NEW CODE ON BANKRUPTCY PROCEDURES: WHAT WILL CHANGE

In the author’s column, the senior partner of Ario Law Firm, Julian Khorunzhyi, who is one of the developers of the draft Code on Bankruptcy Procedures, tells about the current Ukrainian reality in the sphere of bankrupt property sale and possible revolutionary changes, subject to the Code adoption by the Verkhovna Rada of Ukraine.

An auction is the main, central event of a bankruptcy case. Despite the fact that the developers of the current version of the law tried to encourage reorganization in every possible way, its norms were written in such a way that, firstly, they make reorganization unattractive for both the debtor and the creditors, and secondly, the very formulation of the law makes it impossible to carry out most of the reorganization activities. Therefore, the current Law, in essence, leaves for the debtor and its creditors the only mechanism – liquidation of the debtor and sale of all of its assets from the auction.

If in the European countries the reorganization procedure is an opportunity for the debtor to clear from debts and save the business, and for creditors – an opportunity to receive satisfaction of their claims with quite tangible financial losses (creditors make concessions to the debtor on understandable terms) and the liquidation procedure is aimed at maximum satisfaction of the creditors’ claims where, in fact, there are no debtor’s interests, then in the realities of Ukraine, the liquidation procedure is used by the debtors to clear their assets from debts and the interests of the creditors are violated in every way. This, in fact, is the main reason why we have such low ratings, particularly in Doing Business.

There are also a number of factors for this, ranging from the actual inability to carry out effective reorganization, continuing with the fact that in a normal country a “scam” of the creditor by the debtor, if does not create problems in the field of criminal justice for the debtor (its actual owner), then definitely results in significant reputational losses, so the “debtor” is almost guaranteed to lose its positions in the market.

In Ukraine, reputational consequences for the “bankrupts” that have cleared their assets from obligations in the liquidation procedure are not working at all. Some of the “debtors” after 2-3 bankruptcy procedures, not only compete successfully with healthy companies, but even strengthen their positions in the market, gain trust from counterparties and attract new loans. There is no need even to talk about the absence of criminal responsibility for such actions. One of the main reasons for such state of affairs (of course, except for the ineffectiveness of criminal justice and the “faulty moral compass”) is precisely the procedure prescribed for preparing and holding an auction. Taking into account the need for changes in the legislation in terms of the auction, we and the state must decide what purpose we are pursuing: to provide the debtor with an opportunity without a competitive procedure with almost 100% guarantee to keep business through the “controlled” auction for an a-priori known buyer and scam of the creditors? Or, nevertheless, solve the issue of high cost of loans, creating an investment climate, the guarantees to counterparties regarding the possibility to receive unpaid funds from the debtor and in general, in order not to be considered a banana republic any more at least in this sphere – to create transparent mechanisms for holding auctions, the purpose of which will be selling at the highest price and maximum satisfaction of the creditors’ claims?

So, let us first look into existing realities of the auction. In other countries, in analogous laws, 3-5 articles are devoted to the issues of preparing for an auction and selling assets. In our current law – a separate section is devoted to this, as well as articles in other sections. And we see how this “works.”

There are several reasons. The first is the lack of independence of the arbitration manager. First of all, financial one. In addition, despite a significant number of rules regulating these issues – the rules are either not clearly defined and do not provide answers to key questions of the procedure, or contradict other provisions.

Considering the above, there was a hope that before the judicial reform, the Higher Economic Court of Ukraine and the Supreme Court of Ukraine would form the corresponding legal positions and ensure the unity of judicial practice in this matter. However, this did not happen. And as for the key issues – we had a plurality of different legal positions of these instances, which, moreover, often contradicted each other, and some even deepened the problems already inherent in the law. As a result, a market has emerged that can be characterized by the following indicators.

In the beginning let me note that none of the authorized authorities keeps any official statistics (although such a publication would be logical for the possibility of a quick market situation analysis). Therefore, the information that we publish below is obtained as a result of manual analysis of messages posted on the official portal of the judicial authority of Ukraine, and therefore in view of the significant amount of data and errors in the messages – its 100% relevance is not guaranteed.

Each year the number of the auction organizers who conducted at least one auction in a year is more than 110 subjects. On average, the cost of the property sale makes about 20-25% of the initial value, it means that discounting reaches 75-80%. Moreover, electronic auction demonstrates significantly higher performance.

Consider: the initial value of the entire bankrupt property, which was put up for sale and sold both at regular and electronic auctions, in 2015 exceeded UAH 4.4 billion. The sale price of this property was just over UAH 1 billion. Financial efficiency – less than 24%. At that, in ordinary (“hammer”) auction, the cost as a whole fell to 23% of the initial. Whereas electronic auctions showed twice the efficiency – and the sale price was about 48% of the initial cost.
In 2016, the situation was similar. At the initial value of UAH 4.2 billion, the property was sold for only UAH 1 billion. The overall efficiency is almost 25%. The price reduction in non-electronic auction exceeded 76% (selling price was about 24% of the initial value). The property was sold more efficiently at electronic auction – at 46% of the initial value.
Year 2017 confirmed the trend. At the initial value of UAH 5.7 billion, the property was sold for more than UAH 1.3 billion (about 24% of the initial value). In non-electronic auctions the value dropped to 22% of the initial price. In electronic – the property was sold for 66% of the initial cost. This is the highest figure in three years.

For sure, not the entire discount in “non-electronic” auctions results from abuses that occur in the sale procedures. But, taking into account my own experience in appealing against illegal auctions, and analyzing court practice, according to which a significant number of lawsuits are filed precisely for the reasons of understated cost of sale, it can be stated with absolute certainty that the percentage of such abuses is decisive and indicative. Otherwise – we would not observe such a discount.

Some of the opponents of such a conclusion would say that the mentioned difference is a consequence of putting up for sale a significant number of integral property complexes of debtors, the price of which during the auction decreases significantly. However, the liquidators who are really aimed to sell the property at the highest price, could hold auctions, proceeding not from the aggregate of all creditors’ claims, but would put up the same property complex as a single lot at the next auction in an initial cost that would be adequate to the market price. Or, the liquidators could divide the property into “logical” lots (for example, having sold a land plot, in two months they could put up for an auction a real estate object located on it). This would allow attracting a larger number of participants without scaring the potential participants away by the size of the guarantee fee, which is very often higher than the cost of this property sale as a result of such an auction.

In addition, formation of a real market for the assets sale is definitely not promoted by such a significant number of auction organizers, who, firstly, do not interact with each other on information about lots, participants and price offers, and, secondly, there is no single, normal, information field of assets offered for sale. Since the websites of the Ministry of Justice and the Judicial Authority, which are devoted to the auctions, are clearly not informative due to the absence of at least normal search mechanisms. First of all, they perform an information function for the participants in bankruptcy proceedings, rather than for the potential buyers.

What does international experience say? It can be divided into two categories. This is either a monopoly or complete freedom for the arbitration manager both in the choice of the auction organizer and in the choice of the sale method. And both approaches work there, first of all, due to the fact that the arbitration manager is not interested in frauds and sale cost understatement. However, introduction of any of these systems in today’s conditions in Ukraine will have the same efficiency that we have today, since there is absolutely no confidence in both the state monopoly and the complete freedom of the arbitration manager.

So how can this situation be solved if the given international examples in general do not suit us? Searching for our own “unique way” in the field of the bankrupt debtors’ property sale, as it was done in the field of public procurement or sale of problem assets in various areas – a complete transition to a two-level system of electronic auctions. With such a system, all auction organizers and their clients have equal access to the asset that is to be sold; and the auction itself, in order to ensure objectivity and transparency of its conduction, takes place on the organization’s server, which itself is deprived of the right to sell assets, and provides only IT-support of software used for conduction of such auction. This system eliminated all the above risks almost completely. At least the problematic issues of admission to the auction, posting information about the auction and the issues of conduction of the auction itself have lost their relevance. This system was successfully implemented in the procedures of the Deposit Guarantee Fund in the framework of the Prozorro.sale project and now something similar is being implemented in the field of e-commerce of seized property (OpenMarket).

As far as I know, very such a system for selling assets of bankrupt debtors is laid in the latest version of the draft Insolvency Code No. 8060. Even just for this, this draft is worth supporting.