The Right to a Second Chance: Ukraine Implements a European Mechanism for Preventive Business Debt Restructuring

In Ukraine a new mechanism, as required by the EU, will be implemented to help companies avoid bankruptcy. This is known as preventive restructuring procedure. This is a significant step forward for the country’s insolvency sector and good news for investors. Let’s find out why. 

Background

Ukraine is not “reinventing the wheel”, but is merely implementing European legal standards into its legal framework. And it’s worth noting that we are one of the first European countries to do so.

Directive (EU) 2019/1023 on preventive restructuring frameworks, on discharge of debt and disqualifications, and on measures to increase the efficiency of procedures regarding restructuring, insolvency and discharge of debt, was introduced in 2019. Its aim is to standardize the mechanisms for restoring solvency across European countries. Currently, only a handful of countries, including Austria, the Netherlands, Germany, Lithuania, and Latvia, have implemented the Directive.

Despite the existence of legislation on the restoration of solvency, including pre-trial restructuring procedures (business rehabilitation), in most EU countries, as well as in Ukraine, it has often proved to be ineffective. Speaking specifically about Ukraine, it’s worth noting that the new Bankruptcy Procedures Code of Ukraine came into force in 2019. However, in almost five years of its implementation, only a few dozen pre-trial business rehabilitation proceedings have taken place in Ukraine.

Preventive restructuring, in contrast to pre-trial rehabilitation, does not take a long time, is more economically feasible for the debtor, and is primarily aimed at operating companies in temporary financial difficulties. Interestingly enough, the European drafters of the Directive on preventive restructuring drew on the experience of the United States when implementing rehabilitation procedures. There, this tool enables companies to recover more quickly and easily than in Europe.

In addition to the economic and business benefits, the integration of the European preventive debt restructuring mechanism into domestic legislation is a key component of the government’s Ukraine Facility Plan. The plan, as approved by the Cabinet of Ministers earlier this year, is designed to support the implementation of the EU’s €50 billion financial assistance program for 2024-2027.

Moreover, the introduction of the preventive restructuring procedure in Ukraine is a key aspect of our path towards the EU. The European Commission is closely examining national solvency restoration procedures and considers them to be an important part of European integration.

Taking into account all the above points, Ukraine has introduced Law No.10143, entitled On Amendments to the Code of Ukraine on Bankruptcy Procedures and Other Legislative Acts of Ukraine in connection with the implementation of Directive 2019/1023 (EU) of the European Parliament and the Council and the introduction of preventive restructuring procedures. The Verkhovna Rada adopted it in its first reading in May 2024.

About the Law

Target Audience

This law is designed for businesses experiencing temporary, non-critical financial challenges but with a strong chance of recovery.

What’s new

The preventive restructuring mechanism differs significantly from other solvency restoration procedures.

Its clear advantages include relatively short timelines and relatively low costs.

The procedure begins when the debtor presents his/her own plan or concept to the court, outlining possible solutions to his financial difficulties. For example, in the pre-trial rehabilitation process, it begins with the convening of creditors’ meetings. This is one of the key differences between these processes. In the current pre-trial rehabilitation process, the debtor first develops a pre-trial rehabilitation plan, calls creditor meetings and, if the plan is approved at those meetings, submits it to the court for approval. Somewhere between the debtor’s formulation of a pre-trial rehabilitation plan and the convening of creditors’ meetings, there should have been a stage of negotiations with creditors and coordination of proposals for the plan. However, such a stage is virtually absent. The main reason for this is that at this stage the debtor has no protection from creditors who, upon learning of the intention to undertake pre-trial rehabilitation, have ample opportunity to disrupt the process. This includes collecting the debtor’s funds, foreclosing on collateral or mortgages, or petitioning the court to commence bankruptcy proceedings. As a result, debtors present a pre-trial rehabilitation plan at creditors’ meetings that has not been actually discussed with any of the creditors.

Therefore, a crucial aspect of the European mechanism is that the negotiation phase takes place during the preventive restructuring procedure, which provides the debtor with specific protections. In particular, bankruptcy proceedings cannot be initiated against the debtor during this period.

Next, what exactly is a plan or its concept? Essentially, it serves as the initial phase of any preventive restructuring. The negotiations with creditors begin with the plan or its concept. The debtor is required to keep the court informed of the progress of these negotiations, and this information must be available to all parties involved in the process. It is important to note that even if the court approves the debtor’s plan, it doesn’t necessarily mean that dissatisfied creditors must accept the restructuring terms. Such creditors have the option of challenging the debtor’s proposals in court. If negotiations fail to produce an agreement, the creditor may be deemed to be disinterested in the claims and retain the right to sue the debtor for recovery. However, once the consent of each creditor has been obtained, the plan is presented at the meeting of creditors.

It’s worth noting that an administrator plays a key role in preparing the plan, negotiating, monitoring its implementation, and informing the court. In other insolvency proceedings, this role is typically performed by an insolvency practitioner. While insolvency practitioners may effectively be the only parties authorized to conduct the debtor’s activities, administrators primarily act as mediators and do not participate in the management of the debtor’s assets. Depending on the circumstances, candidates for the role of administrator may be nominated by both debtors and creditors.

However, it’s important to note that in certain cases, the parties may choose not to hire an administrator at all. If a small business owner or individual entrepreneur intends to use the preventive restructuring mechanism and their proposals for debt repayment satisfy the creditor(s), then the portion of the expenses that would have been allocated to pay the administrator and lawyer can be redirected to the business operation or debt repayment. In this regard, the legislator has taken steps to support the participants in the proceedings. According to Law No. 10143, the Ministry of Justice is tasked with developing a standard form for such a plan. Additionally, the Ministry of Justice is required to introduce specialized methodologies and recommendations for drafting a restructuring plan, as well as to create a dedicated web resource for this purpose.

Let’s get back to the proceedings. So, the court initiates the preventive restructuring procedure. What comes next?

Next, the debtor will have access to a protective mechanism designed to protect it from possible unfair actions by certain creditors. However, it’s important to note that these protective measures are not unlimited and are subject to certain time limits. For example, for a period of 6 months, no bankruptcy proceedings can be initiated against the debtor at the request of a participating creditor (although a non-participating creditor retains the right to initiate bankruptcy proceedings against the debtor at any time). In addition, the accrual of fines and other financial penalties for obligations to participating creditors is suspended for a period of six months. The statute of limitations on claims of participating creditors against the debtor is suspended for the entire duration of the preventive restructuring. And this is only a part of the protective measures available to the debtor under preventive restructuring.

Another important difference between the European preventive restructuring mechanism and existing insolvency procedures lies in the approach to creditors. Under the European Directive, it’s the debtor who forms the pool of creditors and decides whom to include in the plan (i.e., with whom to restructure debt). For example, they may seek to restructure debts with the bank and the supplier while ensuring timely and full payment to the landlord, as the landlord could simply evict the debtor from the premises at any time. This situation could potentially lead to even greater financial difficulties. For instance, spending time looking for new premises for production, shops, cafes, or offices, incurring relocation costs, and negotiating new agreements with advance payments is not economically justifiable. Moreover, even if the landlord is not a party to the restructuring plan, the debtor must still include the landlord in the plan along with all other creditors and provide justification for the classification of creditors as participating or non-participating.

However, there are even more innovations in the approach to creditors. The new law further divides creditors into classes. Law No. 10143 establishes four classes: secured creditors; unsecured creditors; unsecured creditors interested in the debtor; debtor’s founders. However, this doesn’t mean that the debtor is limited to these four classes; he can create other classes at his/her discretion. For example, the EU Directive allows creditors to be divided into classes such as employees, suppliers, etc.

One of the key innovations in the bill implementing the EU Directive is the novel approach to providing financial support to debtors during the preventive restructuring procedure. These include the concept of interim financing, which refers to the financing that the debtor seeks and may obtain from a third party in order to maintain the company’s operations or carry out the preventive restructuring procedure. In addition, there’s the concept of additional financing, which involves securing this type of financing as outlined in the restructuring plan after its approval. This is essential to enable the court to decide on the feasibility of the procedure and the preventive restructuring plan. In addition, the bill includes provisions for the protection of such investments in order to encourage investors to support the debtor’s recovery.

Debt Restructuring: Options and Opportunities

The new bill offers a wide range of debt restructuring options for debtors. These include deferral, installment plans, partial debt forgiveness, securing additional financing, reprofiling or even reorganization of the debtor company

Consequences

Ukrainian businesses are grappling with the aftermath of extensive Russian aggression. And it’s not just the enterprises situated in frontline territories. The socio-economic and demographic ramifications of the major conflict have left their mark on the vast majority of domestic companies.

While the new mechanism is no silver bullet for debtors, it does offer a potential lifeline to prevent a company from collapsing and to detect and address issues at an early stage. Unlike much of Ukraine’s creditor-centric bankruptcy legislation, the European mechanism for preventive debt restructuring places greater emphasis on debtors.

However, it’s important to understand that the European Directive does not ignore the interests of creditors. In fact, this mechanism offers creditors a valuable opportunity to recover their funds quickly and without lengthy court proceedings. In addition, according to the bill, creditors have the right to terminate the procedure at any time.