Kirill Galetski

Russian companies are making progress on developing corporate governance, but corruption, large legal loopholes and the lack of a watchdog on companies filing for bankruptcy are still major obstacles, says a new paper released by Moscow’s Institute of Corporate Law and Governance (ICLG).

The paper, "The Isolation and Eradication of Objective Corruption Factors in Conjunction with State Governance System Reform in the Russian Federation," was presented at a seminar given by the Moscow Carnegie Center last week.

Written by ICLG Director Dmitry Vasilyev, who is also former chairman of the Federal Securities Commission, along with his long-running legal consultant Pavel Drobyshev and Alexei Konov, coordinator of the Corruption and Government Reform program at the Carnegie Center, the report focuses primarily on one of the major problems in Russian corporate governance today: the regulation of bankruptcy proceedings.

The ICLG has been working on improving corporate governance in Russia and protecting investors’ rights since 2000. It analyzes Russian companies’ corporate governance based on in-house techniques, and offers counseling on legal and financial issues to companies trying to improve their profiles and eventually win the right to be traded publicly.

This year, the institute has reported a large number of companies bringing their corporate policies into line with legislation, more companies focused on step-by-step improvement of corporate governance and better and more disclosure of information. But the dual problems of corruption and lack of a legal base for corporate governance remain.

"Immaterial of the fact that liberals are now in control of the Central Bank, no extensive changes have occurred, so the grounds for scandals remain," Vasilyev said in his opening remarks at the seminar. "The causes of corruption are no mystery – our laws are contradictory, law enforcement is weak, and, because government structures have been subject to privatization by groups associated with the oligarchs, weak legal power. There is a whole array of such things, added to which is the lack of transparency."

"We chose the subject of bankruptcy because we came to the conclusion that this is one of the most acute problems in the Russian corporate world," he continued.

"There are scores of such situations having to do with bankruptcy proceedings, where aggressive corporate takeovers were able to be executed within the confines of the law.

"In some of these, I’ve had to fulfill the role of a consultant to investors, attempting to guide investors out of the troubles associated with these scandals, such as with Goskhrustal where American investors were being bilked by a scheme involving bankruptcy proceedings."

In the West, 98 percent of bankruptcy proceedings are initiated by debtors as a way of minimizing the harmful effects of their debts. But in Russia, bankruptcy procedures are often used by creditors for hostile corporate takeovers, bilking investors by stripping assets and funneling them into another companies.

Even when investors take perpetrators to court and win, enforcement of courts’ decisions is not guaranteed. Despite the high visibility of the issue in the Russian and foreign media and the attention of President Vladimir Putin, these problems have continued.

"With regard to bankruptcy, this sphere must be put in order immediately, and on the level of legislation first of all," Putin said while addressing the Federal Assembly this year. "’Assembly line’ bankruptcy has even become a profitable business. We must make the mechanism of conducting enterprise bankruptcy and restructuring proceedings transparent and market-oriented, and this means unsusceptible to corruption."

Russia’s government has passed two bankruptcy laws, one in 1992 and one in 1998, neither of which was deemed adequate. Putin vetoed the latest proposed law on bankruptcy, presented in early August this year. On the recommendation of the Kremlin’s legal department, he sent the bill back to the State Duma because some of its stipulations contradict the Civil Code in its categories of priority creditors. Putin is also asking deputies to revamp standards used to appoint independent directors and amend sections on the bankruptcy procedures for state-owned and private enterprises.

The latest insolvency law, passed by the Federation Council on Oct. 16, was sent to be reviewed by the executive branch of government, but its consideration was delayed by Moscow’s hostage crisis last week. Putin is expected to sign this version of the law before the end of November, after minor technical amendments regarding state debt and tax issues.

Bankruptcy issues seem to affect some industries more than others.

"In metals and mining, bankruptcy is not an issue with the way the market is now," said Alexei Goncharov, a spokesman for SUAL Holding and a corporate governance expert.

"The assets that are successful continue on their course, and those assets that continue to be in a difficult economic state because of inefficiency, they just die. If you look at the latest property disputes such as that of the Moscow Petrochemical Processing Plant, the main issues were raw materials delivery and consumer pricing, and not the opportunity to buy out the company debt and announce its bankruptcy.

"Today large companies have learned to manage debt instruments, and now debt is not used as an instrument to rig a bankruptcy and take away a business, like what went on before," Goncharov continued.

"I would be hard-pressed to find an industry where such a model is relevant. It’s good that the laws are improving, but the perception or non-perception of corruption of a business first and foremost hinges upon its efficiency."

Viktor Pleskachevsky, head of the Duma’s property committee and a member of the Unity party that lobbied for the bill, attended the Institute session Wednesday. He said amending the existing law will, in turn, create mechanisms to protect the rights of private owner.

The previous law had been abused by creditors and competitors to initiate bankruptcy procedures and seize control of companies, he said.

A final version of the Institute’s bankruptcy report has not been published yet and is expected by the end of the year, with changes reflecting the latest legislative developments. It will then be sent to lawmakers that drafted the new law, state organizations and analytical and educational organizations.

"As far as I know, according to the Duma property committee and Pleskachevsky, practically all the obstacles to the signing of the bill have been eradicated," said Drobyshev.

"The property committee will recommend signing the bill, and the chances are close to 100 percent that it will be passed. The first publication of the report will appear some time after the law has passed so that we can also document the results of the law’s implementation."