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This year, new rules have been put in effect in Russia permitting new debt restructuring mechanisms for business entities (joint-stock companies, limited liability companies). On 31 December 2009, a new law took effect lifting the ban on setting off monetary claims to a company for the purpose of increasing its charter capital. Please see our report on this issue.

This year, new rules have been put in effect in Russia permitting new debt restructuring mechanisms for business entities (joint-stock companies, limited liability companies). On 31 December 2009, a new law took effect lifting the ban on setting off monetary claims to a company for the purpose of increasing its charter capital. Besides, joint-stock companies have been allowed to increase their charter capital to cover for the losses they incur.

From now on, the business entities in financial difficulties may reach an agreement with their creditors and have their debt swapped for equity (interest in an LLC or shares in a JSC) without recourse to any sophisticated restructuring with borrowings.

These changes mean that a new legal instrument for restructuring and restoring solvency has arrived in Russia. In foreign jurisdictions, this instrument is known as a debt-for-equity swap abbreviated to D4E.  This swap, however, is possible only with respect to shares or interest in LLCs. No such swap is contemplated for equity securities of joint-stock companies, other than shares. This condition significantly increases the value of the new instrument by protecting creditors against being fobbed off with other issuer's securities.

The prohibition to form charter capital by setting off claims remains effective only for credit institutions (due to their status) to secure protection of their clients' right.

The new instrument has a great potential for the national economy, especially in the new context of the global and domestic recession. D4E is the least costly or risky and the simplest method of direct restructuring of a business company's debt towards its creditors. Businesses are not required to raise new borrowings to wipe off their debts. By acquiring a shareholder status, the creditors will be able to take part in the company's decision-making, including for the purpose of increasing its financial effectiveness. The arrangements that were frequently used earlier in 2009 for financial restructuring of default bonded loans provided for changing default bonds for other bonded loans. This approach was followed by, for example, the companies owning the Seventh Continent, the White Fregat, the 36.6 Drugstore chains. The IPO recently launched by UC RUSAL was intended for debt restructuring, too.

When swapping debt for bonds, the debtor was obliged to spend the money on serving the new debt (coupon redemption) and to repay the bonds' nominal value upon expiry of the agreed period. This is not required in case of equitized debt. The creditor would suffice with a restored financial effectiveness of the issuer and higher capitalization, after which it will be able to sell the shares received from D4E and benefit from it.

The described amendments introduce an effective instrument for restoring signs of solvency prior to bankruptcy procedures without borrowings or litigation. Besides, D4E may be used as an additional motivation tool for company executives (with no option arrangements involved) providing for a partial compensation in the form of ownership interest in the employer's business under an employment contract.