i The transport finance industry
The financial sector is an important part of Russia’s economy and includes national and international players (through Russian subsidiaries). The biggest banks, such as Sberbank and VTB, have the Russian state as their principal shareholder, but there are also a substantial number of purely privately owned institutions, such as Alfa-Bank, Otkrytiye and others. In addition to the banks, other types of institutions, including finance leasing companies and financial companies, are entitled to lend money under various arrangements. Following the Ukrainian crisis, substantive Western sanctions have been applied against the Russian financial sector, and a number of institutions have been directly affected.
As far as the transport finance industry in particular is concerned, a number of principal points should be noted. First, the current federal legislation allows almost unrestricted access to the international financial market for Russian lenders – in other words, any Russian commercial enterprise is permitted to borrow abroad in foreign currency. Second (and particularly important for shipping and aviation asset financing, and less so for rail assets), in many cases, lenders prefer to have the financed assets registered outside of Russia, because of the belief that this provides them with a more transparent and flexible means of enforcement of security measures. Indeed, in the 1990s, when the market reforms had just begun, Russian legislation did not provide the borrowers with sufficient protection in this respect; however, things have changed quite substantially since then. Third, the current terms of financing offered by Russian lenders are, in many cases, less attractive than those that are available on the international markets. Because of this, Russian borrowers acquire from foreign lenders in a large number of transport finance transactions. This is particularly true for the ship finance sector, but less so for aviation and rail asset financing, where Russian lenders have a bigger share of the market.
ii Recent changes
Over the past few years, Russia’s legislation regulating many aspects of asset financing, in particular legislation on pledge and mortgage, has been considerably modernised in many respects. This is not directly connected with the Ukranian crisis, but rather with the Russian government’s goal of increasing Moscow’s attractiveness as a financial centre of international importance. In particular, it is now possible to enforce a Russian law mortgage without a corresponding court judgment, as well as enter into mortgage management agreements between mortgagees, pledge rights over a bank account, etc.
II LEGISLATIVE FRAMEWORK
The list of legislative acts that apply to transport finance is quite substantial and includes the Civil Code of Russia, the Merchant Shipping Code, the Air Code, and Federal laws ‘on banks and banking activities’, ‘on hypothecation (mortgage)’, ‘on financial lease’ and ‘on registration of rights to aircraft and transactions with them’. Various aspects of (or relating to) financial transactions are also regulated by sub-legislative acts issued by various federal bodies of the executive branch (e.g., the Government of the Russian Federation and the Ministry of Transport) and by the financial regulator (the Central Bank).
i Domestic and international law and regulation
In accordance with the Constitution of the Russian Federation, generally accepted principles and provisions of international law and international agreements to which Russia is a party form an integral part of Russia’s legal system. If there is conflict between provisions of national legislation and of an international agreement to which Russia is a party, provisions of the latter shall have priority. At the same time, the Civil Code of Russia recognises the right of the parties to choose law applicable to their contracts. Only in relatively few cases does the law explicitly state that certain contracts shall be governed by the Russian law – usually when the contract or its object is closely related to Russia. In cases when Russian law is not mandatorily applicable and the parties have chosen to apply foreign law, but the contract is closely related to Russia and not to any other country, applicability of foreign law chosen by the parties will be recognised by Russian courts, unless this would come into the conflict with imperative provisions of Russian law. In such cases, such imperative provisions will apply in spite of the choice of foreign law.
ii Specific practices
In most transport financing transactions, the parties will be relatively free to choose the law applicable to their contractual relations – this applies to the principal contract and to the associated contracts and instruments, in particular to the security instruments. In the majority of cases, choice of law will be determined by the lender: if the lender is a Russian institution, it will be most likely to insist on Russian law to govern the relations in question; if the lender is a foreign or international institution, the applicable law will most probably be the law of domicile of the lender or the law of the third country, which is ‘neutral’ to both parties, most often English law.
However, in most instances of transactions where the principal loan or credit agreement is governed by foreign law, provisions of Russian law will inevitably come into play in more than one instance. Most obviously, this will be the case when collateral is located in or registered in Russia. It should be noted that ships and aircraft are treated by Russian law as immoveable property, and Russian law shall apply to the contracts in respect of immoveable property that is registered in Russia. Russian law will also regulate the procedure of enforcement of the mortgage or other measures against collateral that is physically located on the Russian territory at the time of enforcement, even if it is registered abroad. It is also necessary for foreign lenders to understand the impact of provisions of Russian law on such issues as insolvency, currency control, taxation of interest, enforcement of claims, customs issues, compliance requirements relating to the relevant transport operations, etc.
III FINANCIAL REGULATION
As outlined above, Russian financial legislation is fairly liberal with regard to providing Russian borrowers with access to foreign or international financial markets. Therefore, Russian financial regulations apply to Russian lenders (including the subsidiary banks of foreign financial institutions) irrespective of the nationality of the borrowers, but when foreign lenders provide loans to Russian borrowers, provided they do so directly (i.e., cross-border loans), they are subject to their national financial regulations.
i Regulatory capital and liquidity
As a member of the Basel Committee on Banking Supervision, Russia undertook to implement Basel III standards in accordance with the schedule adopted by the Committee; in other words, until 2018 inclusive.
ii Supervisory regime
In Russia, banking activities are subject to licensing, with licences being granted by the Central Bank of Russia. Banking institutions licensed in Russia are subject to supervision and control from the Central Bank of Russia, which in the recent past has also taken over supervisory functions in respect of other financial institutions – particularly exchanges and entities involved in the securities market.
IV SECURITY AND ENFORCEMENT
i Financing of contracts
There are two widespread mechanisms of financing new-build means of transport in Russia: through bank loans or through finance leasing.
In the first case, upon reaching the agreement and signing the appropriate instruments, the bank advances the amount of the loan either to the borrower directly or to the seller or builder of the respective means of transport as payment of the purchase price. Normally, the bank would fund only part of the purchase price with the remainder, on average 20–40 per cent, being pre-financed by the borrower itself. In most cases, the repayment of the loan and interest is secured by the mortgage or pledge of the respective means of transport, with loss and damage insurance placed in favour of the lender (jointly with the borrower), and with special arrangements in respect of the cash flow attributed to the item, channelled through a special account in the lender bank. In most cases, mortgage of the means of transport must be registered in the same registry where the title thereto is already registered; for ships, it is also possible to register them (and mortgages over them) in the registry of vessels under construction. The borrower becomes the owner of the respective item and starts to repay the loan.
In the second case, it is normally the finance leasing company that becomes the owner of the ship, aircraft or rolling stock. Its purchase price is paid over time by the lessor (normally the item’s long-term lessee or operator). When the lease payments are completed, the title to the item of lease passes to the lessee.
Russian legislation with regard to pledge enforcement has undergone substantial change over the past few years. Principal new trends have been the increase of protection of mortgagees’ rights and simplification of enforcement. Initially, enforcement of mortgages was only possible on the basis of a court judgment. However, it has recently become possible to enforce a mortgage out of court – by public sale, by private sale or by appropriation of the object of mortgage by the lender. The legislation is yet to be tested by practice, but the availability of this option shows substantial progress.
Rights of the mortgagees are highly ranked: for example, in bankruptcy, the registered mortgagee, although obliged to surrender mortgaged property to the receivers, is also entitled to receive up to 70 per cent of the proceeds of the sale (80 per cent if the creditor is a bank that lent money for the purchase or construction of the respective property). Claims from the side of the mortgagees of the ship are outweighed only by the claims secured by the maritime liens, by the shipbuilder’s lien and claims for costs of wreck removal.
iii Arrest and judicial sale
Russia is a party to the 1952 International Convention Relating to the Arrest of Sea-Going Ships and to the 2001 Cape Town Convention on International Interests in Mobile Equipment. Specific provisions concerning ship arrest on the basis of maritime claims are also contained in the Merchant Shipping Code of Russia (with the wording of respective provisions being based on the 1999 International Convention on the Arrest of Ships rather than the 1952 International Convention for the Unification of Certain Rules Relating to the Arrest Of Seagoing Ships). Arrest of a ship or aircraft (or of any other property of the debtor or defendant) can also be applied for as a security measure or as a preliminary security measure within the frames of judicial procedure. In such case it will be governed by the Code of Civil Procedure and Code of Arbitration Procedure (the latter regulates procedures in Russia’s commercial courts, which are traditionally known as ‘arbitration courts’).
The primary purpose and focus of arrest on the basis of a maritime claim is to obtain security – sale pendente lite is not possible under Russian law. Ship arrest may be imposed by the ruling of a competent court or, in some cases of arbitration, on the basis of an application of a creditor. The court must consider such application within the next day, and if the arrest is granted the vessel will be forbidden to leave port or its other location by the bailiffs or the harbour master. The applicant should be prepared to provide guarantee against damages caused by wrongful arrest on its own initiative or upon the order of the court. The vessel may be released from arrest only if the owner or debtor provides a guarantee in a suitable format. Normally, the vessel may be arrested if it is owned or bareboat-chartered by the debtor under a maritime claim. A sister ship (a vessel owned by the debtor but not connected with the claim) may also be arrested. However, the 1952 Convention also provides for the possibility to arrest the vessel when the party responsible under the claim was merely the time-charterer of the ship.
The recent collapse of OW Bunker, a major ship fuel supplier, raised a wave of claims and threats to arrest ships from the unpaid physical suppliers of fuel against the shipowners in many countries, including Russia. In some instances, shipowners that took delivery of the fuel have been time-charterers rather than owners or bareboat-charterers of the vessels in question, so the possibility of invoking the relevant provisions of the 1952 Convention was widely considered.
Procedure for judicial sales of ships or aircraft
Ships or aircraft may be sold on the basis of the court judgment ordering such sale. On the basis of the judgment, the court will issue an execution order, pursuant to which the bailiffs shall impose an executional arrest and appoint a specialised organisation to make the arrangements for the sale. Notification of the sale shall be published and the court will also send notices of the intended sale to the registered owners and mortgagees. As a rule, the sale will be effected by way of public auction. If the sale is not successful, the creditor that initiated the sale may be entitled to take the title to the vessel, in which case 10 per cent will be deducted from the initial sale price of the vessel (25 per cent if sales repeatedly fail) and this will be set-off against claims to the owner. Proceeds of the sale shall first be used to cover the costs of the sale and related procedures, then the interest accrued and then the principal amount of the debt
All procedural issues related to enforcement shall be governed by Russian law.
V CURRENT DEVELOPMENTS
i Developments in policy and legislation
Russian civil legislation, particularly legislation on mortgage and pledge, as well as on loans and credit, is expected to develop further, which could lead to Russia becoming a more attractive jurisdiction for lenders. Russia’s banking regulations are intended to gradually simplify foreign investors’ access to the country’s financial sector. However, the sanctions imposed against Russia in connection with the crisis in Ukraine are unlikely to be removed very soon, and this obviously has a negative impact on the economy’s growth.
1 Alexander Mednikov is a managing partner at Jurinflot International Law Office.