Practice Areas Review: Debt Restructuring

Debt Restructuring

PROfile

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Almost three years have already passed since the redrafted On Restoring the Debtor’s Solvency or Declaring Its Bankruptcy Act of Ukraine (the Bankruptcy Act) came into force, and now its provisions of concern which materially restrict a lender’s rights and pose a threat for prospective investors, are very obvious.

The main and very controversial provision which the banks had tried to oppose before the Act came into effect (unfortunately, with no success) is restricting the rights of so-called secured lenders. That is, the claims of lenders which are secured with the debtor’s or guarantor’s property. They have been fully deprived of a casting vote and been granted only an advisory vote. In other words, all they can do is to give advice, which is taken into account by hardly anyone. Secured lenders have been fully excluded from participating in representative bodies deciding on the future of the company, judicial proceedings and other aspects. Furthermore, when the liquidation procedure commences, a secured lender is not given a full scope of capabilities for influence over selection of the way in which the property is sold. In this case, it has to wait until the liquidator tries to sell the asset package.

Although Article 42 of the Act stipulates that the collateral of the secured lender is not included in the liquidation estate, and the liquidation estate shall be sold to cover all financial claims of the lender, this is actually done another way. The liquidator puts up all the bankrupt’s property as the asset package for sale in order to cover and discharge claims of all lenders, including unsecured, post-bankruptcy and secured ones. And the claims of a secured lender may be discharged only after the second or third bidding. It is supplemented with the manipulations of insolvency practitioners designated for reducing the cost of the assets, the general market environment (and in the majority of bankruptcy cases, amounts from 2006 are stipulated) and the letter of the Supreme Economic Court of Ukraine (No.01-06/606/2013 of 28.03.2013) which states that the property may be sold for the nominal sum of UAH 1 if there is no demand for it.  It is obvious that secured lenders, i.e. banks in the main, often find themselves in an unfavourable position.

In so doing, the Act opens up vast possibilities for the bankruptcy of state enterprises and their sale on the cheap. This tendency is not new, but it has recently been catching the eye. We have lately been facing a situation when the assets of enterprises which cost billions of Hryvnias underwent bankruptcy proceeding due to a debt of UAH 3 million.

The existing legal framework offers no efficient ways to fight such cases. Bankruptcy proceeding provides for the sale of an asset package which costs billions, but nobody needs it at that price. And during the year which is designated for sale of the property there is a legal opportunity to sell one nominal “gatehouse” and discharge the minimum debt stipulated in the bankruptcy case. Meanwhile, the current debt of the company which is discharged in the first instance is accrued by the enterprise. As a result, the property of the state enterprise is sold at a cheap rate, and shadow privatisation takes place. Nevertheless, it is legal, as the insolvency practitioner has only one year for the liquidation proceedings, and the low price of the property sold may always be explained by the war, crisis, market and the decline of the Hryvnia.

There is an applied method which may be used by secured lenders today to have impact on bankruptcy proceedings. It is not always applicable, but it is quite efficient. It is a regulation which has been taken from the old law to the new one and stipulates that a secured lender may lodge claims in the part which is not collateral. Bankruptcy proceedings often include loans received before 2007. And the current value of the collateral is substantially lower than that on the date of execution of the mortgage agreement. Therefore, something that used to cost, say USD 500, and was pledged for the sum of USD 100, costs just USD 50 now. So the lender has a nominal USD 50 left, which are not covered by the collateral, and this uncovered amount enables the lender to enjoy the rights of an ordinary lender, have one’s finger on the pulse and control the mortgaged property.

Moreover, interest on the loan shall be taken into account. If the lending legal relations have already existed for many years, the interest has accrued in such an amount that, even if the property has not gone down in value much, the debt to the bank is substantially higher than the value cost of the collateral.

Of course, a debtor and its lenders may achieve consent, but such cases are very rare. Once again, due to the imperfections of the Bankruptcy Act which, for instance, provides for such a procedure as prejudicial recovery, but gives few opportunities for its implementation. And these issues of concern are of a purely technical nature. Also, in practice there have been cases of an amicable agreement following commencement of bankruptcy proceedings. In fact, this deal is also stipulated by the law. But I have rarely encountered amicable agreements in our country because of the low level of legal culture.

One of the complications faced by the debtor and the lenders wishing to reach consent is that in the overwhelming majority of bankruptcy cases there is such a lender as tax authorities. In practice, an amicable agreement may not be approved until the tax authorities grant their consent. And they may not sign such consent as the discounting mechanism is not stipulated in the laws on tax debts. And when all lenders agree to get less now, the tax authorities simply may not do this. This is where the attempts to reach consent end.

The Draft Act On Amending a Number of Legislative Acts of Ukraine, including the current version of the Bankruptcy Act, was registered. One more is being developed with the participation of lawyers of our company.

The main purpose of the amendments is to recover the casting vote of the secured lender. That is, recover the right to participate in the general meeting of lenders, in the lenders’ committee so that a secured lender will be able to take active part in deciding on the debtor’s future and selecting the proceedings: financial rehabilitation, liquidation or amicable agreement.

The banking and legal communities have lots of questions as to the current version of the Bankruptcy Act. We hope they will be answered.