Insolvency regulation is customarily considered a sensitive area with many pitfalls, and this causes fear in investors. Consequently, it is critically important to set favorable rules at all stages of doing business – establishment, operational activity and exits. Olena Volianska, partner at LCF Law Group, who supported a series of landmark bankruptcy proceedings across the most strategic economic sectors, has seen the situation from the inside out. She’s drawn our attention to those changes that should bring certainty and credibility in Ukrainian law, and explained the developments in the profession of bankruptcy trustees.
UJBL: What changes, caused by the adoption of the new Bankruptcy Code, will affect the business community?
Оlena Volianska: Bankruptcy reform has been actively debated in the legal services market for almost a year now. Though the oncoming changes involve procedural matters, they will actually have an impact primarily on doing business. The new Code is a well-timed document aimed at improving insolvency procedures in our country. Thus, upon the Code’s coming into force, Ukraine is expected to move up 30 more places in the ‘Doing Business’ ranking from its critically low 145th place (out of 180).
The World Bank’s ‘Doing Business Index’ is one of the main indicators that are meaningful to investors pondering whether or not to start their business in a country. Insolvency settlement is one of the most important criteria enabling investors to determine how easy it will be to withdraw from their business and recover their investments. Currently, the average recovery rate is 9 cents on the US dollar in bankruptcy proceedings. By comparison, this rate is 63 cents on the US dollar in neighbouring Poland, which occupies 22nd place in the ‘Doing Business’ ranking.
Will the new Code change the situation? We hope it will.
The first criterion: how easy is it to withdraw from a business or, in other words, is it difficult to open bankruptcy proceedings under the new rules in Ukraine?
The Code has lifted all restrictions on opening bankruptcy proceedings initiated by creditors. The previous law required that a court judgement on the collection of debts from a debtor be obtained, then followed by three months of unsuccessful attempts to enforce the judgement. And only after that could one apply to court to open a proceeding. If the sum of the debt was less than 300 minimum wages, it was impossible to open a bankruptcy proceeding. During the period, debtors could dissipate all valuable assets and so leave behind just a shell entity.
Now any creditor who believes that a debtor is delaying paying off debts, can open a bankruptcy proceeding without obtaining a court judgment, with no minimum amount requirements.
Nevertheless, the Code imposes certain restrictions on creditors to prevent potential abuse. Thus, a bankruptcy case will not be opened if a dispute over a debt has arisen between a creditor and a debtor to be resolved in court and if the debtor declared the dispute. To protect a debtor from opening bankruptcy proceedings on small amounts, an initiating creditor is obliged to make a deposit of the asset trustee’s fees to the court’s account in the amount of 2 minimum wages for 3 working months.
It is obvious that despite the criticism, the Code is well-balanced in terms of regulating creditor-debtor relations.
The new bankruptcy procedure provides more protection for secured creditors.
These creditors include banks and financial institutions. Such creditors’ claims to debtors have arisen from loans granted or have been acquired as part of pools of non-performing loans of banks that are under liquidation and currently being sold by the Deposit Guarantee Fund.
It is no secret that many bankruptcy proceedings initiated by debtors or their related persons are not caused by objective economic reasons, but aimed at avoiding debt payments and to make use of a moratorium on debt repayment and financial penalties. In such proceedings, a debtor does not lose actual control over the business and receives “holidays” for debt payments and debt recovery out of assets.
Once the new provisions come into force, it will be not so easy to do this.
In particular, the term of the moratorium on enforcing pledged assets is now limited. One hundred seventy days after the bankruptcy case is opened, the moratorium is terminated and secured creditors may dispose of these assets as if the debtor was not under a bankruptcy procedure.
In addition, secured creditors have more means to influence the main conditions of auctions at which pledged assets are to be sold. Besides, a secured creditor may now take possession of the debtor’s pledged assets if they were not sold on the second (first repeated) auction.
That said, a creditor may not hinder an auction or obstruct a sale of assets at a low, though market-determined, price. A court still may permit a liquidator to conduct an auction when a secured creditor does not agree.
One could say that the new provisions are creditor-oriented.
In fact, they are aimed more at discouraging a debtor from acting in bad faith. As a result, proper economic relations between debtors and creditors may be established without shifting the balance in favor of one party to the relations.
One of the most important novelties of the Code is the implementation of the exclusively electronic tender procedure. The Code requires the holding of online auctions. A two-tier system will be developed on the principles of transparency and publicity of procedures, as well as easy and equal access to tenders via independent, accredited trading platforms.
This auction mechanism has proved to be a tried-and-true method in developed countries. It ensures that prices are determined in the market, with less room for manipulation and for a controlled sale at an artificially low price.
As lawyers practicing in this area of law, we are cautiously optimistic about the Code. We cannot rule out the possibility that complex, conflicting issues will arise that provoke various interpretations in courts. Nonetheless, I am confident that we will manage to deal with them in the interest of our clients.
UJBL: Now in Ukraine, a large part of bankruptcies are de-facto controlled. How can the new law influence this situation? Can we expect such practices to be eradicated?
O. V.: Frequently, parties to a bankruptcy proceeding do not act in good faith and are interested solely in pursuing their own goals: a debtor and owners wish to transfer as many assets as possible and to avoid repayment of debts, while creditors intend to obtain satisfaction of their claims prior to satisfaction of the claims of others in the maximum amount by way of establishing control over the proceeding.
What makes the situation even worse is the criminalisation of bankruptcies and the apparent incapacity of law-enforcement agencies to counteract this tendency. Moreover, legislation may be interpreted and applied in a creative way. It is, therefore, unlikely that these practices can be completely eradicated. Nevertheless, in my opinion, mechanisms laid down in the new law can significantly reduce the percentage of controlled bankruptcies.
Thus, limitation of the term of a moratorium on pledges makes it disadvantageous to drag out the first stage in a bankruptcy, i.e. the asset disposal procedure. If a liquidation or rehabilitation proceeding is not opened within 170 days, then secured creditors will dispose of the assets.
The opportunities for manipulation are also limited by the new online auction procedure, and a bank or another creditor may gain possession of unsold assets.
Furthermore, the new Code does not provide for a simplified procedure for liquidation of a legal entity after its liquidation by its owner. There was so-called Article 95, which allowed fast-moving bankruptcy after the institution of a liquidation proceeding based on the owner’s decision. It was through application of this article that many debtors, their property surety providers and financial surety providers managed to avoid repayment of debts. Besides, bankruptcy management could be entrusted to a person not holding the special license of a bankruptcy trustee. Generally, such a person was the former CEO of the company. That situation precluded from achieving a balance between the interests of debtors and creditors, as the proceeding was managed by a person related to the debtor. Above all else, the regulating authorities were unable to take disciplinary actions against the said person and, therefore, had no mechanisms for controlling the person’s activities.
All the novelties of the Code make a controlled bankruptcy more complicated, even though they do not eliminate it, and thus create a positive impact on the bankruptcy field.
UJBL: Can you see any loopholes enabling debtors to neglect their obligations to creditors?
O. V.: I would not call them loopholes. Above all, we strive to ensure that our clients reach a compromise with their creditors and maintain a reputation of being a reliable partner. Even a financially sound and good faith client can become insolvent due to economic reasons.
For example, many industrial holding companies and manufacturing groups became hostages of circumstance on occupied territories and lost a significant share of their businesses. In the meantime, the lion’s share of assets became unavailable, production levels either dropped or stopped, or our clients had to reorganize their manufacturing processes by investing huge additional financial resources. These clients are ready to fulfill their financial obligations to banks through an acceptable compromise.
Unfortunately, not every bank is willing to get down to negotiations and restructure debt liabilities.
For these clients, a bankruptcy procedure and a debt collection moratorium can be a period for solvency recovery or a way of “dropping out of the game” less painfully, and satisfying the claims of creditors out of the proceeds of asset sales with a partial debt write-off.
UJBL: How would changes regulating corporate bankruptcies influence the work of external legal advisors?
O. V.: I would say that the adoption of the Code regarding corporate bankruptcies has changed many approaches, but it has not changed the procedure fundamentally. Personal bankruptcy brought about revolutionary changes, whereas for the corporate sector, it involves evolutionary development, improvements which will not significantly affect the work of legal advisors. It’s the only thing that they should consider when developing strategies for clients.
Is there any evidence that banking creditors are interested in applying corporate bankruptcy procedures more intensively in response to new legal possibilities? Will the amount of work for legal advisors increase?
O. V.: I would rather call it a necessity than an interest. When we are working on any complex debt collection case for the interests of a bank, we are certain that it almost always entails, or will entail, a debtor’s bankruptcy risk in the future.
Perhaps new provisions of the law may seem so promising to banks that they may expect to handle matters in-house. But bankruptcy is a complex process and external advisors will still be engaged in serious cases with complicated borrowers. All the more so because the new provisions are to be tested in courts and we will definitely see conflicts, even with forward-looking legislation.
UJBL: Quite often, bankruptcy schemes involve a criminal element related to various misappropriations, abusive practice, etc. How can the new provisions solve this problem?
O. V.: The Code does not regulate matters related to criminal prosecution of offenders. These matters are covered by Article 219 of the Criminal Code, which provides punishment for deliberately putting a company into bankruptcy.
Nonetheless, the new legislation laid down preventive measures designed to restrain senior managers of companies from acting in bad faith.
For example, the CEO and the company will be jointly and severally liable to creditors, if the CEO has not applied to a court within one month when there is a threat of insolvency.
Another novelty relates to the possibility of revising suspicious transactions made by a debtor retroactively. It will preclude acting in bad faith, particularly, dissipation of assets and creation of lots of dubious transactions aimed at accumulating a company’s debts artificially.
Previously, a transaction could be disputed within one year before bankruptcy, now the period is extended to 3 years. Consequently, a liquidator or a creditor in bankruptcy can review all transactions, and those transactions that were inappropriate and caused bankruptcy can be rendered null and void. In doing so, improperly disposed assets of a creditor will be returned to the liquidation estate.
UJBL: Could you highlight notable cases that influenced the practice of bankruptcy in our country?
O. V.: The most high-profile case in the agricultural sector is the bankruptcy of Mriya Agro Holding. Within the agribusiness sector in general, bankruptcy is not the most interesting method of debt settlement for agricultural companies. Their creditors are also aware of the fact that if bankrupt, the company will lose its most valuable asset – its land bank. Due to the fact that there is no free land market in Ukraine, agroholding companies accumulate land banks on a rental basis, without having a mechanism for selling their rental rights to land through a bankruptcy procedure.
If a company holding a land bank of dozens or even hundreds of thousands of hectares of land declares itself bankrupt, it faces risks that competitors will “eat up” the valuable assets by way of re-signing lease agreements.
One such successful example is the bankruptcy of the Okean shipyard in Mykolayiv. Despite the difficulties, after 7 years of the bankruptcy procedure, the sale of its assets took place for a fairly high price. In the process, the enormous arrears in salaries, which came to around UAH 100 million, were paid off.
The practice is also in demand for banks that are managed by the Deposit Guarantee Fund, any financial companies that acquire financial assets. By providing support to several large cases in the interests of financial companies, we managed to prevent the sale of assets of bankrupt borrowers at low prices, actively counteract violations of entry tenders and to help our clients invest significant amounts during bankruptcy proceedings.
UJBL: Let’s refer once again to the restructuring of Mriya Agro Holding’s debts, which were bought out by an Arab investor. Several companies of the group are still going through a bankruptcy procedure. You provided support and keep working under the national procedure. How was the bankruptcy procedure in such a large case as this one coordinated?
O. V.: Mriya Agro Holding’s default and insolvency could affect not only the agricultural market, but also provoke a negative reaction among foreign investors and change their attitude towards Ukraine in general.
Nevertheless, after default the holding company’s management was transferred to creditors who changed the management team and provided working capital to Mriya, thereby allowing the company’s activities to be stabilized and the retention of the company’s team of employees, land bank and the majority of its assets. Concurrently with the process, the management team and creditors’ advisors developed a model of Mriya’s cross-border debt restructuring which was eventually implemented in several jurisdictions. This debt restructuring enabled the sale of the holding company to the investor. This case resulted in success and demonstrated the effectiveness of transferring an insolvent company’s management to its creditors.
As a result of achieving an agreement with creditors, the debt has been restructured in the amount of USD 1.1 billion. By restarting the repayment for almost USD 300 million and converting the remaining amount of debt into capital. A number of Ukrainian legal entities as tenants of the land bank, which belonged to Mriya Agro Holding and were surety providers, should have gone through the national bankruptcy procedure. At present, 10 out of 11 bankruptcy proceedings have ended with the signing of settlement agreements which provided for a write-off of debts in full; the last settlement agreement must be approved in the near future. The purpose of bankruptcy proceedings was to preserve the land bank. The closed bankruptcy proceedings resulted in debt forgiveness by creditors and withdrawal from bankruptcy without the companies losing the legal personality.
UJBL: In your opinion, what events that took place in the last five years have influenced the bankruptcy practice area?
O. V.: I would stress the critical importance of judicial reform and adoption of the new Commercial Procedure Code as well as new approaches applied by the Supreme Court in the consideration of bankruptcy cases.
Commercial courts hear bankruptcy cases according to special laws and under rules of commercial procedure. Consequently, the introduction of new procedural rules had influenced the whole procedure in bankruptcy cases, especially on disputes as to claims to debtors and debtor’s assets which were concentrated within a bankruptcy case. A crucial role in developing new approaches to bankruptcy cases was performed by the Supreme Court.
For instance, with regard to a number of unresolved matters, practices of applying the law and principled positions have been adopted in response to many issues that were not regulated by law. In particular, the following matters have been addressed: fees of bankruptcy trustees, secondary liability of CEO and owners of a bankrupt company, the powers of fiscal authorities in proceedings, absolute completeness of the actions to be performed by a liquidator for the lawfulness of the procedure, and many others.
UJBL: How would you comment on the current situation with bankruptcy trustees? What are your expectations given the latest legislative initiatives?
O. V.: Perhaps, the most expected changes regarding bankruptcy trustees relate to the need to set up a self-regulatory organization (SRO).
We are actively engaged in this process at present. The first working meeting was held in July to prepare the formation of the SRO and hold the general meeting. Today, bankruptcy trustees are the only legal profession without proper self-regulation that would ensure high ethical and professional standards.
However, the solidarity of colleagues and the desire to create a single SRO, as required by the new Code of Ukraine, inspire and fill us with optimism. I am confident that in the near future we will become part of positive changes and developments in the profession.
LCF LAW GROUP
Year of establishment: 2009
Location: Kyiv, Ukraine
Number of partners/lawyers: 3/32
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