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Disputing a pledge agreement over property pledged as collateral for a loan to another person

On May 25, 2023, the Supreme Court of the Russian Federation (hereinafter – the SC) clarified in its Determination how to dispute a property pledge agreement, if it was concluded as security for a loan to another person and was signed less than six months before the start of the bankruptcy procedure of the pledgee.

As a rule, the conclusion of such agreements, for example, during bankruptcy proceedings, means giving one creditor an advantage over the others, since in the case of settlements with creditors, the preference may appear in the order of preference. In practice, such transactions are known as preference transactions and can be disputed[1].

In disputing a property pledge agreement entered into in the above circumstances, the SC, among other things, explains that (1) it is not required to resolve the issue of the counterparty’s good faith, in particular the bank’s knowledge of the debtor’s or borrower’s insolvency, etc. (on the contrary, it is required to establish only those conditions which are expressly provided for in the legislation); (2) it is sufficient to prove that the pledge on the earlier obligation was established within 6 months before the initiation of bankruptcy proceedings or later; (3) references to the fact that there was a deal made in the ordinary course of business of the debtor should not be taken into account when considering the case, since security presented on the already existing obligations of another person cannot be qualified as the ordinary conduct of a business entity; (4) the fact that the borrower and the mortgagor are in the same group does not prove the economic feasibility of the deal.

Although the clarifications are relevant and applicable in the context of bankruptcy proceedings, they may also indicate (1) a trend of the courts of shifting their attention in making decisions towards determining the economic interest of a particular participant and treating the group less favorably (as opposed to the earlier practice, according to which the economic interests of the entire group were considered and protected[2]) and (2) a possible future tightening of banks’ requirements towards borrowers and an increasing number of denials to grant unsecured loans directly at the time of issuing the loan or as soon as possible/reasonable afterwards.

In this case, in our opinion, mitigation of risks (reducing the probability of risk realization and reducing the negative consequences, including indirect consequences) of the interested parties could be achieved by exercising ordinary discretion and by conducting a comprehensive assessment of the exposure and realization of possible risks and expenses before the signing of the relevant deal (for example, by conducting such standard procedures as Due Diligence, etc.).

[1] Usually, such deals are defined as a transaction concluded in favor of one of the creditors to the disadvantage of satisfying the claims of all other creditors or a deal in which payments bypassed one of the creditors in bankruptcy proceedings and should have been divided among the various participants in the case. For more details, see, for example: Decision of the 13th AAS of 17.12.2020 in case No. A56-70649/2017.

[2] Previously, the Supreme Court acknowledged that the execution of security deals in the interests of one group of persons “may be economically justified even without the condition of payment for the debtor’s actions” (counter security), if such security “implied future guarantees of profit in the interests of all related persons.