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Amendments to Russian Civil Code on pledge – Wind of change

Briefing note May 2014

Amendments to Russian Civil Code on pledge – Wind of change At the end of 2013, long-expected changes were finally adopted to the chapters of the Civil Code on pledges Key issues and to the transfer of rights and obligations, representing  Registration of pledges of another set of amendments in the course of the reform moveable will be launched 1 of the Civil Code . The changes will come into force on  Pari passu ranking 1 July 2014. Whereas the list of new concepts and some security will be available  A concept of security principal provisions remained as under the initial draft, agent holding pledge in the particular wording and essence of many of them are favour of multiple creditors is introduced significantly different from those of the initial draft  A pledge of bank adopted at the first reading and available to the general ("secured") accounts will be available public. At the same time the vast majority of the  A pledge of contractual amendments reinforce the approaches developed by the claims will be regulated in detail courts and, in particular, by the Supreme Arbitrazh Court so far.

Although regulation on pledge was subject to overall revision and the list of changes is extensive, the following new concepts and key changes are of the most importance:  making numerous changes to the general provisions on pledges aimed at decreasing unnecessary formalities for the creation and validity of pledges, providing better protection of the rights of bona fide pledgees and addressing certain deficiencies in the existing regime on pledges;  introduction of a concept of pari passu ranking of pledges over a single asset in favour of multiple creditors;  introduction of a prohibition to restrict contractually the creation of a subsequent ranking pledge;  incorporation in the Civil Code of a regime for the registration of pledges over property other than immoveable property introduced previously (with deferred effect) by amendments to other ;  introduction of the concept of security agent, intended to deal with security to be created in favour of multiple creditors, primarily in syndicated financing;  amending the rules on the enforcement of pledges over different types of moveable property (in particular, out- of-court enforcement) to replace the provisions of the on Pledge which from 1 July 2014 will be repealed;

1 Federal Law No. 367-FZ "On amendments to Part I of the Civil Code of the Russian Federation and abolishment of certain laws (provisions of certain laws) of the Russian Federation" dated 21 December 2013.

Amendments to Russian Civil Code on pledge – Wind of change

 introduction of a pledge of rights over bank interest will automatically arise as soon as the debt is accounts setting out special rules for the regime of acknowledged by the court and will date for priority a secured account, and a special mechanism for purposes from the date of the grant of the injunction. It is the enforcement of such pledge; not entirely clear to what extent the registration of a  introduction of some rules regulating the pledge of registrable would affect the priority of a participants' and shareholders' rights in a limited pledge arising under an injunction and its enforceability liability company and a joint stock company. against a bona fide acquirer. We set out below a preliminary overview of the key Protection of a bona fide pledgee changes and amended provisions that may have implications for the taking of security over moveable The amendments provide for the preservation of a pledge property, contractual claims and receivables, bank created by an unauthorised pledgor (for example, if the accounts and securities under Russian law. We also pledgor was not the proper owner of a pledged asset or highlight the areas which may give rise to questions of otherwise was not duly authorised to act on behalf of the interpretation and therefore will require further owner of the asset) in favour of a bona fide pledgee (being clarification from draftsmen and the courts. a person that did not know nor could be expected to know of a defect in capacity or authority of the pledgor)4. General rules on pledge However, this rule does not extend to cases when the pledged asset was removed from the owner's possession Additional rights granted to the pledgee against its will. In addition to the rights of a pledgee arising by operation of Formalities for the pledge agreement to law over insurance proceeds payable to the pledgor by be effective reason of loss or damage to the pledged assets, a pledgee will also be entitled by operation of law to claim (i) the The Amendments abolished the formal requirements for amounts payable to the pledgor as a result of the use of the certain matters to be reflected in the pledge agreement as a pledged property by third parties; and (ii) the property due condition for its effectiveness. to be transferred to the pledgor under contracts which were Value of the pledged property pledged, in each case to be applied in or towards There will be no longer a requirement to specify the value satisfaction of the secured claim2. The pledgee will have a (ocenka) of the pledged property in the pledge agreement right to claim the proceeds and property directly from the for the agreement to be considered as entered into5. pledgor's counterparty (such as an insurer, a lessee or supplier/seller of the property). Under the new provisions regulating the value of pledged property6 as a general rule such value (stoimost') will be Pledge arising from a court injunction determined by an agreement between the parties to the A creditor in whose interests the court issues an injunction pledge agreement and, unless otherwise provided by law, restricting the disposal of assets by the creditor's debtor will an agreement between the parties or a court order on "acquire the rights and obligations of a pledgee" with enforcement must be treated as the starting price for respect to those assets3. The attachment of a security realisation of the pledged property in the course of interest to the assets is effective on the date a court enforcement. decision in favour of the creditor comes into force (i.e. when Description of the secured obligations the obligations effectively secured by the immobilised assets are confirmed by the court). However, priority of the Irrespective of whether a pledge secures a debtor's own claim secured on these assets will be determined by obligations or those of a third party, under the amendments reference to the date when the immobilisation of the assets a reference in a pledge agreement to the agreement in question is deemed to occur. Therefore, the security constituting the secured obligations would be sufficient for a

2 4 Art. 334 of the revised Civil Code (hereinafter the references are Para. 2 of Art. 335(2) 5 made to the articles of the revised Civil Code) Art. 339 3 6 Art. 334(5) Art. 340

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pledge agreement to be considered as entered into7. Under Perfection requirements for a pledge over moveable the current regime a description of the nature, size and the property term of the secured obligations must be included in the The amendments incorporate into the Civil Code the key pledge agreement itself or alternatively the agreement principles of recording of certain pledges in the register of constituting the secured obligations is attached to a pledge notices of pledge over moveable property established by agreement. earlier legislation8. Such register of notices is expected to According to the amendments, if the pledgor engages in be held through the unified information system of notaries. commercial activity, the description of the secured In particular, a pledge over any property, other than obligations may be less precise, provided that it permits the immoveable property and property for which the law secured obligations to be identified at the date of prescribes another form of perfection9 may, with effect from enforcement, including by reference to all current and/or 1 July 2014, be recorded through a notary in the register of future secured obligations up to a certain amount. notices. Description of the pledged property Although the registration of pledges in the register of The draftsmen attempted to introduce a concept similar to notices will not affect the enforceability of the pledge the English law by providing that pledges between the parties or against unsecured creditors of the granted by entities engaged in commercial activity may pledgor, the absence of registration means the pledge will describe the pledged property so that it can be identified at not be enforceable against a person acquiring the pledged the time of enforcement. It is specifically stated that the property from the pledgor in the absence of the knowledge description may refer to all property of the pledgor or of the existing pledge, or against another secured creditor certain types or generic features of the pledged property. with a registered pledge over the same property10. According to the amendments, the priority of creditors' However, in our view, without elaborating more detailed claims is to be determined by the date of registration in the regulations to distinguish this type of security from other register of notices so that the earlier registered pledge will types of pledges which are subject to general rules, it is have priority over a later registered or non-registered one11. possible that this concept will not be used in practice. It may be that additional rules will be introduced since the There is an argument to the effect that a pledge of provisions above will become effective only from January 1, contractual claims will also fall within the registration 2015. requirements. At the same time it remains unclear whether and how the registration requirements will apply to a pledge Registration and perfection requirements over assets described in a generic way (as in the case of The amendments introduce certain new registration the floating charge described above), a pledge over future requirements for pledges and new perfection requirements assets or a pledge arising under a court injunction. for pledges over certain types of assets other than Another issue may arise in relation to pledges of immoveable property in the form of recording notices of participatory interests in the absence of transitional pledge in a register which is to be established. provisions in the amended legislation relating to previously Registration created pledges. Although registration of pledges of participatory interests in a limited liability company has With effect from 1 July 2014 in addition to the necessity to been a legal requirement since July 2009, the register encumbrances over property the to which is consequences of such registration were not entirely clear, subject to registration (such as immoveable property like including whether such registration affected the priority of land and buildings), when participants' rights in a limited liability company become subject to pledge the amendments require a pledge over participatory interests to be registered. Such pledges will arise only upon their 8 Art. 3391(4) registration. 9 In particular, for a pledge over property subject to state registration (as mentioned in Registration above), a pledge of shares, a pledge of participatory interests and a pledge of rights to bank accounts the law specifies other perfection requirements. 10 Para. 3 of Art. 3391(4) 7 11 Art. 339 Art. 3421(10)

4 Amendments to Russian Civil Code on pledge – Wind of change

pledges as against other secured creditors with a registered Transfer of pledged property into temporary pledge. possession or use Although since 2009 we have advised that pledges of As a new general rule, the transfer of pledged property by participatory interests should be registered, there may be the pledgor into the temporary possession of or use by a certain pledges either created before July 2009 or created third party will be allowed without the consent of the by operation of law that have not been registered. Although pledgee, unless expressly restricted by contract or any their validity, in our view, should not be questioned, their other law15. Under the current regime for such a transfer priority after 1 July 2014 may be affected. the consent of the pledgee was required by law, unless the pledge agreement provided otherwise. Protection of a of pledged property At the same time, according to the amendments, a right of possession or use of the pledged property acquired by any The amendments introduce the rule that upon acquisition of third party without the consent of the pledgee will be the pledged property for value by a purchaser in good faith automatically terminated in the event of enforcement of the (i.e. who was not aware or could not have been expected to pledge. Arguably third party rights to the pledged property be aware of the existence of a pledge) the pledge will terminate irrespective of whether consent of a pledgee terminates12. As a result, if a registrable pledge was not for transfer to or use by a third party was required under a registered and the pledged assets were acquired by a pledge agreement. purchaser in good faith without notice of the existing encumbrance, the pledge will automatically terminate. Substitution of the pledged property There are no "grandfathering" provisions dealing with The Amendments provide that a pledge is to be automatically extended to property arising as a result of pledges created before the registration requirement 16 becomes effective and which are not registered as soon as processing or other changes to the pledged property . In the amendments become effective (i.e. 1 July 2014) to addition, in the case of a pledge of rights under a contract, mitigate any risks of a third party purchaser in good faith the property (other than receivables) received by the acquiring the pledged property without notice of the existing pledgor as a result of performance of the obligations of the pledge13. debtor under such contract will become subject to the pledge from the moment the pledgor acquires title to that property. However, if an interest in the pledged property is subject to state registration, a pledge over the newly Restrictions on the disposal of pledged acquired property should only arise at the moment when property the relevant state registration is completed17. Disposal of pledged property Granting security in favour of Similar to the current regime, the pledgor is prohibited by law from disposing of title to the pledged property to third multiple creditors parties without the pledgee's consent14. In breach of this prohibition the pledge will follow the property into the The amendments have clarified the rules applicable to the ownership of the third party. However, the amendments priority of pledges and introduced a concept of pari passu provide general protection to a bona fide purchaser of the ranking of security as well as a concept of security agent pledged property for value in the form of a rule to the effect acting on behalf of multiple creditors. that if the purchaser was not aware or could not have been expected to be aware of such encumbrance the pledge then terminates.

12 Point (2) of Art. 352(1) 13 For more details regarding consequences of disposal of the 15 pledged assets to a bona fide purchaser refer to Priority of Secured Art. 346(3) 16 Claims Art. 345 14 17 Art. 346 Art. 345(5)

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Prior and subsequent ranking pledges the existence of a prior ranking pledge, the claim of such pledgee will rank behind the claim of the existing pledgee. Restrictions for subsequent ranking pledges18 It should be noted that according to the transitional Under the new rules a subsequent pledge may be provisions23, the priority of security subject to registration in prohibited only by law and not by a prior ranking pledge. the register of notices and created before July 1, 2014 and However a prior ranking pledge may stipulate the terms and registered from July 1, 2014 until February 1, 2015, will be conditions on which subsequent pledges may be entered determined by reference to the date of execution of the into. A breach by a subsequent pledge of the restrictions pledge agreement and not the date of registration. The law set out in a first-ranking pledge will entail the following lacks any grandfathering provisions for pledges created consequences: before the launch of the register of notices and not (a) the first-ranking pledgee will be entitled to claim registered during the above grace period, in the event the damages from the pledgor; secured assets were acquired by a bona fide purchaser for (b) if the pledgee under a subsequent pledge was or value after the launch of the register that gives rise to the should have been aware of the requirements in risk of termination of such non-registered pledges. the prior ranking pledge on subsequent pledges, Consequences of enforcement for a prior ranking the obligations towards that pledgee will be pledge and a subsequent ranking pledge discharged subject to such requirements; The Amendments finally deal with the consequences for a (c) as under the current regime, the pledgee under subsequent ranking pledge when a prior ranking pledge is the prior ranking pledge will be entitled to enforced24 which are as follows: accelerate the secured obligations and if they are not discharged, enforce the first-ranking pledge;  the pledgee under a subsequent ranking pledge will be however, under the amended law this right can be entitled to accelerate the obligations secured by a waived by the parties to the subsequent pledge19. subsequent pledge and if the debtor fails to discharge Another novelty is that the priority of pledges can be varied the secured obligations, join in the enforcement by agreement between the pledgees and/or the pledgor. initiated by the pledgee under a prior ranking pledge;  if the pledgee under a subsequent ranking pledge fails Priority of secured claims20 to accelerate and to join in the enforcement initiated by As under the current regime, the priority of creditors with the first-ranking pledgee, the subsequent pledge will pledges secured over the same assets will be determined terminate, save for when the secured property by the order of creation of the respective pledges. remaining after enforcement of the first-ranking pledge For registered security (i.e. security over assets the rights would be sufficient to cover the obligations secured by to which are subject to registration as described above) the a subsequent ranking pledge. date of registration will determine the priority. It should be noted that the right to accelerate the obligations secured by a subsequent ranking pledge may In the case of security over assets subject to registration in 21 be waived by agreement of the pledgor with the the newly created register of notices , the priority will be subsequent ranking pledgee25. If this is the case, following determined by the date of entries made in the register, so enforcement of the first-ranking pledge, the subsequent that a registered pledge will have priority over earlier non- pledge also terminates. registered pledge and over a later registered one22. The consequences for a prior ranking pledge as a result of As an exception of the general rule, the amendments enforcement of a subsequent ranking pledge remain the provide that if at the moment of creating the pledge the same as under the current regime. If the pledgor under a pledgee knew or could have been expected to be aware of first-ranking pledge does not accelerate the secured obligations and enforce its pledge, in enforcement of the 18 Art. 342 subsequent ranking pledge the first-ranking pledge will 19 Item (1) of Art. 351(2) 20 Art. 3421 21 23 Refer to Registration and Perfection Requirements with respect Item 6 of Art. 3 of the Federal Law № 367-FZ of 21.12.2013 24 to the procedure and consequences of such registration Art. 3421 22 25 Art. 3421(10) Art. 3421(2)

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follow the pledged property into the ownership of the A concept of security agent holding person acquiring it. security on behalf of multiple creditors28 Allocation of proceeds of realisation between multiple pledgees In an attempt to create a legal structure to facilitate granting Russian law security over a single asset in favour of The amendments introduce new rules establishing multiple creditors so eagerly demanded for further mandatory priority for satisfaction of claims under which the development of a Russian syndicated financing market, the main secured obligations such as principal and interest, amendments have introduced a concept of a security and arguably enforcement costs, have priority over claims 26 manager acting for a fee on the basis of an agreement arising from a breach of obligations . In practice this would entered into with multiple lenders. mean that the proceeds of realisation of the pledged property must go towards the discharge of the amount of Unfortunately the version adopted in the final reading is default interest, losses and damages due to all secured based on underlying principles different from those creditors only after satisfaction of the main secured suggested in earlier versions of the amendments. As a obligations of all secured creditors enforcing their claims. result, in our view, the concept appears to add practically Within each order of priority, the claims of each secured nothing new to the structures that market practitioners have creditor will be discharged according to the ranking of its already developed for security under syndicated financing security. Any other order of priority for claims arising from a agreement using the existing legal concepts of Russian law. breach of obligations will only be possible if permitted by Although at a first glance it may appear to represent special laws regulating securities. progress that in addition to any of the creditors having a Pari passu ranking of security claim against a debtor, any other person engaged in commercial activity can be appointed as a security The amendments introduced a concept of equal (pari passu) manager, even if it is not a creditor of the borrower under ranking of security over a single asset in favour of multiple the syndicated facility agreement, on closer examination of 27 creditors to secure different debts owed to such creditors . the status of a security manager this has limited benefit. This concept is also aimed at securing obligations owed to The security manager must act in the interests and on joint and several creditors as well as several creditors. behalf of the creditors (i.e. not in its own name) and in this Under this concept each co-pledgee will be entitled to capacity will (i) enter into a pledge agreement with the exercise its rights independently of the other co-pledgees, pledgor; and (ii) exercise the rights and perform the unless otherwise provided by law or agreed between co- obligations of a pledgee (including enforcing security on pledgees. In the event of enforcement by one of the co- behalf of the secured creditors). According to the pledgees, the other pledgees will be entitled to join the amendments, the secured creditors are prohibited from enforcement proceedings. As a general rule, the proceeds exercising their rights as pledgees independently and must of the enforcement of a pari passu pledge will be distributed do so through the security manager unless the security among the co-pledgees pro rata to their claims. If the co- management agreement is terminated. pledgees fail to join the enforcement proceedings, the In essence, under this concept a pari passu security consequences will be the same as those applicable to a interest is created in favour of multiple co-pledgees who are first-ranking pledge in the event of enforcement of a not permitted to enforce their security individually and are subsequent ranking pledge. In other words, the pledge in entitled to act only through the security manager. However favour of the non-participating pledgees continues to exist the security manager acts simply as an attorney authorised and will follow the property into the ownership of a by the secured parties to act on their behalf and in their purchaser. interests. In practice this would mean for a registered security that each secured creditor will need to appear as a registered co-pledgee in the register and any new creditor would need to be registered as a co-pledgee upon transfer

28 Art. 356 26 Art. 3421(8) 27 Art. 3351

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of any part of a secured debt for the purposes of priority include new rules on mortgages, was supposed to be and/or enforceability (depending on the type of the pledged significantly reformed, but amendments have not been asset). However, the necessary registration of each co- adopted yet. The law on mortgage also has not been pledgee could be effected by the security manager. amended to bring it in line with the amendments on pledge. In our view, the unified approach could not be developed at In the event of enforcement of security, the security the moment and the question on which rules would prevail manager will not become the owner of the proceeds of (the revised rules on pledges or special regulations on realisation of the pledged property, nor the owner of the mortgage) should be determined on a case by case basis pledged property in the event of enforcement by way of (by reference to each particular provision of law). appropriation. According to the amendments, the secured creditors become joint and several owners of such General Rules on Enforcement proceeds or property pro rata to their share in the secured obligations. Therefore there is a strong argument that in  The grounds for enforcement of a pledge remain the case of bankruptcy of the security manager the same and, as previously, the right to enforce will be enforcement proceeds should not go into the bankruptcy subject to the materiality of default by reference to the estate of the security manager and the creditors should be value of the pledged property. The criteria of the able to claim such proceeds or property outside the amount of default (less than 5% of the value of the bankruptcy procedure. In the event of enforcement of the pledged property) and the period for which the default is outstanding (less than 3 months) for a default to be security by way of appropriation, it is expressly provided 29 that such property must be sold at the request of any of the presumed as non-material remained the same . secured creditors.  As under the current law, a pledge can be enforced either though the courts and, if agreed between the The amendments prescribe that other well-established parties in writing, without recourse to the courts. concepts under the current Civil Code are to supplement  Among the innovations the pledgee and other persons the provisions regulating the relations between secured authorised to realise the pledged assets in creditors and the security manager. Given that such enforcement are obliged to ensure sale of the pledged concepts were not initially developed for such purpose, and property at the best price. Any loss caused to any party that the rules governing the relations between the creditors by a failure to get the best price may be claimed from and security manager are quite vague, there is a risk that in the persons in breach of such obligation30. the proposed form the concept of security manager will not be widely used in practice unless developed by court  An agreed out-of-court enforcement procedure will not practice or further legislation. deprive the pledgee of the right to enforce a pledge though court. However, if enforced through the courts, the pledgee will bear the additional costs of Enforcement of pledge enforcement as a result of application to the courts, The most significant change relating to the enforcement of unless it is proved that out-of-court enforcement failed 31 pledges is the repeal of the Law on Pledge and the for actions of the pledgor or third parties . incorporation of the provisions dealing with enforcement  If under the current regime the out-of-court into the Civil Code. At the same time, the existing rules enforcement procedure was not available when (i) prior have been refined to address shortcomings and resolve and subsequent ranking pledges stipulate different ambiguities. The general rules on enforcement have not enforcement procedures or different ways of realisation therefore been substantively altered. of the pledged property; or (ii) a pledge over a single asset secures obligations owed to different creditors, However, it is now not entirely clear how and to which according to the amendments the out-of-court extent the revised rules on the enforcement of pledges as enforcement procedure will be available if pledgees well as any other rules applicable to pledges apply to under a prior and subsequent ranking pledge agree mortgages over immoveable property. This concern is driven by a new rule providing that the rules on pledge should apply to mortgages in a supplementary manner to 29 the extent not covered by the general provisions on rights in Art. 348 30 rem and the regulation set out in the law on mortgage. Art. 349(1) 31 However, a section on the rights in rem, which should Art. 349(1)

8 Amendments to Russian Civil Code on pledge – Wind of change

otherwise or the parties agree a unified out-of-court in each case at a price not less than the market value. enforcement procedure, as appropriate32. It is noteworthy that the mandatory requirement to engage Enforcement through courts an independent appraiser to determine the market value of As under the current regime, enforcement through the pledged property for the purposes of realisation, as well as courts is a fall-back option and the sale must take place by the limit for the starting price at an auction to be not less way of a public auction to be conducted in accordance with than 80% of the market value determined by an the rules of the Civil Code and civil procedure legislation. independent appraiser, ceased to apply under the However, if the pledgor is engaged in a commercial activity amendments. A sale through a commission agent is no (as under the existing regime) the parties may agree when longer mentioned as a method of sale. enforcing though the courts the methods of realisation Seizure of secured assets for the purposes of available for out-of-court enforcement (see Out-of-court realisation: It is still not entirely clear whether, for the 33 Enforcement (item 2) below) . The courts will still be purposes of realisation in out-of-court enforcement, the entitled to postpone the sale of the pledged property for a secured property needs to be transferred into the period of up to 1 year, with the loss and accrued interest, possession of the pledgee. The amendments prescribe the including default interest, being indemnified during this moment of transfer of title only in the event of appropriation suspension period. by the pledgee upon failure to sell at an auction and only The rules of sale at a public auction do not generally differ for situations when the pledgee has the secured property in from those under the current regime. its possession; in this case title to the secured property is transferred to the pledgee upon receipt by the pledgor of a Out-of-court enforcement procedure notice of appropriation of the secured assets35. Essential terms of an out-of-court enforcement When the pledged property is not in possession of the agreement:34 As under the current regime, under the pledgee under any method of out-of-court enforcement it amendments an out-of-court enforcement agreement appears that, as under the current regime, before should specify: commencement of realisation the secured assets must be transferred into the possession of the pledgee. The  the method of sale of the pledged property and may amendments authorise the pledgee to claim the secured stipulate several methods, with the pledgee having the assets from the possession of the pledgor and any other right to choose one at its discretion; and third party and upon refusal to meet such claim the pledgee  the value (starting price) of the pledged property or the is expressly entitled to seize such assets through a notary method to determine such price. by obtaining the notary's executory endorsement36. Arguably, access to the notary for the purposes of such Methods of out-of-court realisation: Similar to the current seizure is only available if the pledge agreement has been regime, the realisation of pledged property in an out-of- certified by a notary. course enforcement may be effected: However, the approach may differ depending on the type of 1. by sale at an auction according to the rules provided secured assets. for by the Civil Code or as otherwise agreed by the Enforcement through notaries: As under the current parties; regime, out-of-court enforcement through a notary (by 2. if the pledgor is engaged in commercial activity, in one obtaining a notary's executory endorsement) will be or a number of the following ways which may be available only under pledge agreements containing a agreed by the parties in writing: condition on out-of-court enforcement which were executed (a) appropriation of the pledged property by the before a notary37. pledgee; (b) private sale without an auction by the pledgee,

35 Art. 3502(5) 32 36 Art. 349(3) Art. 3501(4) 33 37 Art. 350 Art. 349(6) 34 Art. 349(7)

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Right of courts to cease out-of-court enforcement: In However, the debtor will have a remedy for breach of case of breach, or a significant risk of breach, of the rights contract against the pledgor (in practice, a claim for of the pledgor during out-of-court enforcement, the court damages)39. will be entitled to cease out-of-court enforcement and order Pledgee's recourse to the debtor: The Amendments enforcement through a sale at public auction38. contain rules entitling the pledgee to direct the pledgor's debtor to perform its obligations under the underlying Pledge over different types of pledged contract to the pledgee on account of the secured obligations40. In addition, as a general rule the pledgor will assets be obliged upon request from the pledgee to transfer Pledge of goods (stock) in turnover receivables obtained under the underlying contract to the pledgee again on account of the secured obligations. In The amendments facilitate the way in which stock subject case of a failure to perform any of the above obligations to a pledge may be identified in a pledge agreement by directly to the pledgee, the pledgee will be entitled to permitting a reference to generic features of the assets and accelerate the secured obligations and upon the pledgor's to their location in specified buildings, premises and even failure to perform such obligations, enforce the pledge41. on specified land plots. In addition, notaries may be Enforcement procedure: In addition to levying execution engaged for attachment of the secured stock by certifying by way of sale at an auction (whether under a court or an the fact of location of the pledged stock in a precise place out-of-court enforcement procedure), the parties to the at certain time. pledge may also agree (as a method of realisation for both Pledge of contractual claims the court and out-of-court procedure) the transfer of the pledged contractual rights to the pledgee or to a third party General provisions: As under the current regime only upon the pledgee's request. The amendments do not property claims (i.e. rights to payment of a sum of money provide any mechanism to ensure transfer of such rights in (receivables) and claims to receive property (e.g. usually an out-of-court enforcement without cooperation of the under supply or sales contracts)) can be subject to a pledge. pledgor. If the pledgor refuses to effect such transfer, the The amendments also expressly specify that not only pledgee may claim such transfer through the court or existing claims but also claims which will arise in the future through a notary and claim damages from the pledgor for both under existing and future contracts whether in whole refusal to transfer42. or in part may be subject to pledge. Pledge of rights to bank accounts There is an argument that a pledge of contractual claims falls within the requirements on registering pledges in the The amendments introduced long-expected regulations register of notices. However, it remains unclear how such enabling the creation of a pledge over bank accounts, registration can be effected, especially with respect to a which will take the form of a pledge of rights under the bank pledge over future claims under future contracts. It is also account agreement. not clear whether notification of the debtor is necessary General provisions: The concept of a pledge over bank upon entry into the pledge to preserve priority against any accounts suggests that a special secured account subsequent pledgee. (zalogovy schet) is to be opened with a bank and the rights To create a valid pledge over contractual claims, no with respect to this account are to be subject to pledge. consent of the debtor under the underlying contract is As a general rule, a pledge will be created with respect to required, unless a prohibition on pledge or assignment is the whole amount standing to the credit of the secured contained in the underlying contract. However, according to account at any time after execution of the pledge; the amendments a pledge of claims under a contract alternatively it would be possible to stipulate a pledge of relating to commercial activity and containing a prohibition rights to a bank account agreement with respect to a fixed on pledge or assignment in the absence of the debtor's consent will not result in the pledge being invalid nor will it 39 serve as a ground for termination of the pledged contract. Art. 3582 40 Art. 3586 41 Art. 3587(1) 38 42 Art. 3501(3) Art. 3588

10 Amendments to Russian Civil Code on pledge – Wind of change

amount below which the balance should not decrease while Pledge of shareholders' and participants' the pledge is in force. rights Perfection requirements: A pledge will arise on notice to The amendments envisage specific rules for a pledge of the the account bank of the pledge, with a copy of the pledge rights of shareholders or participants in a joint stock agreement. company or a limited liability company. These rights, If a pledge is created in favour of the account bank where a according to the common understanding, include all rights secured account is opened, the pledge arises as of the granted by shares or participatory interests such as the date of execution of the pledge agreement. right to dividends or distributed profit and other property interest upon liquidation of a company, voting rights, Regime of a secured account: Unless otherwise stated in challenging corporate decisions and transactions of a a pledge agreement, before an enforcement event the company and receiving information on the activity of a pledgor will have the right to use the funds in the secured company. account without restriction (or to the extent the balance remains above the fixed limit set by a pledge agreement). According to the amendments, a pledge of such rights is Upon receipt of a pledgee's notice of default, the account created by way of a pledge of shares or participatory bank will be prohibited by law from performing any interests. It is expressly stated that unless otherwise agreed, instructions from the pledgor as a result of which the the shareholders' rights in a joint stock company during the balance on the secured account would fall below the life of the pledge are to be exercised by the pledgor amount of the secured obligations specified in the pledge (shareholder). During the life of a pledge of participatory agreement. interests in a limited liability company the rights of a participant are to be exercised by the pledgee, unless this In addition to the above, the pledgee has the right to right under a pledge agreement remains with the pledgor. receive from the account bank on request certain relevant When shareholders' or participants' rights are exercised by information about the secured account without this being pledgees, the parties should take into consideration other expressly provided or authorised in the documentation. related issues that may arise in this respect, such as Without the pledgee's consent, a secured bank account antimonopoly requirements that may need to be complied agreement may not be amended or terminated. with, including obtaining consent from or providing notification to antimonopoly bodies. As mentioned before, a Enforcement procedure: Enforcement both through the pledge of participants' rights in a limited liability company is courts and without recourse to the courts is by way of subject to state registration in order to become effective. debiting the secured account on the instructions of the pledgee and crediting the funds to the account specified by Pledge of securities the pledgee. The new regulation provides only certain details with Implications: Arguably, for a pledge over bank accounts to respect to a pledge of securities. Among notable provisions be available, further banking regulation (i.e. adopted by the are the following: Central Bank of the Russian Federation) is required at least for a secured account to be opened.  As under the current regime, a pledge over book entry securities will arise upon recording such pledge in an Recognition in bankruptcy: The legislation on bankruptcy account of the holder of securities (i.e. the pledgor) or, applicable to companies (but not banks) has been if provided by law, in an account of the other person; amended to ensure a pledge over bank accounts will  In a pledge over securities it will be possible to agree survive in the pledgor's insolvency. Such amendments also that the pledgee will exercise either all rights vested in envisage specific enforcement rules for this particular type a pledgor by such securities or all rights other than a of security in a pledgor's bankruptcy. These amendments right to receive income (dividends, coupon, etc.) and will become effective on 1 July 2014, simultaneously with for exercise of such rights no power of attorney in coming into force of the provisions on a pledge of bank favour of the pledgee will be required; accounts.  Upon conversion of pledged securities into other type of securities or other property, the pledge will extend to such new securities or property.

Amendments to Russian Civil Code on pledge – Wind of change 11

Conclusion

This note is not intended to be a comprehensive survey of all amendments to the pledge legislation. We have confined our attention to those which in our view constitute a significant development for secured financing, or which may have a material impact on existing and future security. We have highlighted a number of areas where the legislation is unclear, and more may come to light as the legislation is applied. These are likely to be resolved as further legislation is introduced and the courts and practitioners gain familiarity with this legislation and its implementation. The analysis will vary according to the circumstances of each particular transaction and this note should not be treated as a substitute for taking legal advice.

12 Amendments to Russian Civil Code on pledge – Wind of change

Authors

Victoria Bortkevicha Vladimir Barbolin Marina Kizenkova Partner Counsel Senior Professional Support Lawyer E: victoria.bortkevicha E: vladimir.barbolin E: marina.kizenkova @cliffordchance.com @cliffordchance.com @cliffordchance.com

This publication does not necessarily deal with every important topic or cover Clifford Chance, Ul. Gasheka 6, 125047 Moscow, Russia every aspect of the topics with which it deals. It is not designed to provide © Clifford Chance 2014 legal or other advice. Clifford Chance CIS Limited www.cliffordchance.com

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