V.Dzhun: Critical Review Of New Procedure Amendments To The Law Of Ukraine “On Restoring Debtor Solvency Or Declaring a Debtor Bankrupt”

The Law of Ukraine No 4212-VI “On Restoring Debtor Solvency Or Declaring a Debtor Bankrupt” dated 22.12.2011 with subsequent amendments (hereinafter – “the new version”) satisfactorily has only solved some of the issues concerning procedures in bankruptcy cases which were identified by the scientific doctrine and jurisprudence. A series of unfortunate solutions to the old version of the Law remained unnoticed by the legislature and have been transferred unchanged into the new version. In addition, the legislature enacted some new regulatory decisions, which further worsened the organization of the procedures. Therefore, with a strong legal basis, we can predict the problems arising in judicial practice during the application of the new version of the Law, in particular those relating to the interpretation of some of its provisions.

1. Major shortcomings of the new version are the archaisms and inaccuracy of its key terminology.  The improvement of the conceptual structure and terminology of national insolvency legislation should be made on the basis of the terminology of international legal documents concerning cross-border insolvency, as this terminology is the most versatile and suitable for the modern development of the science of competition law. In addition, the classical terminology of this science should be used.

Based on these requirements, the new version of the Law contains a limited number of more or less precise terminology matches for legal constructions and concepts of bankruptcy proceedings, which are competitive processes by their legal nature. The range of these terminological equivalents includes terms such as bankruptcy creditors, debtor, restructuring, liquidation procedure and settlement agreement. Other key terms need to be clarified, since the term “bankruptcy” should be replaced with the term “insolvency” (this term is used in legal theory and the legislation of most European countries and international legal documents), “proceedings in bankruptcy” – to “competitive proceedings”, “moratorium” – “competitive moratorium” (as in civil law as the term moratorium, but in another sense), “arbitration managers” – “bankruptcy trustee” (it is not understood why the term “arbitration managers” is used, as even the name “arbitration court” disappeared long ago), “liquidation pool” – for “competition pool”, “disposal of the debtor’s property ” – “external management process”, “manager of the debtor’s property” – “external manager”, “manager of foreign insolvency proceedings” – “bankruptcy trustee of a foreign proceeding” and so on.
2. The new version of the Law retains the clearly irrational structure of fixing (defining) legislative provisions. The provisions of insolvency legislation should be clearly distinguished and separated in acts of legislation of Ukraine on a sector basis. The contents are divided into material, procedural and organizational provisions.

The formation of the optimal structure of insolvency legislation necessarily requires a consistent separation, consolidation and defining its material, procedural and organizational provisions in the sector’s relevant regulations. Under this proposal the substantive provisions of competition law should be included to the Commercial Code, the provisions of the competition process – to the Commercial Procedural Code, and the provisions of the systems of bankruptcy trustee and the organization of the competition management – to a separate law. The advantage of this proposal is that, first, it is based on sustainable canons of systematization of legislation that require the highest possible consistency between the system of law and legislation, secondly, it allows systematically identify and apply the common procedural principles and key provisions of the Commercial Procedural Code to all proceedings and, thirdly, it takes into account the needs of judicial practice.

The imperfect structure of the locations of the provisions which is fixed in the new version of the Law resulted in a lack of the necessary sections of system organization of proceedings in bankruptcy cases, which in turn essentially limits the procedural possibilities of the courts during proceedings of this category of cases. Thus, the general provisions of the Commercial Procedural Code and the norms of the Code concerning evidence and the means of proof should apply not only to the civil proceedings but also proceedings in bankruptcy cases. In addition, the reform of the procedural mechanism for considering bankruptcy cases necessarily requires the introduction of such means of proof as statements, but not just explanations of the parties, witnesses and other participants in the proceedings, as these sources of evidence are essential for tracking the assets of insolvent debtors, especially if those assets are abroad.

In terms of the standards of the Council of Europe, the legitimate means of ensuring creditors’ claims in bankruptcy cases of their insolvent debtors are underused in the new version of the Law. These means should appropriately include the institution of checking the correspondence of the insolvent debtor by an arbitration administrator. The European Court of Human Rights allows for such types of verification, but only with respect to the principle of proportionality regarding the right of everyone of respect for his correspondence, as guaranteed by Article 8 of the Convention for the Protection of Human Rights and Fundamental Freedoms 1950.

For officials and owners of property of the debtor (legal entity) against which the bankruptcy case was initiated and persons responsible for the obligations of the debtor, denial of permission to go abroad, is another means that can be included.

Article 6 of the Law of Ukraine “On Regulation of the Procedure for Exiting and Entering Ukraine for Ukrainian Citizens” provides, inter alia, the possibility of a temporary refusal to issue a passport or a temporary prohibition from going abroad for the citizens of Ukraine, if they have unresolved obligations regarding alimony, contracts and other obligations, until they fulfill these obligations or resolve  the disputes by agreement of the parties in accordance with the law or secure  the fulfillment of the obligations by collateral, unless otherwise stipulated by an international agreement of Ukraine. This requirement can be directly applied in regard to unscrupulous officials and owners of property of the debtor (legal entity) against which the bankruptcy case was initiated and persons responsible for the obligations of the debtor.

3. The new version keeps extrajudicial procedures to prevent the bankruptcy of the debtor, such as the restructuring of the debtor before the initiation of proceedings in bankruptcy cases (Article 6). This procedure, although being an adjacent structure to insolvency regulations, is an independent institution of commercial law, the essence of which is not to restore solvency, but to solve the problem of operating margin (profitability) of a business entity. Therefore, this procedural structure should be located in a separate chapter of the Civil Code.

4. The new version of the Law contains numerous examples of apparent contradictions and oversights.

Thus, part 3 of Article 2 stipulates that legislation on restoring the solvency of the debtor or recognizing its bankruptcy in court proceedings for recognition of a bank as insolvent (bankrupt) is applied while taking into account the legislation on banks and banking. However, this statutory provision directly contradicts the requirements of part 7 of Article 36 of the Law of Ukraine “On the System of Guaranteeing Deposits” which states that the Law of Ukraine “On Restoring Debtor Solvency Or Declaring a Debtor Bankrupt” does not apply to banks.

There are cases of obvious oversights in terminology use in the provisions of the Law.

Thus, part 2 of Article 119 uses the term “manager of foreign insolvency proceedings”, and part 3 of the same article uses “foreign arbitration manager”.

Part 9 of Article 26 provides that the decision of the creditors’ meeting (Committee) is adopted by the majority vote of creditors if it was voted by creditors present at the meeting (Committee) whose votes are determined pursuant to part four of this Article. However, this norm does not specify if it should be an absolute majority or a relative majority, especially in the cases of competing options of proposed decisions.

Obvious defects by the legislature are the references in Articles 14 and 15 of the new version of the Law which stipulate, respectively, the grounds for refusal to accept the application for the initiation of bankruptcy proceedings and returning an application to, respectively, Articles 62 and 63 of the Commercial Procedural Code. In these articles of the Code a range of grounds for refusal to accept the claim and its return is established. These provisions are intended solely for disputes between the parties, while bankruptcy proceedings can only be begun in the absence of signs of a dispute regarding the existence of debt. Therefore, the relevant provisions of the Commercial Procedural Code can not be adequately applied to proceeding in bankruptcy cases.

5. The legislature stipulated extremely controversial rules of procedure for the satisfaction of the claims of current creditors, i.e. the creditors with claims against the debtor which arose after initiating bankruptcy proceedings. The claims from this category of creditors must be satisfied out of turn and generally immediately. Therefore, the moratorium really should not extend to the claims of current creditors as specified in the provisions of part 5 of Article 19 of the new version of the Law and these requirements should not be included in the register of creditors’ claims (Part 8 of Article 23). Part 6 of Article 19 also correctly states that during the procedure of disposal of property, the debtor is allowed to satisfy only the claims of creditors that are not subject to the moratorium in accordance with part five of this article.

However, the next regulation in the order of satisfaction of the claims of current creditors completely contradicts to the above mentioned provisions. Thus, part 8 of Article 23 unequivocally states: “Current creditors with claims against the debtor that arose after initiating bankruptcy proceedings, can make such claims after the commercial court adopts a decision declaring the debtor bankrupt and beginning the liquidation procedure. Before the recognition of the debtor as bankrupt, the debtor’s disputes with creditors who have ongoing claims against the debtor shall be resolved by consideration in civil proceedings in the same economic court which considers the bankruptcy case”. However, the question arises immediately: are enforcement documents of current creditors enforceable in procedures of property disposal or restructuring after the considering their claims by the court?

This question is caused by the prescription of part 15 of Article 16, which provides that since the initiation of proceedings in a bankruptcy case the presentation of the claims of current creditors against the debtor and their satisfaction may happen in the manner and procedure stipulated by this Law and the provisions of Part 1 of Article 45, which unequivocally states that creditors’ claims, arising from obligations in the procedure for disposal of the property of the debtor or the debtor’s restructuring, are satisfied in the liquidation procedure.

The procedure of satisfaction of claims of the current creditors in the liquidation procedure as defined by the new version of the Law has caused well-justified objections. Part 1 of Article 38 states that from the date of the determination of a decision declaring the debtor bankrupt and starting liquidation procedures, by the commercial court, claims incurred during the bankruptcy proceedings against the debtor declared bankrupt, may be filed only in the liquidation procedure within two months after the official publication of the notice of bankruptcy and the beginning of the liquidation procedure. A specified period is the time limit and is not subject to renewal. Part 1 of Article 45 provides that creditors’ claims, arising from obligations in the procedure for disposal of the property of the debtor or the debtor’s restructuring, are satisfied only in the fourth turn. So, in our opinion the developers of the new version of the Law committed a significant error regarding the procedure of satisfying the claims of current creditors, because the satisfaction of their claims in the fourth turn destroys their incentives to have economic relations with the debtor after the initiation of the proceedings of its bankruptcy, including the supply of resources, materials and services, etc. And this immediately makes the debtor unable to conduct any business in property disposal procedures and restructuring and, therefore, the achievement of the objectives of these procedures.
6. The legislature very contradictorily uses the issue of satisfaction of creditors’ claims regarding the payment of a forfeit (fines, penalties) and other financial sanctions, by the debtor (the bankrupt).

Part 3 of Article 19 provides that during the moratorium on satisfaction of creditors’ claims [the debtor] … shall not be charged a forfeit (fine, penalty), any other financial sanctions for non-fulfillment or improper fulfillment of obligations to satisfy all claims to which the moratorium extends shall not be applied. However, part 1 of Article 38 unequivocally determines that from the date of the of the determination of a decision declaring the debtor bankrupt and starting liquidation procedures, by the commercial courtforfeits (fines, penalties), interest and other economic sanctions for all types of debt of the bankrupt are suspended.

In addition, part 2 of Article 25 provides, inter alia, that:

Forfeits (fines, penalties) are included in the register of creditors’ claims separately from the main obligations in the sixth turn and can be subject to the settlement agreement.

Redemption of forfeits (fines, penalties) in the bankruptcy case is possible in the liquidation procedure, but only for the simplified procedure of considering a bankruptcy case.”

From an analysis of the provisions of Article 25, the question arises: why the redemption of forfeits is possible only in a simplified procedure of considering a bankruptcy case, given that, according to the provisions of part 2 of Article 7, a simplified procedure is applied during the liquidation procedure of the bankrupt entity without using procedures of restructuring and disposal of property?

7. Paragraph 8 of Part 1 of Article 83 of the new version of the Law does not exactly follow the principle of competition proceedings in bankruptcy. This norm provides that the economic court terminates the proceedings in the bankruptcy case if … no one makes claims against the debtor after the official publication of the announcement of the initiation of the proceedings in the bankruptcy case.

It should be taken into account, that both the debtor and the creditor have the right to submit to the commercial court for the initiation of bankruptcy proceedings against the debtor. If the creditor who initiated the case remains the only one after the official publication of the announcement of the initiation of the proceedings in the case, there is no reason to continue the proceedings, which are collective by their legal nature, because there is no competition of creditors in the case. Claims of the initiating creditor, having the nature of individual proceedings, must be satisfied within civil or enforcement proceedings.

If the application was submitted by the debtor, and after the official publication of the announcement of the initiation of the proceedings in the case, and only one creditor or no creditors could be found in the case. In these cases, there is also no competition of creditors. Therefore, paragraph 8 of Part 1 of Article 83 should be read as follows:

“8) after the official publication of the announcement of the initiation of the proceedings in the case of its (the debtor’s) bankruptcy only one creditor of the debtor was found or no creditors put forward claims against the debtor after the initiation of the proceedings at the application of the debtor.”

8. According to part four of Article 13 of the Constitution of Ukraine, all entities having property rights are equal before the law. However, the new version of the Law contains unconstitutional provisions regarding private owners of property of debtors. In accordance with part 1 of Article 29 and part 7 of Article 77 of the new version of the Law, the arbitration manager must necessarily pre-coordinate plans for restructuring and settlement agreements of public enterprises or businesses in the authorized share capital of which the state property exceeds fifty percent, with an agency authorized to manage public property. However, the right to submit plans of restructuring and settlement agreements for approval concerning private companies is not provided for the owners of their property. The absence in the law of the rights of the private owners of debtors’ property is an obvious manifestation of its unconstitutional discrimination compared to the rights of managers of public property.
9. Article 115 of the new version of the Law stipulates clearly unrealistic sources and order of payment for compensation for arbitration managers. Practice shows that these calculations for advance payments by the initiating creditor or debtor are mostly utopian. Only funds from the sale or disposal of the property of the debtor, or, of its own claims and, possibly, funds from a property owner or investor in the debtor during restructuring procedures, should be considered realistic. That is why it would be advisable to provide the following grounds for termination of a bankruptcy case in Article 83 for a violation of norms of Part 4 of Article 11, which provides that the debtor may only submit an application to the Commercial Court in the presence of the assets sufficient to cover court costs, unless otherwise provided by this Law.

10. The new version of the Law strengthened its anti-creditor orientation and thus further suppressed the incentives for the economically efficient use of resources by economic agents. Thus, Article 85 of the new version of the Law provides that local government can decide whether to apply the procedures stipulated by this Law and terminate bankruptcy proceedings toward business entities which have a particular public value to the Autonomous Republic of Crimea or local community. So this may apply not only to the debtors of the respective municipal properties, as mandated by the old version of the Law, but businesses in any form of ownership, including private. An objective analysis of Article 85 states that with this norm, the legislature gives wide possibilities for abuse and manipulation by leaders of communities and it contains potentially significant corruption opportunities.

V. Dzhun © 2013

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©2013. Всеукраїнська громадська організація «Саморегулівна організація фахівців конкурсного процесу».