Using Bankruptcy as a Takeover Tool
October 7, 2000
By SABRINA TAVERNISE
NOVOKUZNETSK, Russia The Novokuznetsk Aluminum Plant here turns out 276,000 tons of metal a year, more than 10 percent of Russia's total production and enough to build more than 3,500 Boeing 747's.
It makes a profit on every ton by selling its ingots abroad for foreign currency after processing it in Russia, where workers' wages and supplies are priced in rubles far below world cost.
Nonetheless, in January, a local court, prodded by the regional governor, declared the company bankrupt and named a new set of managers. It is now controlled by a former competitor, one that has cultivated a relationship with the governor.
As Novokuznetsk Aluminum's fortunes demonstrate, bankruptcy in Russia often has more to do with politics than it does with balance sheets. A two- year-old bankruptcy law lets debts of as little as $5,000 topple companies worth millions, if the bills go unpaid for three months. In Russia, where even the government routinely runs months behind in paying wages and other obligations, that means most companies are candidates for receivership. The number of bankruptcies has soared 150 percent in two years.
All over Russia, local politicians and business tycoons have latched onto the bankruptcy law to effectively seize valuable companies at a fraction of their market value, critics say. Powerful local politicians start the process by opening the door to
a predator business group and pressing judges to put the target company into bankruptcy and name one of the predator's own employees to manage it. Through these managers, called receivers, the process is most often abused, critics said.
"In a developed economy, bankruptcy is a process that eliminates enterprises that aren't effective, but in Russia it doesn't work like that," said Pyotr Karpov, the former deputy head of the Federal Bankruptcy Service. "Bankruptcy here has absolutely no
relation to how economically effective a company is or to the amount of its debts.
"The law thinks in a Western way," he said, "but the creditors think only of how to use bankruptcy to grab the company."
Probably the best-known example is the BP Amoco investment of $500 million in a Russian oil company called Sidanco. A rival Russian business group pushed Sidanco's most valuable subsidiaries into bankruptcy last year after acquiring their debts from other creditors. The rival group, the Tyumen Oil Company, used the process to snap up those subsidiaries at bargain prices, eviscerating BP Amoco's investment. BP Amoco, based in London, eventually recouped a part of its investment, but only after enlisting the United States government to threaten a key loan to Russia.
Russia rewrote its bankruptcy statute two years ago to try to correct problems caused by a 1992 law approved soon after the collapse of the former Soviet Union's centrally planned economic system. That law let companies accumulate debts with impunity and resulted in a tangle of unpaid bills that choked the economy. The new law addressed that problem, critics said, but created others by setting too low a threshold for bankruptcies and allowing local politicians too much control over the process.
Almost 11,000 companies entered bankruptcy last year, compared with 4,300 in 1997, before the new law was passed, according to Russian research published by the Center for Economic Policy Research, a private London-based institution. Most of these companies were liquidated to pay creditors. But more than 10 percent most often big companies were put into receivership, with their debts frozen and cash flows put in the hands of court-appointed managers.
The law lets healthy companies fall into bankruptcy almost as often as sick ones, the Russian researchers found. Because the amount of debt required to start the process is so small, Russia's bankruptcy process has yet to begin separating truly insolvent companies from those that can pay their debts.
Yekaterina Zhuravskaya, an economist at the Center for Economic and Financial Research in Moscow and a co-author of the Center for Economic Research study, found that Russian companies under external management were usually no worse, and sometimes much better, at servicing their debts before being put into bankruptcy than were companies not pushed into receivership. There is no economic reason these companies are being bankrupted when the others, which are worse, are not, she said.
In the Kemerovo region of Siberia, where Novokuznetsk Aluminum is situated, the aluminum plant is not the only enterprise in the hands of a receiver. Local authorities have used bankruptcy to unseat the owners of all the largest enterprises.
Formally, the local electric utility started the aluminum company's bankruptcy. The state-controlled utility company said that the smelter was $54 million behind in payments for electricity. Novokuznetsk Aluminum said it owed far less. The company declined to give its net worth, but a former manager said it sold $414 million worth of metal last year. Politics, however, pushed the bankruptcy through, and the region's powerful governor, Aman Tuleev, does not hide his own role."We had to change the owners," Mr. Tuleev said in an interview, waving his hand in his spacious office in the region's capital, Kemerovo. He described the previous owners, the Zhivilo brothers, as con men.
If the bankruptcy served the needs of the governor, it did not help the aluminum company's largest creditor. The electric utility
became a victim of the process it had started when the court-appointed receiver, Sergei Chernyshyov, challenged the very debt that had driven the aluminum plant into bankruptcy. A court let him revalue the debt at about $1 million, less than 2 percent
of what the creditor expected to collect.
Now a former competitor is consolidating control over Novokuznetsk Aluminum. Exports flow through companies affiliated with Russian Aluminum, the holding company that controls about 70 percent of the country's aluminum industry. Though Mr. Chernyshyov said he was not connected to the group, the general director he recently hired came from one of Russian Aluminum's subsidiaries. A photograph of Russian Aluminum's chief executive, Oleg Deripaska, hangs on the new general director's wall.
"This was theft in broad daylight," said Mikhail Zhivilo, the former owner, in an interview earlier this year. "If it was the money they wanted, they could have just seized the supplies that were en route to the plant. They wanted the factory, and the only
way to do this was through bankruptcy."
While Kemerovo regional authorities needed the electricity company's help to bankrupt the aluminum smelter, they have been
able to intervene directly with larger enterprises in the region. The new bankruptcy law enables local governments to prevent the closing of a city's main employer. Under the law, local governments can extend receiverships for companies with at least 5,000 employees to as long as 10 years, compared with 18 months for other concerns. Companies with more than 5,000 employees account for 41 percent of industrial production.
Such lengthy receiverships have given regional governors and their allies time to manipulate the finances of these largest companies. Often, they press courts to name a politically connected receiver who is often allied with one of the creditors. The receiver is motivated to run up its debt, giving the creditor more control over the company. Rather than restoring companies to solvency, receivers often drive them deeper into debt.
Kemerovo's biggest steel plant is one example. The Western Siberia Steel Works, known as ZapSib, was so indebted in 1996 that Mr. Karpov's federal bankruptcy committee and the company's main creditor both recommended immediate liquidation. But the former regional governor stalled efforts to close ZapSib which with 35,000 workers is Kemerovo's largest employer until the new bankruptcy law took effect with a clause shielding big employers. ZapSib was put into receivership.
Since then, the company has had three changes of management and its debts have ballooned to about 12 billion rubles from 4 billion rubles. Each receiver has worked in the interest of a different creditor, critics say, with the latest favoring a Moscow- based trading company called Evraz Holding. Last year's profit of 600 million rubles, or about $21 million, should have exceeded $150 million, the critics add.
"My question is, where's the money?" said Igor Burtsev, who worked under a previous ZapSib bankruptcy team. ZapSib's current managers said they reinvested profits to expand production, a decision they said was validated by the mill's return to profit after years of steady losses.
A local court extended bankruptcy proceedings at ZapSib this summer for another seven years, ostensibly to give the company more time to improve its finances. Critics like Mr. Burtsev said the extension was granted to give Evraz, whose spokesman ran Mr. Tuleev's presidential election campaign this year, more time to consolidate control among the creditors.
Despite the weakness of bankruptcy as a tool in Russia, it is a vast improvement over the chaos of the early 1990's, when property struggles in the aluminum industry were sometimes settled with lead. Rival business groups used contract killings to try to intimidate one another.
"At least people are going to court these days," said Mr. Burtsev, who has quit the metals business and recently started an Internet company. "Five years ago they would have been shooting each other."
Some rough business tactics remain, however. Mikhail Zhivilo, the former owner of the aluminum plant, is in hiding after the regional prosecutor threatened to arrest him on charges of trying to assassinate the governor. An Olympic biathlon champion who is Mr. Zhivilo's close friend has been in custody for more than a month for the same offense. Mr. Tuleev made similar accusations against others on five earlier occasions.
Even the harshest critics said Russia's problems were not that different from those experienced in other relatively young industrialized economies. "The struggle in Russia now, pitting strong regions against the federal center, closely resembles the one that was raging in the U.S. in the 19th century," said Eric Berglof, director of the Stockholm Institute of Transitional Economies.
Western economists agree, however, that Russia needs an effective bankruptcy process. Its economy has never gone through the process necessary to separate companies that can survive under market conditions from those that cannot. As a result, sick companies are sucking valuable resources from healthy ones, dragging out Russia's transition to a market economy.
"We have loss-making enterprises in all economies," said Barry Ickes, a professor of economics at Penn State. "In the U.S. we have Amtrak, but it doesn't matter because its share in the economy is small. In Russia, you have a lot of Amtraks."
