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Russian sanctions are creating bankruptcy complications

The West has put up a united front against Russia, using a raft of sanctions to pressure Putin into reconsidering his ambitions in Ukraine. This, as intended, has put Russian businesses on the ropes.

In a globalized world, it’s impossible to damage one country’s industries and economy without creating a ripple effect. Debtors, creditors and assets are often associated with more than one country and a single company may have operations in multiple markets.

How could the current suite of sanctions pose complications for bankruptcy proceedings in the US?

1/ Sanctions may not stop Russian insolvency proceedings from going forward

Chapter 15 was added to the Bankruptcy Code in 2005 and provides for co-operation between US and foreign courts when overseas bankruptcy proceedings touch upon US financial interests.

The question that corporate lawyers are now asking themselves is whether the current sanctions could prevent recognition of Russian insolvency proceedings or, in fact, recognition of any foreign proceedings that would involve funds that pass through foreign banks.

There is a public policy exemption in Chapter 15 that gives the courts the power to refuse to act if it would be “manifestly contrary to the public policy of the United States.” It’s not a stretch to argue that recovering US assets for distribution in a Russian insolvency proceeding would be contrary to America’s current public policy. But case law offers little precedent for this.

To date, there have only been four significant Chapter 15 cases involving Russian insolvency proceedings, three of them heard in the US Bankruptcy Court for the Southern District of New York.

In two cases, the judges found that the public policy exemption was not applicable and should only be used in “exceptional circumstances.” In the case of Midway United, a Russian-American plywood processor, the judge decided that applying the exemption relied upon the foreign insolvency proceeding being procedurally unfair and whether recognizing the proceeding would severely impinge US statutory or constitutional rights.

Applying this test strictly, it appears unlikely that the public policy exception would justify denying recognition of all Russian insolvency proceedings.

2/ Section 1503 may block claims on US financial interests—for now

There are other levers to pull in Chapter 15. Under Section 1503, any distribution of US assets to Russian parties could be blocked if those assets were to pass through, or ultimately be paid to, any one of the many sanctioned Russian banks.

The code says that, to the extent that Chapter 15 conflicts with an obligation of the US under a treaty “or other form of agreement” it has with other countries—as it does currently with the European Union and others­—the requirements of the agreement prevail.

It is worth noting that, according to Debtwire’s Restructuring Database, Sberbank has been a creditor in several Chapter 15 cases, including those of SEL Manufacturing, Metinvest, International Bank of Azerbaijan, DTEK Finance and Agrokor, Sergey Petrovich Paymanov. Likewise, VTB Bank has been a creditor in the Chapter 15 cases of Agrokor, Midway United, Natalia Mikhailovna Pirogova and Metinvest.

Section 1503 may be all that’s needed to block recognition of foreign bankruptcy cases that would involve funds that pass through Russian banks. However, it may also not be long before the public policy exemption is again put to the test.

The White House has spoken vehemently about the need to isolate Russia from the global financial system and cut off economic support to the country. It could be argued that granting access to Chapter 15 to any entity that even indirectly helps to fund Russia’s war effort should be denied on public policy grounds.

After all, today’s events are nothing if not exceptional. Case law may soon set a new precedent.