Vol 2, No 1
10 January 2000
R U S S I A:
Corporate debt evasion in Russia: Part I
Unlike a number of other post-Soviet pitfalls, the Russian legal system's allowance of corporate debt evasion has received very little attention. Nevertheless, chronic financial evasion, legitimized by the mechanism of legal procedures, became one of the key factors contributing to the massive and all encompassing crisis of the Russian Federation.
It is important, however, to recognize that all of this was enflamed by Western cash inflow. According to the American Office of the Comptroller of the Currency, in the summer of 1998, American banks persisted - for the fourth year - in making loans based on lower standards. Some reports sum up Western capital injections into Russia at above USD 200 billion - German banks now leading the way with USD 52 billions in losses.
The corresponding capital flight out of Russia has been enormous. In a recent study conducted by the Center For Strategic and International Studies, former US National Security advisor Zbigniew Brzezinski asserted that 65 percent (USD 78 billion) of the USD 120 billion in Western funds and loans was transferred to private offshore accounts. Gravely, by November 1997, Russian government officials estimated the full value of capital flight since the Soviet Union break-up at approximately USD 200 billion. Anatoly Kulikov - Deputy Prime Minister at the time - declared that the monthly total of Russian capital flight exceeded USD 1 billion.
The absolute value of the incurred losses is somewhere in the balance between debt and tax evasion, deepened by unpaid wages but subtracted from foreign capital inflow and Russian GDP. Clearly, this is not some penny racket conducted by a babushka through her vegetable market stall. Rather, Russian debt evasion has contributed considerably to global financial and economic instability. For Russia itself, the mass debt dodging stalled the transition away from a command-style economy.
The most immediate and perilous human cost is the delay in wage payments. Analysts estimate that just the 130 000 Russian scientific researchers - a rather small percentage of the entire labor force - are owed some USD 55 million in back wages. Out of the millions of unpaid employees, these few have a strategic value; but for all of the workers, the pay shortfalls curtail a more sophisticated credit usage by ordinary Russians.
The aforementioned evasions collectively degenerated economic relations into a "shadow economy" functioning outside of the law. Even the conservative statistics of the Russian Ministry of the Interior (MVD) documented a 26.5 percent increase in detected white-collar crime from 1994 to 1996. Much of this is the result of the Russian business culture. The pattern of Russian deal making - both legal and illegal - lacks an illustrious history.
As Katharina Pistor points out: "The 'battle of the form' problem - which the courts face once contracts are litigated - sufficiently documents how business people ignore the fine point of standardized contracts." Such an omission is further augmented by the corporate efforts of tax evasion. To perpetrate any effective evasion, commercial agreements - providing they are reported - are intentionally distorted in official reports to the State Tax Service. This conduct intensifies the economic crisis shaping the current business, political, economic and social environment of Russia. The extent of this criminal activity is quite substantial, in both absolute and relative terms.
The relative share of the shadow economy in the Russian gross domestic product has reached 40 percent. To compare: it is 5 to 7 percent in the developed countries of the West and up to 30 percent in Africa and Latin America.
Unlawful debt avoidance does fall under section 315 of the Russian Federation's Criminal Code, qualifying as a "malicious default of the judicial and impeding to its execution." It encompasses the conspiracy and the attempt of these actions. Moreover, it was a criminal offence under the RSFSR Criminal Code, section 188-2. The normative means to prevent the skirting of the law evidently do exist. However, to be recognized as a crime the activity must include direct intention. The possibility of a conviction under this framework - requiring the proof of direct intent - remains quite minimal. Since white-collar criminals are generally highly educated and sophisticated, they can maneuver amidst the obscure regulations and procedures to protect themselves against criminal allegations and convictions. Their felonious activity in effect thwarts the protection of criminal law.
Thus, well-intentioned Russian and foreign business people must not depend exclusively on the protection of criminal law remedies. Instead, the norms of civil procedural law can and should be more effectively adjusted to protect the public. After all, civil law exists to regulate and serve commercial forms of public conduct.
Despite the evident criminality of this subject matter, the current article will ignore its sociological, economic and criminological aspects, since the human costs seem to receive ample attention. Instead, this work aims to outline the legal loopholes of the compulsory collection of debts conducted by corporate bodies, describing the lawful methods of enacting resource-draining obstacles to shield debtors from collection that have gone largely unnoticed. It is a summary of first-hand research by a participant of the Russian legal system, and thus to maintain the client-attorney privilege, no references to specific disputes are included.
Currently, legislation and legal practices arm unscrupulous contractors with sufficient methods to establish procedural conditions that logistically avert the possible process of judicial debt collection. In this week's installment, we will look at three of them: address "concealment," defendant "substitution" and liquidation of the "parent corporation."
Concealment relies solely on judicial indifference to accurate debtor identification. Evidently, courts do not concern themselves with the address's correctness. Russian legal scholars place the onus of providing the defendant's exact address on the plaintiff. Although most Russian educators of law have never heard of the concept, their ethos emphasizes a prevailing and systemic inculcation closely mirroring the caveat emptor doctrine.
Based on section 102, subsection 2, point 1 of the RF Code of the Arbitration Procedure (CAP), the defendant's mailing address must be declared in the claim statement. Hence, the arbitration court's decisions and the execution orders stipulate the debtor's postal address. In Russian business practices, the identification of the corporate body requires the corporate business name with the site of operation - not the postal address. The site (legal address) must be and is indicated in the registration documents of the corporate body. The postal address is generally excluded.
However, many debtors conduct their business activities by using strictly the postal address. It differs from the corporate location, which is omitted by debtors from the contracts aimed, drafted and enacted for later debt evasion. The legal address is generally not used in legal contract transactions. Post office boxes (POBs) are frequently used as the mailing address.
Thus, the execution creditor, using the execution order containing only the debtor's mailing address (or the POB), is severely disadvantaged. Pristav-executors  (there are no exclusive enforcers for the arbitration of court decisions) - in the region of the mailing address - can and do waive the collection court orders, because of the debtor's absence in their territorial jurisdiction. Moreover, the bodies of compulsory execution in the debtor's area can refuse to fulfill the executive orders; according to the text of the executive document, the evasion occurred outside their subordinated territory.
The aforementioned method of address concealment is a variation of the widely practiced method of defendant substitution. To their purpose, management establishes two or more organizations with identical names, duplicating the contents of corporate documents but with a different address. The corporate twins exist in different geographic - and thus jurisdictional - locations of the RF. The clone organizations are generally registered in regions removed from each other by a vast distance. In a country sprawling over eleven time zones with a dilapidated communications and transportation network, geographic setting does function as a deterrent to litigation.
The company's management connects all debts and obligations to one organization - in the region with most of its corporate activity. All benefits are connected to the other organization - with the identical name but seated and functioning in another jurisdictional area. The organizational "linkage" between the two occurs, for instance, through the opening of a bank account in a third region, geographically detached from the registration location of each of the corporate twins.
There are some managerial challenges during the operations of the two firms. Nonetheless, this scheme can function for years without serious difficulties, while creditors remain oblivious of their risky exposure to the evasive twin in another location. With the use of this method, filing a suit against the debtor is senseless. After all, every document testifies that the firm with obligations possesses only liabilities.
Liquidation of the "parent corporation"
Another variation of the above method is the establishment of a corporate body in one region and the opening of its branch in a different area. Subsequently, the parent organization is liquidated, while the branch continues operating. Occasionally, even the liquidated firm continues to function informally.
In both evasion variations, serving the claim to the debtor-organization is senseless; formally, it does not exist. Although the management of the debtor company may be charged with fraud, obtaining a conviction is quite resource draining and thus highly improbable. The creditor can enact a suit under section 183, subsection 1, of the RF Civil Code, providing that:
In the absence of powers to act in the name of another person or in the event of exceeding such powers, the transaction shall be considered to be concluded in the name of and in the interest of the person who concluded it unless the other person (person represented) subsequently approves expressly this transaction.
Yet, even with a favorable ruling, the creditor is highly unlikely to obtain a settlement, because the property of an individual is generally insufficient to recover a large-scale debt, particularly when the liquid assets were already lost to capital flight.
Next week, Piotr Przychodzki continues to look at methods of corporate debt evasion in post-Communist Russia.
1. "Banks Lowering Standards Risk of Bad Debts Grows as Banks Take on Riskier Loans, Government Report Finds." CNNfn. September 17, 1998.
2. Eric Margolis. "Karl Marx, Meet the Marx Bros." The Sunday Sun. September 6, 1998. The comment section, p. 7.
3. Doug Rohlfs. "Crime Adapts to Market Conditions." The Russian. Feb. 1998., p. 41.
4. Matthew Fisher. "Russia's Roulette: Former Soviet Union Sinks Deeper into Economic Quagmire." The Sunday Sun. June 7, 1998. p. 42.
5. Doug Rohlfs. "Crime Adapts to Market Conditions." The Russian. Feb. 1998., p. 40.
6. Katharina Pistor. "Supply and Demand for Contract Enforcement in Russia: Courts, Arbitration and Private Enforcement." Review of Central and East European Law. July 1996, No. 1. 55-87.
7. Katharina Pistor. "Supply and Demand for Contract Enforcement in Russia: Courts, Arbitration and Private Enforcement." Review of Central and East European Law. July 1996, No. 1. 55-87.
8. Aleksandr Kakotkin. "Russia: Organized Crime's Economic Clout Assessed." Moscow Argumenty i Fakty. July 1996, No. 30. p. 8.
9. Section 315. "Malicious Default of the Judicial and Impeding to its Execution." Ugolovniy Kodeks. Vedomosty Federalnogo Sobraniya. #18, 21.06.96, s.792. Translated by Andrei Markine.
10. RSFR. - The Russian Soviet Federated Socialistic Republic. It was the name adopted for the Russian Federation from 1918 to 1991.
11. Until 1997, the RSFR Criminal Code remained in force. As such, the beginning of the economic transformation was remained under the Soviet Criminal Code. The new Russian Federation Criminal Code was approved on July 13, 1996, and enacted on January 1, 1997.
12. Under the Soviet Establishment, unarmed bureaucrats, consisting mostly of women staffed the judicial executors. With the latest administrative and procedural reform, the former judicial executors became "pristav-executors."
One of the direct translations of the word Pristav means "usher." However, its auxiliary meaning is important. Its etymology originated with the verb "pristavlyat" meaning lean, add, attach, place, as well as set. This word is very similar to "pristavka" which means "prefix". The word pristav also invokes using of physical force.
In Tsarist Russia, Pristavs maintained order and security at the court. Pristavs, as a word describing and occupation, all but disappeared in the presumable one social-class system of the Soviet Union. However, the contemporary Russian legislative reformers sought to revive even some symbolic links with the legal administrative practices, personnel and terminology of Tsarist Russia.
In the text of the work, the term "Pristav-executors" applied to reflect the contemporary transformation and usage of this office and designation, along with a partial translation. In fact, nothing changed with the rehabilitation of the term pristav. It was merely the renaming of judicial-executor to pristav-executor, no more.
13. Article 183, Subsection 1. "Conclusion of Transaction by Unempowered Person." Civil Code of the Russian Federation [Adopted by the State Duma on 21 October 1994 and 22 December 1995, as amended 20 February and 12 August 1996]. Parts 1 and 2. Translated from Russian by W.E. Butler. (London: Simmonds and Hill Publishers Ltd. The Primrose Academy Ltd. 1997.), pp. 98 - 99.
The endnote reference number 9 was at the time of writing of this paper, not readily available in an English translation to the authors. Andrei Markine translated the original Russian text into English, based on the various available standards. An effort was also made to bring to the attention of the reader the historical and prevailing inconstancies of translations throughout.
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