entrepreneurial activity will not invalidate the pledge or serve as a ground for termination of the underlying contract, but would serve as grounds for a claim for damages.

Unless the pledge agreement provides otherwise, a pledgee is entitled to (a) direct the pledgor’s debtor (which has been notified of the pledge) to perform its obligations directly in favour of the pledgee and (b) to compel the pledgor to transfer receivables to the pledgee.

7. The Russian law “floating charge”

From January 1 2015 it will be possible for pledgors engaged in entrepreneurial activity to grant security over all or a particular portion or class of their assets owned from time to time (similar to the English law floating charge). Previously, pledged property was to be specified in the pledge agreement.

 


Jeff Browne

Counsel

Chadbourne & Parke

Moscow

 

About the author

Jeff Browne has great depth of experience acting for lenders, borrowers and arrangers on all forms of finance, including commodity finance, real estate finance, acquisition finance, syndicated loans, debt restructuring and derivatives. He also advises on cross-border mergers, acquisitions and joint ventures in Russia, Ukraine and the wider Commonwealth of Independent States. His sector experience includes energy and natural resources, financial services, media, technology and telecommunications, consumer products and retail.

 

Ivan Kozhemiakov

International partner

Chadbourne & Parke

Moscow

 

About the author

Ivan Kozhemiakov advises on all legal aspects of foreign investment in Russia and the CIS, with a particular focus on corporate, banking & finance and energy & infrastructure matters.