Yukos and the recognition of foreign bankruptcies

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1 Yukos and the recognition of foreign bankruptcies Author: Robert van Galen Published: The European Lawyer This article discusses a problem that may arise in relation to the recognition of foreign bankruptcies where the law of the receiving state does not provide for admittance proceedings. The problem is illustrated by the Yukos proceedings in the Netherlands. The Yukos case Yukos Oil Company ("Yukos") is a Russian company. Its 100% Dutch subsidiary, Yukos Finance B.V. held most of the non-russian activities, such as interests in the Lithuanian refinery Mazeikiu Nafta and a pipeline in the Slovak Republic. In 2003 the Russian state commenced actions against Yukos and its affiliates. Yukos' CEO, Mikhail Khodorkovsky, and its managing director, Platon Lebedev, were imprisoned and the tax authorities subsequently issued very substantial assessments against it, ultimately totaling approximately $ 30 billion. Furthermore, the tax authorities obtained freezing orders which prevented Yukos from selling or pledging assets in order to meet the tax assessments. In December 2004 the tax authorities enforced part of their claims against the shares that Yukos held in its most important subsidiary, Yuganskneftegaz, and sold them via an auction to the sole bidder. Thus the shares ended up in the hands of the state-owned company Rosneft, which bought the shares for just over half their estimated value. Yukos has submitted complaints to the ECHR in Strasbourg on the ground that the actions of the Russian authorities amounted to an illegal expropriation and that the court proceedings in which the tax assessments were confirmed were contrary to the principles of fair trial. However, the ECHR is struggling with an enormous work load and to this day has taken no decision on whether the case is admissable. Since as a result of the assessments and freezing orders Yukos was prevented from paying its larger creditors, eventually insolvency proceedings (referred to as supervisory proceedings) were opened against Yukos in Russia. Subsequently, a creditors' meeting voted Yukos into bankruptcy. The majority of the votes at that meeting were cast by the tax authorities.

2 Shortly after his appointment, the Russian receiver, Eduard Rebgun, announced that as the representative of Yukos Finance's sole shareholder, he intended to adopt a resolution replacing that company's management. Yukos Finance and its managing directors commenced summary proceedings before the Amsterdam District Court, seeking an injunction prohibiting Rebgun from adopting such a resolution. They put forward two arguments in support of their claim. The first argument was based on the territoriality principle as it has been developed in two judgments of the Dutch Supreme Court. This principle places very strong limitations on the recognition of bankruptcies from states with which the Netherlands has no bankruptcy treaty. The essence of this principle is that it is applied regardless of the merits of the foreign proceedings. The first of the two cases in which the Supreme Court applied this principle (Dutch Supreme Court, 2 June 1967, NJ 1968, 16, Maître Hiret/Chiotakis) concerned a debtor that had been declared bankrupt in France. One of the creditors, however, sought to take recourse against the debtor s assets in the Netherlands. The French receiver tried to obtain an injunction against this creditor on the ground that the French bankruptcy order operated as an automatic stay (with extraterritorial effect in the Netherlands). The Supreme Court held that if a bankruptcy has been opened in a country with which the Netherlands does not have a bankruptcy treaty as was the case with France at that time the foreign bankruptcy stay does not extend to assets located in the Netherlands and that individual creditors were therefore not precluded from taking recourse against Dutch assets. The second case (Dutch Supreme Court, 31 May 1996, NJ 1998, 108, De Vleeschmeesters) also involved a French bankruptcy. Here the French bankruptcy had ended and, as a consequence thereof, the debtor's remaining debts had been discharged. Subsequently, a pre-bankruptcy creditor seized certain of the debtor's assets in the Netherlands. The debtor sought an injunction on the ground that, by virtue of the French bankruptcy, the debt had been discharged. The Supreme Court decided that in the absence of a bankruptcy treaty, such a discharge had territorial effect only, in the sense that it would not be given effect in the Netherlands and would thus not limit the pre-bankruptcy creditor's recourse rights. In the Yukos summary proceedings, Yukos Finance and its managing directors maintained, on the basis of this territoriality principle, that the Yukos Finance shares were not part of the Russian bankruptcy estate and that the Russian receiver could therefore not exercise the sole shareholder s voting rights on those shares. This argument was rejected by the Amsterdam District Court and, on appeal, by the Amsterdam Court of Appeal. The courts held that the question of whether a Russian receiver can vote on shares in a Dutch company depends on whether he is entitled to represent the company under Russian law, which was undisputedly the case. Thus, the courts regarded the foreign receiver's right to vote on the

3 shares as a matter of company law rather than bankruptcy law. Yukos Finance (represented by the old management) and the managing directors themselves lodged an appeal against the Court of Appeal judgment with the Supreme Court. That appeal is still pending. The second argument used by Yukos Finance and its managing directors in the summary proceedings (in first instance) was that the Russian bankruptcy was spurious and should not be recognized by the Dutch courts because it was contrary to Dutch public policy. The Amsterdam District Court held that a determination as to whether the Russian bankruptcy was illegitimate required a factual investigation beyond the scope of summary proceedings. Under Dutch procedural law, summary proceedings are aimed at providing a provisional measure in urgent cases and not a final determination of the parties rights. In this light, Article 256 of the Dutch Code of Civil Procedure ( DCCP ) states: If the court in summary proceedings ( voorzieningenrechter ) is of the opinion that the case is not suitable for being decided in summary proceedings, it shall refuse the requested order. Therefore, one of the differences between summary proceedings and regular proceedings is that in summary proceedings the court may refuse to give an order if the matter is too complicated to be determined on a provisional basis. This means that in summary proceedings the complexity of the case works against the plaintiff. Thus the Amsterdam District Court rejected the plaintiffs' arguments based on the (abstract) territoriality principle, declined to determine whether the Russian bankruptcy was illegitimate and refused to enjoin Rebgun from adopting a shareholders' resolution dismissing the management of Yukos Finance. The District Court's judgment in summary proceedings was rendered on August 11, 2006 and on that same date Rebgun adopted the envisaged shareholder's resolution. As indicated, the plaintiffs lodged an appeal against this judgment with the Amsterdam Court of Appeal. The appeal was limited to the question whether the territoriality principle precluded Rebgun from voting on the shares, irrespective of the details of the Russian bankruptcy. It was not directed against the decision that the legitimacy of the Russian bankruptcy of Yukos Oil Company could not be investigated in summary proceedings. As indicated above, the court of appeal confirmed the judgment of the district court and a further appeal was lodged with the Supreme Court. A judgment of the Supreme Court is expected in the fall of this year. In the meantime, Yukos Finance (represented by the old managing directors) and the old managing directors themselves commenced regular proceedings, also before the Amsterdam District Court, against Rebgun and against Shmelkov and Hogerbrugge, the new

4 managing directors appointed by Rebgun. The plaintiffs took the position that the dismissals of the old managing directors were void, as were (i) all other shareholder's resolutions adopted by Rebgun (such as the appointment of the new managing directors) and (ii) all actions taken by the new, Rebgun-appointed managing directors. Although the Amsterdam District Court had, in the summary proceedings, refused to enjoin Rebgun from adopting resolutions dismissing the old management and appointing new management, this did not mean that such resolutions were valid. First of all, pursuant to Article 257 DCCP a judgment in summary proceedings does not bind a court deciding the same case in regular proceedings. Secondly, the Amsterdam District Court in summary proceedings had not rendered a judgment on the validity of those resolutions, because it had refrained from considering the legitimacy of the Russian bankruptcy in view of the factual complexity of this question. In its judgment of October 31, 2007 in the regular proceedings, the Amsterdam District Court held first that in the absence of a relevant treaty, foreign court decisions are eligible for recognition in the Netherlands only if (i) the jurisdiction of the foreign court is based on a ground that is acceptable under international standards, (ii) the foreign proceedings were conducted with due observance of the principles of due process of law and (iii) the foreign judgment is not in violation of Dutch public policy 1. Thus, the court applied the rules which have been developed for the recognition of foreign judgments in general and not the stricter rules regarding territoriality which were developed by the Supreme Court in the abovementioned two cases specifically for the recognition of certain aspects of foreign bankruptcies. I will comment further on this below. The court went on to investigate whether the criteria under (ii) and (iii) had been met in the Yukos case and held: The district court is of the opinion that the course of events as represented hereinbefore can only lead to the conclusion that the way in which the additional tax assessment owed by Yukos Oil, and the size thereof, was assessed by first the Russian Tax Authorities and subsequently by the tax court cannot stand the test of criticism. ( ). The (..) hearing before the tax court and the appeal are a violation of the fundamental principles of due process of law as generally accepted in the Netherlands and laid down in article 6 ECHR, but which also apply outside the scope of applicability of that article of the convention (..). The conclusion must ( ) be that in the course of the determination of the tax it owed to the Russian State and the extent thereof, Yukos Oil was deprived of a fair trial 2 1 Consideration 3.4.

5 The district court then went on to decide whether there was a causal link between the determination of the tax obligation and the bankruptcy of Yukos Oil Company. It came to the conclusion that there was such a link and also that in the bankruptcy proceedings no substantive, sufficiently safeguarded, judicial review had, or could have, taken place of the manner in which the additional tax assessments were determined. The district court then concluded: The above leads to the conclusion that the Russian bankruptcy order in which Rebgun was appointed receiver in the bankruptcy of Yukos Oil was effected in a manner not in accordance with the Dutch principles of due order of process and is thus in violation of Dutch public order. For that reason, the bankruptcy order cannot be recognized and the receiver s powers that ensue from it under Russian law cannot be exercised by Rebgun in the Netherlands. This entails that Rebgun was not authorized to represent Yukos Oil in the Netherlands in regard to exercise of the voting on the shares held by it in Yukos Finance. The shareholders resolutions taken by Rebgun on behalf of Yukos Oil, including the resolution to dismiss Godfrey and Misamore of 11 August 2006 and the resolutions to appoint Shmelkov and Hogerbrugge as directors of Yukos Finance, were not taken by the corporate body designated by law to take them, and were therefore null and void. This also means that that Shmelkov and Hogerbrugge were never appointed directors of Yukos Finance, so that all decisions taken by them are also null and void. 3 Rebgun and Shmelkov have appealed against the judgment of October 31, The appeal case is in its initial stages. A further complication is, however, that after the final oral hearing but before the October 31 judgment, Rebgun sold the Yukos Finance shares at a bankruptcy auction in Russia to Russian company OOO Promneftstroy and replaced Shmelkov and Hogerbrugge by new directors. Promneftstroy has taken the position that it is not bound by the October 31 judgment. However, the Enterprise Chamber of the Amsterdam Court of Appeal rejected this position in separate proceedings 4 started by Promneftstroy itself, holding that both Promneftstroy and Rebgun's successor are bound by the judgment and by its consequences, e.g. that Rebgun was unable to provide Promneftstroy with ownership of the Yukos Finance shares 5. For these reasons the Enterprise Chamber decided that the new directors could not be recognized and that Promneftstroy could not be recognized as a shareholder. This situation will of course change if the October 31 judgment is overturned. 2 Consideration Consideration Decision of 21 March 2008, LJN BC This follows from the holding, quoted above, that Rebgun cannot exercise his powers in the Netherlands. The transfer of the shares requires a Dutch notarial deed of transfer.

6 For this reason, Promneftstroy has in the meantime been recognized in several proceedings as an interested party. Recognition of foreign bankruptcies The Yukos case demonstrates an important feature of the recognition issue. The manner in which Dutch law is structured entails that it remains uncertain for a long time whether acts performed by a foreign receiver in the Netherlands are valid. Only after a decision rendered in regular proceedings becomes irrevocable will there be some certainty, but even then there may still be the problem that such judgment is in principle only binding on the parties to the proceedings and their successors and not on third parties. Dutch law does not provide for any form of admittance proceedings which the foreign receiver must win before he can exercise any powers in the Netherlands. Furthermore, summary proceedings cannot provide an adequate barrier against a non bona fide foreign receiver, because the court will deny an injunction against the foreign receiver if the matter is too complicated to be investigated in such proceedings. It is likely that most cases in which there can be serious doubt as to the application of the rule of law in foreign proceedings will not be sufficiently clear-cut to deny access without a more thorough investigation than summary proceedings can provide. In the absence of an admittance test, a strict application of the territoriality principle as developed by the Supreme Court might provide a solution. As explained above, this principle entails that in the absence of a bankruptcy treaty, the foreign trustee cannot exercise control over assets in the Netherlands. However, many Dutch legal authors are of the opinion that the territoriality principle is obsolete and that Dutch courts should cooperate with foreign receivers even where the bankruptcy proceedings have been opened in countries with which the Netherlands does not have a bankruptcy treaty. Furthermore, the Dutch Supreme Court made inroads into the territoriality principle in a judgment of 24 October 1997, NJ 1999, 316 (Gustafsen / Mosk). The alternative criteria discussed above, which the Amsterdam District Court used in the October 31, 2007 judgment to determine whether Yukos' Russian bankruptcy proceedings should be recognized, could be useful, but as long as there are no admittance proceedings, courts in summary proceedings will not be able to keep out foreign bankruptcies on the basis of these criteria, because a request for an injunction is likely to strand on the complexity issue. In view of the problem that was encountered in the Netherlands, it is interesting to see how other legal systems avoid facilitating foreign bankruptcies from non-treaty states in cases where human rights (such as the principle of fair trial) have been violated, where the bankruptcy amounts to a surreptitious expropriation without fair compensation or where the

7 interests of creditors are insufficiently respected. The UNCITRAL model law on cross-border insolvency, which was the result of cooperation between representatives of the UN Member States, represents the "legal state of the art" in this area. The model law has been implemented in a number of countries, including the United States and the United Kingdom. Pursuant to Article 17 of the model law, a foreign proceeding should be recognized as a main proceeding 6 if (i) the debtor has its centre of main interests in the state where the proceedings have been opened (ii) the proceedings and the receiver meet the definition of insolvency proceedings within the scope of the model law and (iii) documents proving the opening of the proceedings have been submitted. These requirements do not necessitate an investigation into the characteristics of the foreign proceedings. However, Article 6 provides that nothing in the model law prevents the court in the receiving state from refusing to take an action governed by this law if the action would be manifestly contrary to its public policy. The receiving court can therefore apply a public policy test under local law before recognizing foreign proceedings. This in fact amounts to an admittance test, albeit not a strict one. The United States has incorporated Article 6 in Section 1506 of the US Bankruptcy Code, which provides that nothing in Chapter 15 shall prevent the court from refusing to take an action governed by Chapter 15 if the action would be manifestly contrary to the public policy of the United States. UK law contains a similar provision 7 However, the admittance proceedings provided for in Article 17 of the model law are not the only test of the foreign proceedings set out in that law. Article 20 provides that upon recognition of a foreign proceeding (a) commencement or continuation of individual actions or individual proceedings concerning the debtor s assets, rights, obligations or liabilities is stayed, (b) execution against the debtor s assets is stayed and (c) the right to transfer, encumber or otherwise dispose of any assets of the debtor is suspended. Thus, recognition alone does not result in a transfer of powers to the foreign receiver. If the receiver wishes to exercise control over the debtor's assets in the receiving jurisdiction, he must, under Article 21(1) of the model law, apply to the court for appropriate relief. Such relief may include entrusting the administration or realization of all or part of the debtor s assets located in the receiving state to the foreign representative or another person designated by the court, which covers such actions as voting on and selling shares of subsidiaries. In granting or denying relief, or in modifying or terminating relief, the court must, under Article 21, be satisfied that the interests of the creditors and other interested persons, including the debtor, are adequately protected. 6 I will not discuss non-main proceedings here, because in general they do not involve the foreign receiver exercising control over assets in the receiving country. 7 Art. 6 Schedule 1 to the Cross-Border Insolvency Regulations 2006.

8 Thus, the model law provides for a substantive test before the foreign receiver can exercise any powers. In addition, although the foreign receiver can obtain provisional relief under Article 19 prior to recognition, the court must apply the criteria of Article 22(1) before such relief is granted. The provisional relief ends when a decision is taken on recognition of the foreign proceedings. In the Yukos case Rebgun obtained provisional relief in the United States. In an ex parte decision, the Bankruptcy Court of the Southern District of New York granted a temporary restraining order preventing the Dutch subsidiaries, including Yukos Finance, from entering into certain transactions. In subsequent proceedings the temporary restraining order was first limited and ultimately lifted. In the end, the New York court never had to decide on the recognition of the Russian bankruptcy. The model law in principle provides for an adequate admittance test at several stages. Other legal systems, such as those of Germany and France, do not contain such sophisticated provisions. Under German law there is an automatic recognition of foreign judgments and under French law an exequatur is required but once granted has retroactive effect. My firm acted on behalf of the Dutch Yukos entities in the Dutch proceedings. Robert van Galen NautaDutilh

32000R1346 OJ L 160, , p (ES, DA, DE, EL, EN, FR, 1. Council regulation (EC) No 1346/2000 of 29 May 2000 on insolvency proceedings

32000R1346 OJ L 160, , p (ES, DA, DE, EL, EN, FR, 1. Council regulation (EC) No 1346/2000 of 29 May 2000 on insolvency proceedings 32000R1346 OJ L 160, 30.6.2000, p. 1-18 (ES, DA, DE, EL, EN, FR, 1 Council regulation (EC) No 1346/2000 of 29 May 2000 on insolvency proceedings THE COUNCIL OF THE EUROPEAN UNION, Council regulation (EC)