By the admission of many specialists, the topic of reforming bankruptcy legislation has now gained global prominence. Reforms should be aimed at increasing the efficiency of the procedure and reducing its cost.
The Russian bankruptcy institute is very costly for all participants in commercial relations (which has proven to be a problem for bankruptcy regimes in all other countries as well). The reform of the relevant legislation will most likely lead to the emergence of qualitatively new bankruptcy laws.
We have previously jointly analyzed the topic of bankruptcy risk, by which we understand the risk of financial losses arising from the filing of a petition to declare a debtor bankrupt and/or the implementation of bankruptcy proceedings against such a borrower. The main merit of that article lies in posing the problem of the cost of bankruptcy proceedings for creditors and business owners, as well as analyzing such cost using examples from Russian enforcement practice.
During a crisis, when many companies face financial difficulties and borrowers often use such difficulties to avoid paying their debts, it is especially easy to write an article about how creditors need to manage the bankruptcy risk of a borrower. Several years ago, during a period of actively growing economy, bankruptcy risk seemed to have little to do with reality. It could be considered nothing more than a memory of the turbulent 90s. Conversely, currently, many creditors feel an extremely acute need to account for bankruptcy risk, often learning from their own financial losses.
Lessons should be learned from negative experiences.
Managing bankruptcy risk entered international financial transaction practice after the 1987 crisis, when in the US and many other countries, unscrupulous debtors began to use bankruptcy en masse either to pressure creditors during debt restructuring or to altogether evade fulfilling obligations, including through the application of a moratorium on repayment of the principal amount and/or interest payments.
The time has come to recognize the necessity of managing bankruptcy risk in Russian financial practice as well.
In a broad sense, managing bankruptcy risk can be accomplished through a variety of instruments. For example, from this perspective, the use of collateral is also aimed at reducing financial losses in case of the debtor's bankruptcy (as it increases the priority of the secured creditor and reduces the risk of insufficient funds to satisfy its claims). In this article, we will discuss the use of a special legal structure, based on which a whole set of instruments for reducing bankruptcy risk is applied. Following international practice, such a legal structure for the purposes of this article will be called an SPV (special purpose vehicle), which can be a legal entity (company) or not be one (in international literature, the latter are agreed to be called funds). In Russian law, an example of this type of SPV is a unit investment fund and a mortgage cover for mortgage participation certificates.
As a result of analyzing specific instruments for managing bankruptcy risk, we have noted the following trends. Modern finance, for managing bankruptcy risk, strives to move away from ordinary (corporate) financing against the entire business of the borrower to special types of financial transactions (where the borrower's property is limited in size, and its value equals or approaches the amount of financing provided). For example, such special types of financing include (a) project and infrastructure finance; (b) financing against revenue from a specific asset, e.g., an office building, hotel, warehouse premises, or other type of real or other property (asset finance); and (c) securitization of financial assets (asset securitisation). These types of financial transactions are united by the fact that the financing provided under them is known in advance that the size of assets relative to debt will not increase, and therefore any unpredictable losses will necessarily lead to losses on the investors' side.
One of the reasons for using special types of financing is the desire to gain the ability to manage bankruptcy risk.
In such transactions, the parties either completely avoid the application of bankruptcy law (in the case of using a fund), or preliminarily reduce the probability of bankruptcy (as well as the probability of financial losses), or take measures so that the initiation of bankruptcy proceedings, as well as its implementation and completion, proceed in accordance with the initial agreements between all investors (and under their control). At the legislative level, these trends are expressed in the fact that in many countries, the possibility of using a fund is increasingly expanding for use in a wide variety of financial transactions. Many countries, for special types of financial transactions, supplement bankruptcy rules with dispositive norms or completely exclude the application of bankruptcy rules (providing for the application of liquidation provisions, and according to rules that the parties will determine in their transaction documentation).
The instruments for managing bankruptcy risk used in practice are now described in sufficient detail in various public sources. Modern financing techniques involve the participation of a wide range of professional participants. This includes lawyers who develop the transaction structure with financiers and prepare documentation for it, and rating agencies, through whose opinion the assessment of credit risks is formalized and which often influences the circle of investors and the cost of attracted financing. Another feature – the possibility of dividing the transaction into several stages and elements – allows choosing the most favorable jurisdiction for carrying out a particular part of the transaction. This choice can depend on both economic reasons (presence of a developed capital market, preferential taxation) and legal ones – the flexibility of one legal system and the unsuitability of another. As a result, the creation of special regulation dedicated to financial transactions is influenced by rating agencies and the formalized assessment standards set by them.
In the absence of formal unification, countries creating national legislation that favors such financing techniques largely follow the path of implementing the most successful legislative solutions and existing best practices in foreign legal systems. This is most important for countries with developing economies, which include Russia. Existing doubts regarding the predictability, transparency, and stability of their legal systems necessitate considering the creation of special regulation, verified in accordance with international standards.
This article examines limiting bankruptcy risk through the use of an SPV in the form of a fund.
(In the second article, planned for publication in the next issues of "VN", protection from bankruptcy risk within a company used as an SPV will be considered.) In connection with the upcoming changes in domestic legislation, the regulation proposed by the Draft Federal Law "On Securitization" (FSFR Bill) and the Draft Federal Law "On Securitization" prepared under the auspices of the Association of Regional Banks (ARB Bill) will also be considered.
Protection from Bankruptcy Risk: The Fund
The fund (a legally segregated estate that is not a legal entity) is a very convenient structure for attracting financing. In this article, using the example of the legislation of two countries (France and Russia), funds will be shown as successful "platforms" for attracting financing. The fund in many civil law countries is not very flexible, but the norms on bankruptcy do not apply to it, which increases its attractiveness for participants in financial transactions. The experience of France seems to be the most interesting and attractive example for comparison. The French Republic was the first civil law country to take care of creating special national regulation for modern financial transactions. Modern French regulation - the fruit of numerous changes aimed at giving greater flexibility and efficiency to the model with a parallel expansion of its application - is now considered one of the most successful in Europe.
France
The trust construct in civil law systems caused well-known denials (of the possibility of existence) for a long time, which is why European legislators had to search for a legal construct that imitates (synthesizes) the functional properties of a trust. In relation to securitization, this approach was first implemented in France, the first European country to create special securitization legislation. Law No. 88-1201 of 23.12.1988 introduced a new form, Fonds Commun de Créances (hereinafter – FCC) – a fund without "legal personality", and it was stipulated that bankruptcy proceedings cannot be initiated against such a fund.
This form was new for French legislation, which previously had no similar constructs. An FCC is defined as a co-ownership (common ownership) with the sole purpose of acquiring rights of claim and issuing equity securities (units, shares) representing rights to monetary claims. However, holders of equity securities are liable for the debts of the fund (or sub-fund) only to the extent of the fund's assets proportionally to their shares. Moreover, holders of fund units possess a number of rights of corporate participants. At the same time, the FCC does not have the rights of a legal personality, but the provisions of the French Civil Code regulating co-ownership, as well as the rules of the Civil Code regulating undisclosed partnership, do not apply to it either. Thus, the structure of the FCC does not allow it to be attributed to any of the traditional institutions of civil law. The adopted construct leads to the fact that the rules regulating the activities of other forms of legal entities, as well as regulating other forms of joint activities existing outside the framework of a legal entity, cannot be automatically applied to the FCC. Thereby, the scope of rules applicable to this form is limited to the regulation established directly for the FCC. The result is the possibility of more flexible and targeted regulation of these relations for the legislator and greater clarity of regulation for market participants.
The FCC is formed jointly by the company responsible for fund management (the management company) and the company that will act as the depository of the fund's assets (the depositary). The management company can be a commercial organization licensed by the Commission des Opérations de Bourse (Stock Exchange Commission), whose sole purpose of activity is the management of securitized funds. The management company has the right to act on behalf of the fund before third parties, including in court proceedings. Due to the absence of legislative restrictions, the management company can manage several funds. The management company makes decisions related to fund management, including selecting claims for acquisition, agreeing on the terms of acquisition of the FCC's debt portfolio, jointly with the fund's depositary drawing up its regulations, and, if necessary, agreeing with the selling credit institution or a third party the terms of servicing the acquired debts. The management company also determines the methods of investing excess cash funds whose distribution date has not yet arrived, and under the supervision of the depositary, compiles a register of the fund's assets or its sub-funds every 6 months. A bylaw establishes a restriction regarding participants/shareholders of management companies: banks and their subsidiaries selling claims to the FCC may individually or jointly own no more than 1/3 of the shares of the respective fund's management company.
Special requirements are established for the organization acting as the depositary of the FCC: it can be a French credit institution, a French branch of a credit institution registered in an EEC member state, or any other organization approved by the French Ministry of Economy. The law establishes that the functions of the depositary can also be performed by the assignor transferring the claims to the FCC for management, or an organization performing the functions of a servicing agent for the claims transferred to the fund. In addition to accumulating cash flows and claims received by the fund and distributing funds, this organization also verifies the decisions of the management company for compliance with the rules and conditions established in the General Regulations of the Financial Markets Authority.
The management company and the depositary jointly prepare the texts of the fund's internal documents, which must be approved by the Commission des Operations de Bourse after consultation with the Bank of France, including a memorandum related to the transaction, the purpose of which is to provide subscribers with preliminary information about the transaction.
Holders of securities legally do not participate either in the formation of the fund or in its management, and do not have the right to remove the management company or the depositary from management. French legislation also does not provide for any organization of security holders, either as a separate body or as a representative of the security owners opposing the fund, management company, or depositary. It seems that the legislator did not use these constructs aimed at ensuring control over the actions of the management bodies, whose decisions can be critical for the interests of investors, replacing them with the establishment of a "two-headed" mutually balancing system of FCC management, reinforced by broad control powers of state regulators.
In summary, the French model of Fonds Commun de Créances can be represented as based on the following principles:
The existence of a special entity, against which bankruptcy proceedings cannot be applied, having a strictly defined purpose of activity. The properties of this entity are seriously different both from entities built on a corporate model and from those built on a co-ownership model, but to a certain limit, mixing features of both;
Management of this special entity is carried out by several legal entities, balancing each other to exclude decisions that may lead to consequences undesirable for investors;
Application of special criteria to the entities participating in the management of the special entity (boiling down either to limiting their legal capacity to a single type of activity or to establishing requirements for their existence in the form of a credit institution, for whose activities and financial stability all developed legal systems establish strict standards), thereby limiting the risks of investors associated with the possible insolvency of these entities;
Extensive control over the activities of both the special entity and the companies managing it by state authorities.
It is worth noting that initially the French legislator created a rather cautious and limited (in terms of asset composition) structure, the further development of which went along the path of gradually creating greater opportunities for using the FCC. Thus, today the FCT (in 2008, as part of the reform of securitization legislation, the FCC was renamed Fonds Communs de Titrisation (hereinafter – FCT)), in addition to the right to repeatedly issue units, received the ability to issue bonds, participate in synthetic securitization transactions (securitization with the transfer of credit risks, not the asset itself), and since 2008, it has become possible to use FCT for the securitization of insurance risks.
Subsequently, the model of the French fund was adopted by Portugal and Spain. The possibility of creating an SPV in the form of a fund is also present in the special legislation of Luxembourg.
Another French novelty must be noted. Since 2008, in France, it has been possible to create an SPV also in the form of a company (societe de titrisation), to which bankruptcy proceedings and the general provisions on liquidation contained in the French Commercial Code inapplicable. This company can be created in the form of a societe anonyme (analogous to a Russian joint-stock company) or a societe par actions simplifiee (simplified joint-stock company). The management of the company's affairs is also carried out by a management company and a depositary. The activities of the societe de titrisation cease upon the completion of the circulation of the securities issued by it or in case of the company's financial difficulties. The conditions and procedure for the termination of the company are fully established in its constituent documents.
Russia
Russian legislation also enshrines a form of collective investment in the form of a unit investment fund, which can be used as a special legal structure for attracting financing (SPV). Similar to the French fund, the Russian closed-end unit investment fund (hereinafter – CUIF) is also not subject to bankruptcy risk. The use of this form for the securitization of a broad class of contractual monetary claims became possible after amendments to the legislation allowing the contribution to the trust management of a CUIF of monetary claims under mortgage-secured obligations from credit agreements and loan agreements (2006), as well as other secured loans and borrowings (2008).
A closed-end unit investment fund is not a legal entity, and therefore bankruptcy proceedings do not apply to it. However, the CUIF has significant structural differences from the FCT regarding constructs aimed at removing the risk of unfair actions by the management company. Unlike the FCT, the structure of a closed-end unit investment fund provides for, in essence, only one management body - the management company. The specialized depositary has extremely limited powers in terms of controlling the activities of the management company. As a general rule, the management company has the right to carry out any transactions and actual actions regarding the property transferred to trust management, "represent" the unit fund in court. Control is ensured by giving greater activity to the fund's investors in the form of a general meeting of owners of investment units of the CUIF and/or an investment committee (the latter applies only if the CUIF units are intended for qualified investors).
The general meeting of owners of investment units of a CUIF has the right to approve changes and additions made to the trust management rules on the range of issues provided for by the Federal Law on Investment Funds and by-laws of the FSFR, make decisions on replacing the management organization, early termination or extension of the trust management period of the fund.
The trust management rules of a CUIF, whose units are intended for qualified investors (i.e., "investment units with limited circulation"), may restrict the activities of the management company by requiring approval of transactions with the property constituting the CUIF by all or several investors (the investment committee). The procedure for forming the investment committee and its approval of transactions, as well as the criteria for such transactions, are established by the trust management rules. Obligations under transactions made in violation of these rules are borne by the management company; debts arising from such obligations cannot be repaid at the expense of the property constituting the CUIF. Thus, the risk of unfair actions by the management company can be minimized.
To date, the first drawback of the legal construct of a CUIF whose investment units are intended for qualified investors is the narrow range of claim rights that can be included in such a fund. The Russian draft law on securitization proposes to introduce the possibility of including any negotiable claim rights (including future claim rights) in the property of a CUIF.
Second, attention should be paid to the possibility of issuing bonds for an investment fund. The French legislator directly provided for such a possibility, despite the fact that from a dogmatic point of view, an investment fund is not a legal entity (and therefore, it would seem, cannot be a debtor). The legislator in France overcame the habit of thinking that only a person can issue bonds. We believe that for the development of the Russian financial market, it is also necessary to eradicate such a stereotypical idea. Investors in bonds in this case would receive all the advantages of a CUIF, including the absence of bankruptcy risk, the absence of the need for forced liquidation due to a decrease in net assets below the amount of the charter capital (clause 4, article 99 of the Civil Code of the Russian Federation), etc.
Third, a problem with the CUIF construct is the impossibility of tranching the securities it issues (allocating units with different priority rights in relation to one investment fund). Certainly, the most desirable option would be to directly introduce into Federal Law No. 156-FZ of 29.11.2001 "On Investment Funds" (hereinafter – the Law on Investment Funds) provisions establishing the possibility of creating two or more classes of CUIF securities (with different rights attached to them), be they units or bonds. However, even now the Law on Investment Funds contains provisions, a change in the regulator's understanding of which could allow the creation of different classes of units without amending the law. Thus, according to Article 14 of the Law on Investment Funds, "each unit certifies the ownership right to an identical share in the common ownership right to the property constituting the investment fund, and identical rights." However, the word "identical" can be understood in two meanings: "identical" in the sense of "equal" and "identical" in the sense of "providing an identical set of rights" (listed earlier in the same article: the right to demand from the management company proper trust management of the UIF, the right to receive monetary compensation upon termination of the trust management agreement of the UIF with all owners of investment units, the right to participate in the general meeting of owners of investment units, the right to receive income from the trust management of property). The second understanding would allow moving away from the inflexibility of the existing regulation without amending the Law on Investment Funds, without depriving paragraph 5, clause 1, article 14 of the Law of its meaning – none of the classes of units can be, in principle, deprived of the rights provided by an investment unit, although each of the classes can provide its owners with different levels of risk and return. Such a change in the understanding of the equality of rights for investment units would allow for more flexible establishment of relations between their owners, for example, through the mechanism of a co-owners' agreement on the distribution of income from common property.
Fourth, the Law on Investment Funds provides for a prohibition on the issuance of securities derived from units. In the absence of a clear understanding of the degree and nature of "derivativeness", one can question the issuance of bonds with a pledge of units, although there are no reasons for such a prohibition (Article 14 of the Law).
In conclusion, we would like to emphasize that a fund can serve as a "platform" for attracting various types of financing. There is rich international experience for this, which we must consider and strive for. Predictable expenses for maintaining the fund's activities (depositary, management company, etc.) can sometimes be more advantageous compared to unpredictable expenses and losses in case of filing and/or implementing bankruptcy proceedings against a borrower. It seems to us that for certain types of financing (with a factor of a limited number of assets), avoiding bankruptcy risk through the use of funds can be an acceptable opportunity.