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3 June 2010

Time consuming and costly. Overview of why the insolvency procedure in Ukraine needs overhauling


Author: Oleksiy Didkovskiy and Andriy Pozhidayev
Source: IFLR 1000. Mergers and Acquisitios. - 2010. - p.37-40

Oleksiy Didkovskiy and Andriy Pozhidayev of Asters give an overview of why the insolvency procedure in Ukraine needs overhauling

The world financial crisis affecting Ukraine proved a serious test for its insolvency legislation and procedures. While many countries have experienced a growing number of bankruptcies, the Ukrainian insolvency authority reported that the number of opened insolvency proceedings decreased by 30% in 2009 and by another 20% in early 2010. This trend apparently is a consequence of the time and cost consuming nature of insolvency proceedings in Ukraine.

Ukraine is ranked 145th among 183 countries on closing a business in Doing Business 2010 rankings compiled by the World Bank. According to that research, the recovery rate (the amount of debt that creditors recover from the insolvent company) makes 9.1% on average against 31.6% in Eastern Europe and Central Asia and 68.6% in OECD countries. Insolvency-related procedures in Ukraine absorb 42% of the entire business value against 13.5% in Eastern Europe and Central Asia and 8.4% in OECD countries. Insolvency proceedings in Ukraine last for 2.9 years on average, which is comparable with Eastern Europe and Central Asia, but is longer than the average of 1.7 years for OECD countries.

So, in the current unfavorable economic environment, creditors are generally more reluctant to recourse to insolvency proceedings as a debt recovery method and are more willing to accede to pre-court debt restructuring. On the other hand, distressed companies are increasingly prone to take the insolvency path in an attempt to gain better restructuring conditions, as well as to take advantage of the moratorium on settlement of claims, which remains in place in the course of entire insolvency proceeding.

Pre-judicial procedures

Ukrainian law requires equity holders of a debtor to take timely and appropriate measures to prevent its insolvency. At the same time, the law is silent on the consequences of a failure to comply with this requirement. The law further provides for so-called pre-judicial rehabilitation when equity holders, creditors or other persons may provide the debtor with financial aid sufficient to settle creditors' claims and restore its solvency in consideration of relevant commitments undertaken by the debtor.

Taking into account the complexity and duration of the judicial insolvency proceedings, pre-court procedures enable faster debt recovery and may provide creditors with a better chance to collect indebtedness from revenues generated by the debtor's ongoing business. The most common pre-judicial procedure used by Ukrainian companies is entering into a debt restructuring agreement providing for repayment of debt in installments, a grace period and/or lower amount of debt.

Insolvency procedure

The main statutes governing insolvency proceedings in Ukraine are the Law on Restoring Debtor's Solvency or Declaring a Debtor Bankrupt (the Insolvency Law) and the Commercial Procedure Code of Ukraine.

Under Ukrainian law, insolvency proceedings may be commenced in respect of legal entities and individuals who are registered as entrepreneurs. Applicable law does not provide for insolvency of natural persons. The Insolvency Law and other statutes provide for certain peculiarities of insolvency procedures for banks, insurance companies, securities traders and certain other categories of debtors.

Creditors, state tax authorities, certain other state agencies, as well as debtors may apply to court for an insolvency proceeding. Creditors may petition for debtor's insolvency if the aggregate amount of creditors' claims to the debtor exceeds 300 minimal wages (currently, the equivalent of about €25000), and the debtor failed to settle these claims within three months after they become due and payable. Such claims must be "indisputable": either recognised by the debtor or confirmed by a court decision. As a matter of practice, prior to initiating an insolvency proceeding, a creditor should bring a court action against the debtor, obtain a decision granting its claim and requiring the payment of debt, and apply for a relevant enforcement proceeding to enforce such a decision. If there is a pledge securing the entire creditor's claim, such a creditor may not petition for an insolvency proceeding and should proceed to enforcing the pledge.

The debtor must apply for an insolvency proceeding within a one-month term if: (i) payment to one or a few creditors will result in the debtor's inability to fulfill its financial commitments to other creditors; (ii) the competent corporate body of the debtor approves a decision to file for insolvency; or (iii) the debtor has started voluntary liquidation and is unable to meet creditor's claims. Failure to apply for insolvency in such cases may result in company's management liability.

Insolvency proceedings are within the purview of the relevant local commercial court at the debtor's location. The court considers an insolvency petition and approves all major insolvency documents, such as register of creditors' claims, financial rehabilitation plan, liquidation balance sheet and the like. The court also issues important rulings, for example, to commence an insolvency proceeding and order liquidation of a bankrupt entity.

A court commences an insolvency proceeding following submission of a relevant petition by creditors or a debtor. It should be noted that a debtor is not declared bankrupt automatically after commencement of an insolvency proceeding. The debtor can restore solvency and thereby avoid bankruptcy (for example, through the rehabilitation procedure).

When opening an insolvency proceeding, the court introduces a moratorium on settlement of creditors' claims effective until completion of such proceeding. Moratorium implies that a debtor may not perform its financial liabilities, as well as obligations related to pay-settlement agreement may cover only secured claims and claims of the second and lower ranks ment of taxes, which became due and payable before introduction of the moratorium. Moratorium does not cover payment of salary, indemnification for harm caused to individual's health or life or author's royalty. Moratorium also does not encompass liabilities, which arise after its introduction. Pursuant to a relevant court order, the person that petitioned for an insolvency proceeding publishes in an official Ukrainian periodical a notice regarding commencement of such proceeding with the purpose of inviting creditors to submit their claims. Ukrainian law does not require the debtor to notify each of its creditors individually about commencement of an insolvency proceeding.

Once the said notice regarding the insolvency proceeding is published, all creditors regardless of debt maturity may file petitions setting forth their financial claims to the debtor with the court. At the same time, the creditors whose claims arose before commencement of insolvency proceeding (pre-insolvency creditors) must submit such claims along with supporting documents within 30 days after the notice is published. The lapsed 30-day period cannot be renewed irrespectively of the reason for missing such period, and any claims of pre-insolvency creditors to the debtor not submitted within the mentioned period are regarded as settled. It should be noted that this requirement may pose a problem for foreign creditors as in most cases they do not have an opportunity to closely monitor publications in official periodicals. This issue is also relevant to Ukrainian creditors.

Within the framework of insolvency proceeding, the court appoints a trustee, who may act as an administrator of the debtor's property, a rehabilitation manager, or a liquidator, respectively. Only a licensed individual entrepreneur may act as a trustee. The trustee arranges for a meeting of debtor's creditors which elects the creditor committee. The latter acts on behalf of all creditors in the insolvency proceeding, oversees trustee's activities and is entitled to adopt important decisions. For example it can enter into a settlement agreement, petition the court to commence rehabilitation procedure, recognise the debtor as bankrupt and order its liquidation, dismiss the trustee and the like. All decisions of creditor committee are approved by a simple majority vote.

The following judicial procedures may be applied to the debtor within the framework of an insolvency proceeding: (i) administration of debtor's assets; (ii) financial rehabilitation; (iii) settlement agreement; and (iv) liquidation.

Administration of debtor's assets After commencing insolvency proceedings, the court introduces the procedure of administration of debtor's assets. The goal of this procedure is to preserve the available debtor's assets and ensure their effective use. For this purpose, the court appoints an assets administrator from among licensed trustees. Subsequently, the administrator may be appointed as a rehabilitation manager or liquidator.

The administrator takes steps to preserve debtor's property, participates in consideration of creditors' claims by the debtor's management, maintains register of creditors' claims, notifies the creditors on results of their claims consideration, analyses debtor's financial condition and provides creditor committee with recommendations in respect of financial rehabilitation of the debtor. The debtor's management remains in place. At the same time, certain corporate decisions (for example reorganisation, issuance of securities or obtaining a loan) require consent of the administrator.

Ukrainian law does not limit the duration of administration procedure. Instead, the law provides for a six-month term of administrator's powers, which can be shortened or extended by the court. At the same time, the Supreme Court of Ukraine concluded in its recent clarification that, as follows from the Insolvency Law, the administration procedure may not last for more than seven months.

Financial rehabilitation

The court introduces a rehabilitation procedure and appoints a rehabilitation manager upon a relevant application by the creditor committee. Financial rehabilitation is aimed at preventing recognition of the debtor as insolvent and its liquidation. The term of rehabilitation may be up to 12 months and may be extended up to 18 months or shortened by the court. Sometimes, if rehabilitation does not appear to be feasible, the court decides that an insolvent company should go straight into the next phase of the insolvency process, the liquidation. After the court ruling, the rehabilitation manager assumes all powers to manage the debtor. The rehabilitation manager may enter into contracts on behalf of the debtor, cancel certain types of debtor's pre-insolvency contracts or request the court to invalidate the contracts made by the debtor.

The rehabilitation procedure is performed pursuant to a rehabilitation plan approved by the creditor committee and the court. The rehabilitation plan provides for steps aimed at restoring debtor's solvency and, if applicable, conditions for settlement of creditors' claims by third parties. The rehabilitation plan may provide for sale of debtors' assets at a public auction. Also, pursuant to the Insolvency Law, the rehabilitation plan may envisage exchange of creditors' claims for debtor's assets and/or equity rights. At the same time, as clarified by the Supreme Court of Ukraine, the rehabilitation plan may not provide for issuance of shares or bonds by the debtor for settlement with creditors since this is contrary to Ukrainian law.

After completion of the rehabilitation procedure, the creditor committee requests the court to: (i) terminate the rehabilitation procedure because the debtor's solvency has been restored; (ii) extend rehabilitation procedure; (iii) terminate the rehabilitation procedure, recognise the debtor as insolvent and open a liquidation procedure; or (iv) terminate the rehabilitation procedure and approve entry into a settlement agreement. Settlement agreement

The debtor and creditors may enter into a settlement agreement at any stage of insolvency proceeding. Settlement agreement may provide for a grace period, repayment of debt in installments and/or waiver of debt.

Also, pursuant to the Insolvency Law, the settlement agreement may provide for exchange of creditors' claims for debtor's assets or equity rights. As explained by the Supreme Court of Ukraine, any debt-for-equity swap with regard to existing equity rights may be included in the settlement agreement subject to consent of the relevant debtor's equity holders, and in this case the latter must be parties to and execute the settlement agreement.

A settlement agreement may cover only secured claims and claims of the second and lower ranks (as outlined below).

A settlement agreement may not be concluded regarding allowance payments and expenses in connection with the insolvency proceeding. The creditor committee makes a decision on entering into the settlement agreement by a simple majority vote. At the same time, this decision is deemed adopted only provided that all secured creditors agree in writing to enter into a settlement agreement. The settlement agreement shall be approved by the court. After such approval is granted, the trustee's powers and the insolvency proceeding are terminated.

The approved settlement agreement applies to all creditors, including those who voted against entering into such an agreement and those who abstained from voting. Upon request of any creditor, the court may invalidate a settlement agreement subject to general civil law requirements. The court may terminate a settlement agreement if the debtor defaults on its commitments under the agreement with regard to at least one third of creditors' claims.

Liquidation

If the judicial procedures fail to restore debtor's solvency, the court declares the debtor bankrupt and opens a liquidation procedure. A bankrupt company is managed by a liquidator nominated by the creditor committee and appointed by the court. The liquidation procedure may last for up to 12 months, which term may be extended by the court for another 6 months. At the same time, as confirmed by the Supreme Court of Ukraine, the Insolvency Law does not provide for any consequences if the liquidation procedure continues beyond the said maximum term. After opening of the liquidation procedure, the debtor ceases its business activities, and a liquidation pool is formed. Debtor's pledged assets are also included in the pool, but any proceeds from their sale are used only to meet the claims secured by relevant pledge. Within the framework of liquidation procedure, debtor's assets are sold at a public auction, unless otherwise decided by the creditor committee. Proceeds from the sale of debtor's assets are used to satisfy creditors' claims according to the following priority:

First rank

(i) claims secured by pledge

(ii) certain types of payments to bankrupt's employees, and

(iii) expenses relating to insolvency proceeding.

Second rank

Remaining claims of bankrupt's employees (except for fifth rank claims) and claims arising from harm inflicted on individual's life or health.

Third rank Taxes and duties.

Fourth rank Unsecured claims.

Fifth rank

Claims for repayment of employee contributions to the charter capital of the bankrupt.

Sixth rank All other claims.

Claims of a higher rank must be paid in full before payment towards any lower ranking claims is made. If the proceeds from sale of bankrupt's assets are not sufficient to satisfy all claims ranking pari passu, then such claims are paid pro rata. Those creditors' claims that are not satisfied in the liquidation procedure due to insufficiency of debtor's funds are regarded as settled. If proceeds from sale of debtor's assets are sufficient to settle all creditors' claims, the debtor can continue its business. Otherwise, the debtor goes into liquidation.

Cross-border insolvency

Insolvency proceedings in respect of a debtor established under Ukrainian laws are within exclusive jurisdiction of Ukrainian courts. Foreign creditors participate in Ukrainian insolvency proceedings subject to the general rules and provisions of the Insolvency Law. Applicable Ukrainian law does not govern cross-border insolvency and inter-governmental cooperation in insolvency procedures. Ukraine is currently not a party to any international treaty with regard to cross-border insolvency. Thus, foreign court decisions in insolvency cases may be recognised in Ukraine on the basis of reciprocity principle. As clarified by the Supreme Court, the rehabilitation plan may not provide for issuance of shares or bonds by the debtor for settlement with creditors drafted, in particular the draft laws on insolvency and on amendments to certain laws of Ukraine regarding the improvement of the insolvency procedures. These draft laws are intended to set down more detailed rules for insolvency proceedings, make them more efficient and transparent, as well as remove major discrepancies between insolvency law and other applicable laws and regulations.

In particular, the draft law on insolvency provides for self-regulatory trustee organisations, more stringent qualifications and liability for trustees, new categories of creditors and their status (specifically, a new concept of "property surety provider"), a new method for identifying and notifying creditors about insolvency, the reasons for invalidating debtor's pre-insolvency transactions, which should prevent undue transfer of debtor's assets, as well as a new priority of creditors' claims.

Another draft law on amendments to certain laws of Ukraine regarding the improvement of the insolvency procedures drawn up by the Ministry of Economy of Ukraine is aimed at protecting debtor's and creditors' interests, as well as preventing abuses within the insolvency procedure.

The mentioned draft laws also establish shorter time frames for and tighter control over insolvency proceedings. Enactment of these draft laws will significantly improve the regulatory framework for insolvency in Ukraine. At the same time, a few years may pass before the mentioned draft laws are finally approved and become effective.

Draft laws

Today, a large number of insolvency-related issues call for a more detailed and improved legal framework. Despite this, the Parliament of Ukraine declined a few draft laws in respect of insolvency of individuals, cross-border insolvency and other matters aimed at facilitation of insolvency proceedings last year.

At present, a number of laws on insolvency are being drafted, in particular the draft laws on insolvency and on amendments to certain laws of Ukraine regarding the improvement of the insolvency procedures. These draft laws are intended to set down more detailed rules for insolvency proceedings, make them more efficient and transparent, as well as remove major discrepancies between insolvency law and other applicable laws and regulations. In particular, the draft law on insolvency provides for self-regulatory trustee organisations, more stringent qualifications and liability for trustees, new categories of creditors and their status (specifically, a new concept of “property surety provider”), a new method for identifying and notifying creditors about insolvency, the reasons for invalidating debtor’s pre-insolvency transactions, which should prevent undue transfer of debtor's assets, as well as a new priority of creditors' claims.

Another draft law on amendments to certain laws of Ukraine regarding the improvement of the insolvency procedures drawn up by the Ministry of Economy of Ukraine is aimed at protecting debtor's and creditors' interests, as well as preventing abuses within the insolvency procedure.

The mentioned draft laws also establish shorter time frames for and tighter control over insolvency proceedings.

Enactment of these draft laws will significantly improve the regulatory framework for insolvency in Ukraine. At the same time, a few years may pass before the mentioned draft laws are finally approved and become effective.



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