Secured Financing in Russia: Risks, Legal Incentives, and Policy Concerns

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Secured Financing in Russia: Risks, Legal Incentives, and Policy Concerns^

Introduction

Secured financing plays a crucial role in a market economy.' In the context of Russia's nascent and struggling market economy, the importance of secured financing is greatly augmented.2 Investing in Russia involves significant economic and legal risks for both foreign and domestic investors. The role of secured credit laws is to mitigate these risks.

This Note explores the risks, legal incentives, and policy concerns created by Russia's secured credit laws. Part Two provides a brief overview of the legislative history behind the sections of the Russian Civil Code dealing with security interests, which for the most part have been positively received by Western commentators. Although Russia's secured credit laws are clearly an improvement over those that existed in the Soviet Union, commentators' praise may be overly generous, and at the very least should be clearly qualified. Therefore, Part Three describes the process for acquiring and enforcing a valid security interest in Russia and concurrently identifies several shortcomings and ambiguities by way of comparison to Article 9 of the Uniform Commercial Code (UCC) and the Model Law on

Secured Transactions (Model Law) developed by the European Bank for Reconstruction and Development (EBRD).

The UCC and the Model Law are particularly useful references by which to critique Russia's secured credit laws. Article 9 of the UCC is widely regarded as one of the best secured credit laws in the world.3 A proposal submitted to the Council of Europe by the Service de Recherches Juridiques Comparatives of the CNRS of Paris suggested using Article 9 as the basis for the creation of a uniform secured credit system for international transactions.4 In the context of Russia's transitional economy, the UCC can be a particularly valuable resource in further development of a commercial legal structure.5 The EBRD developed the Model Law to serve as a guide to the former Soviet bloc countries, which possessed either severely antiquated secured credit laws or none at all.' The Model Law was intended to provide a comprehensive basis for legislation, while at the same time affording the flexibility necessary to accommodate local characteristics.7 A guiding principle of the Model Law was to design a model that was compatible with the civil law systems prevalent in Eastern Europe, yet also incorporated features of common law systems more accommodating to modern financing.8 The Model Law has been influential in several countries in the region.9

Part Four discusses related legal and economic factors that directly affect secured financing and without consideration of which the value of a security interest in Russia cannot be accurately measured. As is true in well-established legal systems, Russia's secured credit laws do not operate entirely in a vacuum, independent of other elements of the legal structure. In particular, banking, tax, and bankruptcy laws impose limitations and incentives that significantly influence secured financing. Similarly, economic factors intrinsic to Russia, such as pervasive tax evasion, create additional risks that necessarily affect the value of security interests. Part Four illustrates that these related elements augment the risk and cost of secured lending and highlights the resulting need for reform of Russia's secured credit laws.

Part Five explains that the shortcomings and ambiguities in Russia's secured credit laws, coupled with the related legal incentives and economic factors, substantially limit the utility and ultimate value of security interests in Russia, which in turn makes credit more expensive and thus less available. Part Five then discusses the policy concerns created by this conclusion, namely a stifling effect on the growth of entrepreneurs and small businesses, and a delayed development of a large middle class and its corresponding tax base. …