New Bankruptcy in Action. Who Wins?

Article by Julian Khorunzhy, Senior Partner of Ario Law Firm special for Ukrainian Law Firms 2020.

There is no place for pessimists here, or how optimism triumphs

After the election of the new government last year, a large-scale campaign was launched, the purpose of which was to stop the launch of the “new bankruptcy” that was stipulated by the Bankruptcy Proceedings Code of Ukraine. Some representatives of the “new government” explained this as if the Code was not ready for its practical launch. And the result of this could be the collapse of the procedures initiated by the preliminary law (Law of Ukraine On Restoring the
Solvency of the Debtor or Declaring it Bankrupt), as well as the impossibility of opening new proceedings.

However, the market managed to defend the Code, and the day after the Code came into force, it became clear: the problems that were declared by opponents were far-fetched. Despite some opposition from certain influential groups that have tried (and continue to try) to distort the implementation of individual provisions of the Code, the Code has now been working effectively for six months.

The position of the Ministry of Justice deserves special thanks. Even before the Code entered into force, the Ministry recognized that certain provisions of the Code require amendments to eliminate errors precisely. However, the development and implementation of such changes are necessary after more detailed analysis of the practical application of the Code, which requires a certain amount of time.

Consequently, the Code is in force, and we live in a new reality that affects the adoption by business and citizens of decisions  regarding their solvency, determine the cost and duration of the resolution of insolvency and, at the same time, provide impetus to reformatting the legal
market.

Role and Protection of Creditors now Stronger, Length of Proceedings Shorter

We can declare the fact that creditors cease to be extras in bankruptcy cases. So, unlike previous legislation (when the arbitration manager could conduct the case practically without consulting with creditors), from now on it is precisely creditors that have a decisive role in the procedure. Especially taking into account the specifics of the situation in the sphere at present (most cases are at the liquidation stage), the decision on issues regarding the nominees of arbitration managers who appoint the case, the procedure for the sale of a property, which is one of the cornerstones of the procedure for today,
depends on the position of creditors.

Creditors are empowered to dispute the debtor’s transactions by which the debtor hid assets from creditors.

In addition, despite the controversy surrounding the norm and the desire of the arbitration managers to change it, the provisions on the right of creditors to “dismiss” the arbitration manager at any time are valid.

The specified norm is aimed at eliminating possible conflicts between arbitration managers and creditors that had earlier provoked a significant delay in bankruptcy cases. It is the reduction of the consideration of cases that is one of the goals of this innovation. After all, unreasonably long terms for considering cases are one of the largest imperfections from a business point of view, as reflected in the ‘Doing Business’ ranking.

Changes that were aimed at reducing the time for bankruptcy cases should also include: setting a moratorium on satisfying creditors’ claims, introducing cassation filters to appeal individual decisions in bankruptcy proceedings, changing the procedure for conducting preliminary court hearings, eliminating unnecessary procedural actions (for example, review of the registry claims of creditors in the liquidation procedure previously took 2-3 months), a change in the procedure for the sale of a property, and so on.

Another novelty that affects the maturity of creditors’ claims and the protection of their rights is also worth noting. Namely, the possibility of opening proceedings in a case without the need to present to the court evidence of the indisputability of the claims of creditors.

This is important because lenders no longer need to spend an extra year to get a court decision on recovering funds from the debtor to obtain the right to initiate the procedure. This should prevent unscrupulous debtors from “hiding” assets from creditors.

At the same time, it is worth noting that, indeed, certain procedural issues arise that require changes to the Code. However, such problems are not systemic and do not impede the
application of effective Code norms.

Fair Auctions: “War Ticket” Canceled

There’s another important innovation of the Code, which fundamentally changed the usual market motivation and logic of actions in bankruptcy cases. At the same time, it affects the effectiveness of the procedure for all parties. This innovation is the new procedure for the sale of property of bankrupt debtors.

Under the new Code, the bankrupt property is sold at completely transparent market auctions. The electronic auction system is based on the ProZorro Sale project, which has demonstrated its transparency in the asset market of bankrupt Ukrainian banks, which are sold by the state-run Deposit Guarantee Fund, as well as in privatization procedures to sell state and municipally-owned property.

The main advantage of the new property sale procedure is the formation of a market price. Unlike previous sales, from 21 October 2019, it became impossible to sell any property of the debtor in “secret mode”. It is impossible to prevent anyone who would like to acquire the property of the debtor to bid. It is impossible to guarantee anyone the “targeted” sale of a property. It is worth recognizing that, unfortunately, this practice used to be quite widespread and creditors suffered from it. After all, there were
cases when a property with a market value of millions of hryvnias was sold at dubious tenders for a few hryvnias.

On the one hand, lenders had to spend a lot of time and money appealing against such dubious auctions and protecting their rights. On the other hand, buyers of bankrupt property suffered. After all, even legitimate tenders (according to
the previous procedure) were extremely vulnerable to appeal. Therefore, in fact, along with the assets of the bankrupt, a “war ticket” was also sold in the courts with all the consequences that ensued.

As of mid-March 2020, about 700 tenders have already been announced under the new procedure. The declared value of a property for sale is almost UAH 3 billion. The first auction has already been held.

Of course, it’s too early to talk about judicial practice. However, I can predict a significant decrease in the intensity of appeal against tenders held in Prozorro Sale. It is also too early to talk about price efficiency, but the issue is the formation in new tenders of a true market price for bankrupt assets.

Professional Community of Arbitration Managers Moves to a New Level

Along with innovations that increase the transparency and efficiency of bankruptcy procedures, the Code laid the foundations for institutional independence and self-government of arbitration managers.

This should lead to the formation of an open community, with uniform rules of the game. We can also expect the emergence of “filters” within the professional community, which would weed out dishonest arbitration managers.

Against the background of the formation of self-government of arbitration managers, the community began talking about the ethics and prestige of the profession, which will lead to an increase in the professional level of arbitration managers. This means that the risks for all parties to bankruptcy cases will be significantly reduced.

At the same time, now it is only hoped, and it is too early to talk about this as fact. Along with the Code coming into force, the process of crystallization of leaders and the formation of teams that rally arbitration managers around themselves has begun. The formation of working bodies of the National Association of Arbitration Managers continues. My hope is that after the completion of these processes this organization will begin to formulate the best practices of arbitration managers, which will improve the quality of the procedures.

And considering the fact that some people from the sphere of bankruptcy became members of parliament, the newborn association already has a good lobby in protecting the interests of the professional community at the highest level. Which, of course, is positive.

A Chance for Bankrupt Individuals

All the innovations described above are inherently an improvement to the procedures that existed in the past. At the same time, the Bankruptcy Proceedings Code of Ukraine contains an unprecedented norm for Ukraine – the resolution of the insolvency of individuals. For years, individuals who had colossal debts (before, on mortgages made out in foreign currency, issued during the 2008 global crisis), were deprived of an effective tool to resolve their insolvency. But such a tool exists today.

Individuals with a debt burden may declare their insolvency, restructure it and receive forgiveness of a significant part of the debt. The resolution of insolvency under the procedure provided for by the Code should balance the interests of debtors (who found themselves in a difficult situation for objective reasons), creditors and the state.

It is important that only bona fide debtors, who will show all their property and reveal their financial position, can use the procedure provided for in the Code to resolve the insolvency of individuals. In exchange for honesty, they will receive the forgiveness of part of the debt and restructuring of the remaining part of the debt on terms that are mutually beneficial for the debtor and creditor.

It is worth noting that as of March 2020, there was still no need to talk about a rush in demand for the procedure for resolving the insolvency of individuals. A cautious attitude towards declaring oneself “bankrupt” is observed for a number
of reasons.

Firstly, the forgiven amount of the debt forms the basis for personal income tax payable at the time of such forgiveness. This fact alarms potential bankrupt individuals.

Another limiting factor is the need to advance funds to pay for the services of arbitration managers, which creates certain obstacles for individuals to enter the procedure.

I am glad that these problems are recognized by participants of the legal market, who are trying to eliminate them by introducing appropriate amendments to the law.

Another factor that affects a relatively small number of cases on resolving insolvency of individuals is the hope of the majority of debtors that the moratorium on the collection of mortgages on foreign currency loans will be continued. Due to these factors, we have a lack of judicial practice, which makes it difficult to analyze the effectiveness of the relevant provisions of the Code.

Despite all this, more than a hundred citizens have already used the algorithm to solve insolvency. I am aware of the intentions of many legal teams to invest in the development of individual practices and departments for working with individuals who are bankrupt. And especially for citizens who are experiencing difficulties and cannot afford paid legal advice, the Ukrainian Bar Association is implementing, together with USAID, a large-scale free-of-charge consultation project that has already covered the largest cities of Ukraine.

Summing up, the market went through a busy and interesting year in the context of bankruptcy reform. Optimism defeated pessimism. Lawyers, arbitration managers, the regulator, and MPs managed to lay the foundation for a new quality of bankruptcy procedures, which will become more effective, though time will require lawyers to have a more intelligent approach and continuous professional development.