Kazakhstan Rehabilitation and Bankruptcy Law Amendments Enhance Priority of Secured Creditor Claims

The latest amendments to the Kazakhstan Rehabilitation and Bankruptcy Law were signed on April 2, 2019, and became effective from April 14. The amendments enhance the priority right of secured creditors through the acceptance of pledged assets in kind or the implementation of self-facilitated foreclosure over pledged assets. Notably, the law provides that pledged assets are carved out from bankruptcy estates.

Priority of Claims of Secured Creditors

To exercise a priority right, a secured creditor must comply with the following procedure:

• Offer to Secured Creditor. Within five business days from declaration of bankruptcy, a temporary trustee offers a secured creditor to accept pledged assets in kind or make a self-facilitated foreclosure over pledged assets.
• Rejection of the Offer. If the secured creditor rejects the offer (or in case no response is received from the secured creditor), pledged assets will be included in the bankruptcy estate within 10 business days from the day of the offer.
• Assets in Kind. If the secured creditor agrees to receive pledged assets in kind, a temporary trustee will conduct evaluation of pledged assets no later than 30 calendar days from the day that consent of the secured creditor was received and will transfer these assets to the secured creditor.
• Self-Facilitated Foreclosure: The secured creditor may accept the offer of a temporary trustee and conduct foreclosure over pledged assets according to the general procedure provided by the law. The foreclosure should be completed within six months from acceptance of the offer (by filing a response) to a temporary trustee. The bankruptcy trustee must be notified within 10 calendar days on the amount of foreclosure over pledged assets. If the foreclosure over pledged assets has not been completed within a six-month period, a bankruptcy trustee will include these assets in bankruptcy estate.
• Surplus. Any surplus (i.e., a positive difference between the assessed value of pledged assets and amounts received as a result of foreclosure less expenses and amounts of secured obligations) must be paid to a bankruptcy estate no later than 30 calendar days from the date of transfer of pledged assets to a secured creditor/foreclosure over assets.
• Deficiency. If the assessed value of pledged assets/amounts received as a result of foreclosure less expenses is not sufficient to repay secured obligations, then secured creditors’ claims for such difference will be included in the creditors’ register and satisfied as fourth-priority claims.

Order of Priority of Other Creditors’ Claims

In general, the order of priority for other creditor claims remains the same. The law provides for the following order of priority:

• First-priority claims must be paid in the following order: personal injury damages, unpaid alimony, employee payroll and compensation, social contributions to the National Social Insurance Fund and mandatory pension contributions, social medical insurance, and compensation due under copyright agreements.
• Second-priority claims must be paid to secured creditor claims, claims that arise because of loan received by a bankruptcy trustee during bankruptcy proceedings, and clearing agency’s claims.
• Third-priority claims must be paid to tax claims.
• Fourth-priority claims must be paid to unsecured creditor claims and claims of secured creditors for the difference between the amount received from a pledged property and the amount actually owed.
• Fifth-priority claims must be paid to contract damage claims as well as fines and penalties on such claims.

Note that administrative expenses, court expenses, and taxes incurred during the period of bankruptcy proceedings are outside the order of priority for creditor claims and must be paid ahead of all creditor claims.

Other Important Provisions of Rehabilitation and Bankruptcy Law

Involuntary Petitions for Bankruptcy

The law permits the following categories of creditors to force an insolvent debtor into bankruptcy or rehabilitation proceedings:

• Creditors for claims for personal injury damages, unpaid alimony, employee payroll and compensation, social contributions to the National Social Insurance Fund, mandatory pension contributions, social medical insurance, and compensation due under copyright agreements that are not less than approximately $657 and are overdue for three months.
• Creditors (tax and other competent authorities) for claims for unpaid taxes and other mandatory payments to the budget, including any debts of branches and representative offices of a debtor, that are not less than approximately $986 and are overdue for four months.
• Other creditors for claims that are not less than approximately $1,970 (for individual entrepreneurs) or $6,575 (for legal entities) and are overdue for three months.

The law provides for circumstances when the debtor is obliged to initiate insolvency proceedings. Specifically, this obligation triggers when the following occur:

• In the course of voluntary liquidation, the debtor’s funds are insufficient to cover all creditors’ claims.
• Discharge of one or several creditors’ claims prevents the debtor from satisfying in full the remaining claims.
• The debtor knew or should have known about its insolvency, except for the case when there is a final judgement on the establishment of a settlement procedure (the debtor must file a bankruptcy case within a six-month period).

Management and Founders’ Liability

The law provides for subsidiary liability of the company’s officers for the bankrupt company’s debts if they fail to initiate bankruptcy proceedings in a timely fashion, disclose accounting records and other information to a bankruptcy or rehabilitation trustee, and provide access to such data (as discussed below). Notably, managers may bear joint liability in respect of any amount that cannot be collected from the debtor.

Such provisions have significant practical implications. For instance, under the law, a director may be held liable for an insolvent company’s debts if he or she fails to file for bankruptcy within six months of the date the company’s tax obligation exceeded approximately $986 and was four months overdue.

Further, management and founders (who were held criminally liable under bankruptcy proceedings) are not allowed to register new companies until such liability is lifted. Under the law, information about bankrupt companies is posted on the website of the Ministry of Finance of the Republic of Kazakhstan.

Invalidations and Trustees’ Avoidance Powers

The law includes grounds for challenging and invalidating transactions concluded within three years prior to the initiation of bankruptcy or rehabilitation proceedings (except for project finance, securitization, and stock exchange open-trade transactions). Specifically, a bankruptcy or rehabilitation trustee must seek to invalidate transactions in the following cases:

• If a transaction led to a financial loss
• If a transaction did not match the debtor's usual activity or was not permitted by law or the debtor's charter—this provision is especially important in practice because it underscores the necessity to check if the activity is within the counterparty’s charter and within the authority of the respective person or body
• If the debtor's property was transferred free of charge, at below-market prices, or without economic substance to the detriment of creditors (including for temporary use)
• If a transaction concluded within six months prior to the initiation of bankruptcy and/or rehabilitation proceedings resulted in the priority satisfaction of claims of one creditor before other creditors
• If deeds of gift concluded beyond usual business activity

Further, a bankruptcy or rehabilitation trustee may also challenge certain types of reorganizations on the debtor’s part that involve asset transfer.

The creditors’ committee sets the period for initiating an action to invalidate a transaction discovered by the bankruptcy or rehabilitation trustee. When it is impossible to claw back assets following an invalid transaction, the transferee or person who made a decision to transfer assets as well as the temporary administrator and trustee who approved the transfer should compensate damages up to the value of the transferred assets.

The law preserves the rehabilitation trustee’s right to refuse to perform the debtor’s obligations, in whole or in part, if the trustee believes that performance will be to the detriment of other creditors or if the agreement contains burdensome provisions for the debtor in comparison with analogous agreements. The law also empowers the rehabilitation trustee to refuse to perform the debtor’s obligations, in whole or in part, in interested parties’ transactions (with affiliated parties).

Further, under the law, the bankruptcy trustee is obliged (per the creditors’ committee decision) to amend, terminate, or challenge (depending on circumstances) the validity of contracts concluded before the bankruptcy proceeding.

Termination on Bankruptcy Clause

The law challenges the enforceability of “termination on bankruptcy” clauses (which are common in commercial and financing agreements), under which the bankruptcy or insolvency of one contracting party triggers the contract’s termination by the other party. Under the law, any agreement on contract termination because of bankruptcy proceedings against the debtor (concluded before filing a bankruptcy case) is void. While “termination on bankruptcy” clauses are still not uncommon, practical implementation of this clause remains unclear.

Notably, no statute of limitations for the invalidation of a termination on bankruptcy clause has been imposed. The bankruptcy or rehabilitation trustee may challenge the clause.

Debtor’s Duty of Disclosure

The law includes detailed procedures related to a debtor’s disclosure duties in the course of insolvency proceedings. Specifically, a debtor is obliged to disclose information on its business activity, financial standing, assets (pledged and leased assets, money on bank accounts, etc.), and foundation documents. This information is disclosed to the bankruptcy or rehabilitation trustee, temporary administrator or trustee, court, and/or creditors.

Further, the debtor must provide a report on the implementation of a rehabilitation plan and its commercial activity during rehabilitation to its creditor(s) or creditors’ committee.

Meeting of Creditors in Bankruptcy Proceedings

The law provides for the meeting of creditors in bankruptcy proceedings (in addition to the previously provided creditors’ committee). The creditors’ meeting includes all creditors in the creditors’ register and has broader powers than the creditors’ committee, including the authority to select the bankruptcy trustee and control over the sale of a debtor’s property. In the event that the creditors are not satisfied with the trustee, they may terminate his or her contract and appoint a new trustee. Notably, decisions of the creditors’ meeting are taken under the principle whereby a claim for one Kazakhstan tenge equals one vote.

To avoid lobbying of debtor’s interests by influencing the decisions made in the creditors’ meeting, the law excludes any debtor’s affiliated parties from voting in the meeting until claims of other creditors are fully satisfied. Furthermore, courts will refuse to find the debtor bankrupt in cases where there are no other creditors but the claimant (unless such claimant is a tax authority).

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Almaty
Aset Shyngyssov