Going bust in Russia

By bne IntelliNews June 12, 2009

Ben Aris in Berlin -

At the start of June, Prime Minister Vladimir Putin did something unusual for a Russian leader: he traveled to a factory town of Pikalyovo in the Leningrad region to meet with the disgruntled workers, who blocked a local highway to protest against unpaid wages.

There are three factories in the town that all belong to oligarch Oleg Deripaska's empire, except along with many of his other businesses they have gone bust in the crisis.

The Kremlin has become extremely sensitive to popular dissent in the wake of the crisis and, unusually, Putin decided to respond in person, rather than the usual course of crushing protests with the OMON police or squashing the story in the domestic media.

Putin gave Deripaska and gave the one-time golden boy of Kremlin insiders a public tongue lashing, ordering him to pay the staff. The plant's management said the following day, in a statement forwarded by Deripaska's holding company Basic Element, that all arrears as of June 1 would be met.

Putin went on to say that if the present owners did not find a solution to restart the factory, a solution would be found "without their involvement."

The whole story marks a new direction for Kremlin. The crisis has brought the Kremlin to a crossroads. During the boom years the interests of the people and the state were aligned, but in the crisis they are diverging rapidly and the Kremlin is faced with a choice: crush dissent or listen to the complaints and act.

Of course, Pikalyovo is a single event, but the incident has already engendered copycat protests. A few weeks later the workers of Russian Tungsten in the Primorye region, who found themselves in a similar position, sent a letter to Putin asking: "Do we need to block a federal highway to receive our salaries? We won't survive another hungry winter," the letter said, according to Interfax. An unnamed commercial bank has since paid off part of the debt. Likewise, workers at another of Deripaska's mills, the Baikalsk Paper and Pulp Mills in Siberia, got paid outstanding salaries after 63 workers went on hunger strike. Renaissance Capital notes there are some 700 single-industry towns like Pikalyovo in Russia, "many of which face significant economic problems due to the crisis."

The second affect of the incident was to concentrate the Kremlin's attention on the shoddy state of Russia's bankruptcy laws. A few days later President Dmitry Medvedev met with Economic Minister Elvira Nabiullina and called for an overhaul of the whole bankruptcy regime. "The purpose of our efforts [to draft amendments to legislation] is not to see how quickly we can curtail or sell a company off, kicking its employees out of the gates," Medvedev said. "The main thing is to rejuvenate companies. This needs to be done in such a way as to prioritize recovery procedures."

Reforms to the bankruptcy law have suddenly become pressing as Putin can't fly to all 700 mono-towns and put out bushfires every time a factory is closed. "The case of Pikalyovo indicates that private owners may easily be replaced by state owners, or prompted to sign any contract by government order. However, this way of bringing private assets into public ownership is entirely outside any legal framework," say analysts at Renaissance Capital.

Bankruptcy laws broke

Bad debt is rising and some big name companies are bound to go bust this autumn. What happens then? The Kremlin has worked hard to fix some of the flaws in the law, but as Russia faces its first ever wave of real bankruptcies, there is a lot of uncertainty over how the process will actually work.

"Bankruptcies are inevitable, as some companies are leveraged up to the eyeballs. The oligarchs and big business borrowed heavily in the boom years and some will not be able to cope with their debt now the markets have turned sour," predicts Hugo Stolkin, a partner with Linklaters in Moscow, who has spent over a decade working with Russia's leading companies.

The simplistic bankruptcy laws were widely abused in the 1990s: a debt of $1,000 that was more than a month overdue was grounds to put a firm into receivership and once the owners lost control of the cash flow, the game was over. Shortly after becoming president in 2000, Vladimir Putin put an end to these abuses as part of his "oligarch deal" and legislators unmade some of the more egregious rules. But over the last eight years, the law has never been tested by bankruptcy of note. "The Duma has put through a lot of changes and the insolvency laws are much better than they were, but what is missing is all the supporting instructions that tell you how to actually use the laws," says Stolkin.

Amongst the many headaches, one of the biggest is that secured loans (extremely common in the West) don't work in Russia. Secured loans are supposed to put their creditor at the head of the queue when claiming money back from a bust firm. "In the West, if I don't pay my mortgage, the bank can take my house and sell it. In Russia all the assets have to be sold at auction and as the creditor I don't have access to the money. Even if the loan is secured, I end up queuing up with everyone else in court to get paid," says Stolkin.

However, if there is a wave of bankruptcies later this year, the first lacuna to be filled will be changes to allow debt-for-equity swaps. Creditors usually prefer to rescue a debtor if they can and swap the debt for a stake in the hope of nursing it back to health so it can pay its debts. A quirk in Russian law - due to the different status debt has against equity - means the debt has to be fully paid off before it can be swapped for equity. "It is all very messy and creditors are only going to go down the bankruptcy route as a last resort," says Stolkin. "However, our experience with other emerging markets is that the government can act very fast indeed to update the laws to make them work in times of crisis. Thanks to the crisis, the Russian government is now the biggest creditor out there."

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