Long, expensive and inefficient: bankruptcy procedure in today’s realities of Ukraine

01-03-2016

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According to data collected with the help of the Doing Business rating methodology, the worst situation is with the settlement of insolvency proceedings among all rating components in Ukraine.  

For example, the average duration of an enterprise’s bankruptcy procedure described by the rating methodology is 2.9 years (in comparison, it is 1.7 years in developed OECD countries), and its cost is 42% of the debtor’s property value (9% for OECD countries). However, the biggest shock is an index of funds provided by the domestic bankruptcy procedure for returning to a creditor – 8.3%. As regards this indicator, Ukraine shares the 161st-162nd place among 165 countries, where there is a juridical bankruptcy procedure, with Cambodia. The situation is worse than ours just in the Central African Republic, Federated States of Micronesia, Venezuela and Burundi. The result of Suriname, Liberia, the Dominican Republic, Sao Tome and Principe and Sierra Leone is a little better than our one.

At the same time, we shouldn’t think that the Ukrainian legislation is very imperfect and primitive. On the contrary, the relevant Law of Ukraine “On Restoring Debtor’s Solvency or Declaration of Bankruptcy” technically includes almost all institutions commonly found in developed countries having efficient bankruptcy systems. However, imperfect language of certain provisions of the law and especially its implementation negates any innovative attempts of legislators.

Avoidance of bankruptcy

One of the main problems of bankruptcy in Ukraine is that such a procedure is typically started by enterprises, which are insolvent for a long time and their more or less liquid assets have been already withdrawn. As a result, most creditors are left with nothing and the bankruptcy procedure doesn’t solve their problems.

Generally, according to the international practice, this problem is solved as follows: a head of an enterprise is obliged to apply to a court for bankruptcy of the company he leads if there are the first signs of insolvency. The attempt to implement this approach was made in the domestic Law On Bankruptcy, but it failed because the law didn’t provide for either the terms of such a request or the liability for non-compliance with this obligation. Hence, the law provisions on a debtor’s mandatory appeal to the court don’t actually work.

This problem can be partially solved by the draft law #3132, which is currently under consideration by the Parliament: it provides for a period, during which a debtor’s governing body will be obliged to apply to the court for insolvency. However, as before, this document won’t contain an effective system of sanctions for non-compliance with the mentioned rule.

The practice of some Western countries, where a head who hid insolvency of his enterprise and didn’t apply to the court bears joint liability for debts of the enterprise with all his assets, could be interesting in this regard.

Strengthening the protection of secured creditors’ rights

Another weak point of the Bankruptcy Law is a lack of adequate protection of secured creditors. The Bankruptcy Law is based on two basic ideas regarding these creditors:

1) maximum protection for interests of creditors, whose claims are secured by pledge (for example, by removing the pledged property from the liquidation estate; sending the proceeds from the sale of such a property exclusively to secured creditors; providing secured creditors with the right to veto a reorganization plan or a settlement agreement, etc.);

2) depriving secured creditors of an operational impact on bankruptcy procedures (by excluding their participation in the meetings and a creditors’ committee as well as depriving of right to foreclose on the pledged property by themselves).

In theory, this concept is correct and reasonable, but today, its implementation has many shortcomings. This is primary due to the fact that a secured creditor loses all control over the property, which was transferred to him as a pledge, and sooner or later finds himself in a situation, when this property is sold either at a very low price or too long or there are other difficulties. In this regard, each creditor, whose claims are secured by pledge and who is guided by common sense, doesn’t initiate a bankruptcy procedure and tries to avoid it in every possible way.

It seems that problem described above could and should be solved by strengthening the secured creditors’ control over their collateral and increasing their rights related to the sale of pledged assets. However, the efforts of the banking community to be eligible to vote in the committee or creditors’ meetings seems to be wrong, because in this case the secured creditors will decide the debtor’s fate in matters that don’t concern their rights and interests but significantly affect the rights and interests of other (scheduled) creditors.

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Settlement agreement and reorganization

The bankruptcy procedure should not always end with the liquidation of debtor’s assets. Sometimes the continued operation of the enterprise after making adjustments in its activity, such as selling part of assets, debt restructuring, transferring corporate rights to creditors and others, will meet the interests of all parties concerned. The Bankruptcy Law provides such opportunities to some extent, but does this by using two different instruments, legal and economic nature of which is the same: reorganization procedure and settlement agreement.

Combining these two mechanisms in a single restructuring procedure and, therefore, providing a comprehensive approach to solve the problem of insolvency by using all available tools would make this procedure more efficient and attractive for both a debtor and a creditor.

Limits on maximum period of moratorium

The optimum bankruptcy procedure should find a balance between creditors’ and debtors’ interests as well as take into account social consequences of closing down of an enterprise. However, the current Law On Bankruptcy is considered to be rather a law that protects primarily the interests of debtors. This is largely due to the moratorium introduced for each bankruptcy procedure. This moratorium deprives creditors of the opportunity to forcibly recover the whole amount of funds from a debtor. Moratorium or its analogues exist in almost every country of the world, where there is a practice of bankruptcy, but special features of Ukraine are an excessive duration of moratorium. In fact, moratorium is applied to the whole bankruptcy procedure, hence delaying this process for several years makes it impossible for creditors to protect their rights effectively.

One of the possible problem solutions would be to introduce fixed time limits for the period of moratorium, with the expiry of which moratorium would be automatically ceased despite the continuation of a bankruptcy case. This rule would not only allow the creditors to see “a light at the end of the tunnel”, but also introduce some mechanism to speed up the bankruptcy procedure and keep to the deadlines provided by the law for such a procedure.

Appointment of an estate administrator

For all 16 years of the insolvency practitioner profession, the approach to this occupation has been the same in law and jurisprudence: “the one who has the gold makes the rules”. The main specific feature of this rule in bankruptcy is that it is important not only who has the gold, but also who influences the decision on appointing an insolvency practitioner.

Introduction of an automated system that randomly choses an estate administrator on the basis of the experience and workload of insolvency practitioners was an attempt to overcome this trend. However, according to the reviews of many experts, the operation of such a system is far from being perfect and the choice of an insolvency practitioner in “manual mode” in situations, when the system’s choice failed, allows to apply a very subjective approach to electing a candidate for insolvency practitioner.

The problem of the estate administrator’s appointment is very complex and could be solved only by implementing a range of measures, such as guaranteeing proper wages for estate administrators, introducing the effective liability mechanisms and providing creditors with the opportunity to officially and openly influence the election of an estate administrator, including by choosing the candidates offered by the automated system.

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Insolvency practitioner’s fee

Society began gradually to accept the idea that as a rule, a person who manages significant resources won’t work for a minimal fee. Insolvency practitioners are a very good example of this rule. An insolvency practitioner is a person, who should have deep legal, economic, managerial knowledge and skills and should be liable for his actions (including the criminal liability).

Contrary to international practice, the Law On Bankruptcy doesn’t consider an insolvency practitioner’s fee as a priority fee in the liquidation process and guarantee the payment for labour of an estate administrator. As a result, not only insolvency practitioners who are on a financial hook of certain participants of proceedings in bankruptcy, but also many creditors, whose interests are not taken into account optimally, are suffering.

Only a high and guaranteed salary of insolvency practitioners can ensure their required minimum objectivity and impartiality in the proceedings of bankruptcy.

The Law On Bankruptcy has a number of other moments to be improved, including the better regulation of extrajudicial reorganization, recognizing foreign bankruptcy procedures and bringing the law in real line with the UNCITRAL Model Law on Cross-Border Insolvency, introducing databases for creditors to inform them about the state of bankruptcy. Special attention should be given to the bankruptcy procedure of individuals, the implementation of which would allow to regulate the status and fate of bad debts of individuals to banks in a civilized manner and partially relieve the pressure associated with foreign currency loans secured by a pledge.

All these and many other problems are awaiting to be resolved by the Ukrainian parliament which, unfortunately, is extremely reluctant to deal with the bankruptcy procedure in recent times. The Verkhovna Rada of Ukraine registered a number of draft laws aimed at improving the bankruptcy procedures (among them are #3132, #3163, #228ba, #2714 and #2353a), but their consideration is unduly delayed. For example, the draft law #3132 has been included in the agenda of the Verkhovna Rada of Ukraine six times, but it hasn’t even been considered.

The source: “Economichna Pravda”

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