Changes to the Code of Ukraine on Bankruptcy Procedures

25.01.21

How has the new Code of Ukraine on Bankruptcy Procedures (hereinafter referred to as the ‘Code’) affected the practice of bankruptcy?

 Compared to the previous Law, the Code is a rather pro-creditor document aimed at reducing the duration of bankruptcy proceedings, strengthening creditors’ protection mechanisms, increasing the creditor’s repayment. Significant amendments have been introduced to make the sale of assets more efficient, to make the procedure more transparent and to attract a wider number of potential buyers or investors.

Market players had a lot of time to prepare for the new regulation. Enough time has passed since the adoption, signing of the document and its entry into force. We have accurately predicted both expected changes in practice and problematic or conflict-of-laws issues.

Current period of time is a quite fruitful period for joint activities of specialists in the field of bankruptcy and the regulator, the Ministry of Justice of Ukraine (hereinafter referred to as the ‘MoJ’) as well as representatives of the legislative body to improve relevant legislation. The working group under the MoJ includes insolvency practitioners, lawyers, representatives of the national association of banks, judges of the Supreme Court and judges of the courts of first instance. The role of the National Association of Insolvency Practitioners, whose representatives defend the interests of our professional community, is also very important. In the course of this work, problems are consolidated, common approaches are developed and balanced decisions are made to amend legislation.

Which provisions of the Code are the most problematic and controversial in practice?

In fact, there are many problems. The first problems can be encountered already at the stage of filing a bankruptcy petition or at the stage of initiating bankruptcy proceedings against the debtor. Some of the issues are procedural; they arise from the cross-simultaneous regulation of a number of issues both by the Bankruptcy Code and the Economic Procedure Code of Ukraine.

Other issues related to the application of new provisions that had not previously been approved by the cases. Thus, despite the fact that the Bankruptcy Code provides for the possibility of opening a case without a court judgment, this mechanism does not actually work. The requirement of dispute absence between the debtor and the creditor (indisputability) makes it almost impossible to open a case without pre-legal debt recovery owed to the debtor. It would be sufficient for the latter simply to disagree with the amount owed and submit this information to the court.

We also encountered problematic aspects of applying cassation filters. Judicial reform in general and legislative changes in the field of bankruptcy in particular were largely aimed at reducing the time for consideration of cases, eliminating opportunities for procedural abuse as well as narrowing the range of issues that can be reviewed by the Supreme Court. Thus, ‘optimization’ of the high court work shall improve the quality of justice in disputes that are subject to review.

However, the absence of practice in application of the new provisions of the Bankruptcy Code and a number of conflicts with the provisions of the Economic Procedure Code of Ukraine led to a ‘side effect’ of using filters. Thus, in the absence of a unified position of the Supreme Court on a number of issues, courts of first instance and appeals courts of different regions sometimes form diametrically opposite legal positions.

For example, the Bankruptcy Code provides an opportunity to dispute dubious transactions made by the debtor. This regulation is a particular one for reconsideration of the debtor’s transactions aimed at worsening its economic situation and bringing it to bankruptcy. In pursuance of the Civil Code of Ukraine, such transactions are legal, but the Code allows invalidating the transaction on the grounds that its economic feasibility is questionable and caused damage to the debtor.

Such transactions are appealed directly in terms of bankruptcy procedure, the result of such consideration is a ruling, which enters into force immediately and is not subject to cassation appeal. On the other hand, intrinsically, the decision on the invalidity of the transaction is actually a court judgement that challenges the contract and applies the consequences of invalidity: a third person may be obliged to return the property or pay money to the debtor.

Different courts consider such disputes applying different approaches: in some cases in action proceedings, and in other cases – in terms of a bankruptcy case.

Another example. The Bankruptcy Chamber of the Commercial Cassation Court of the Supreme Court solves the legal problem of whether the ruling to replace the creditor by means of succession can be reviewed in terms of cassation. In pursuance of the Economic Procedure Code of Ukraine, such a ruling is subject to review in cassation, and under the Bankruptcy Code such rulings are not included in the list of rulings that can be appealed. And this is not the first time the Chamber has heard this issue. Previously, the majority of the judges of the Chamber opposed the possibility of review, and at the same time, a number of judges prepared a dissenting opinion, expressing the opposite position. The Chamber is currently studying the positions of legal scholars, members of the Scientific Advisory Council of the Supreme Court. We expect a hearing on this issue on November 26, 2020.

Of course, if the issue of replacing a creditor with its successor is an exclusively procedural decision in terms of replacement one person with another without changing the amount and grounds for incurring of the debt as well as the status (priority of claims) of the creditor in the case, this is not a matter to be considered by the Supreme Court. But if, as a result of such a replacement, the debtor’s obligations to the creditor’s successor have changed, we believe that such an issue goes beyond the procedural one and can be reconsidered.

Of course, if the level of confidence in the courts were higher, this would not become such a problem. But, unfortunately, the parties are not always satisfied with the quality of lower court decisions and they want to be able to challenge such a decision in a higher court, and the Supreme Court enjoys the highest level of confidence in the court system.

What changes have been introduced into bankruptcy procedures by the Law No.686-IX?

On October 17, 2020, amendments to the Code of Ukraine on Bankruptcy Procedures entered into force, introduced by the Law No.686-IX, which the Parliament adopted on June 5th this year. The most interesting innovation of the Law is the temporary change in the procedure of appointing an insolvency practitioner in a bankruptcy case. Now the candidacy of the insolvency practitioner to manage the bankruptcy process of a legal entity can be submitted by the creditor initiating the bankruptcy procedure. Similarly, such a candidacy is submitted by a natural person who initiates its own bankruptcy. This insolvency practitioner shall be appointed in the case without any alternative. Exceptions are cases of impossibility to appoint a candidate, as defined by law. For example, if the initiator of the bankruptcy procedure is the debtor-legal entity itself, or the proposed candidate was previously the manager of the debtor, has a conflict of interest, is a relative of the natural person-debtor, etc.

How was it before?

Since 2013 there has been a system of automated selection of an insolvency practitioner to be appointed in the case. The practitioner was selected automatically from among all the insolvency practitioners included in the system and appointed by the court. This procedure was not perfect, and if a system-selected specialist in the case were to refuse, any other insolvency practitioner could be appointed who had filed the relevant application with the court.

The Code maintained the automated system for the selection of practitioners. In preparing the draft Code, this option was considered the most appropriate to ensure the independence of the insolvency practitioner.

However, now automated selection should have been provided by the Unified Judicial Information and Telecommunication System (hereinafter referred to as the ‘UJITS’). But it has not yet been created, and since the introduction of the Code, the ‘lottery’ for the selection of arbitrations has been taking place in a manner not actually provided for by law. The old system was used, which was finalized so that it could provide three candidates. It is obvious that new defects have been added to previous problems. The mechanism proposed by legislator is a quite advantageous, albeit pro-creditor, solution to the problem before the creation of the UJITS. Thus, granting creditors the right to initiate the appointment of an insolvency practitioner should encourage debtors to perform their duties in good faith. Creditors also get some guarantees of an efficient and fast procedure in the event of addressing a professional and experienced practitioner.

Of course, so-called ‘friendly’ bankruptcy, at the initiative of the debtor’s creditors with the participation of a loyal insolvency practitioner, cannot be ruled out. However, on the other hand, the Code provides for sufficient mechanisms for other creditors to exercise control over the insolvency practitioner as well as to review disputed transactions of the debtor and to refute the creditors’ claims of others.

Important changes were made to the Code by the Law No.728-IX, which entered into force at the same time as the Law No.668. According to the authors of the draft law, such changes were made for the duration of the quarantine restrictions due to COVID-19 in order to support business. Their assessment by bankruptcy experts is contradictory. Along with the positive changes that are necessary and timely to ensure the safe work of the insolvency practitioner and all participants in the case, the Code has been amended, the appropriateness of which is doubtful. Thus, the possibility of holding a meeting and a committee of creditors remotely allows creditors to make important decisions for the procedure without endangering the participants in the case.

At the same time, the automatic extension of the terms of procedures in bankruptcy cases, the possibility of suspension of tenders, the exemption of insolvency practitioners from liability for non-performance of its obligations and managers from liability for non-disclosure of the threat of insolvency, and most importantly, the introduction of a moratorium on the initiation of bankruptcy cases on obligations that arose from March 12, 2020, it is difficult to assess positively. Another moratorium is not a panacea for saving business, but a potential excessive use mechanism and delay in the debt repayment process.

The draft law No.4220 introduced by the President, if adopted, should rectify the defects and imbalances in the provisions of the Code that have already come into force. The draft law excludes the provisions regarding a moratorium on the initiation of bankruptcy cases as well as the possibility of suspension of tenders for the sale of bankruptcy property. The provisions on the extension of the procedures and exemption from liability have been clarified and suggest that such measures can be applied by the court if they are justified.

Has the focus of bankruptcy procedures shifted from liquidation of enterprises to restoration of solvency?

I would not say that. Generally, the repayment of the creditor’s funds is achieved not by the procedure of financial rehabilitation and restoration of solvency, but rather in the liquidation procedure of the debtor enterprise.

From my point of view, the development of the institution of pre-judicial rehabilitation is more appropriate. A debtor without bankruptcy procedure can take advantage of a moratorium on repayment of debts, identify all the resources of its business and, having agreed with creditors, get out of the crisis with minimal negative consequences. Unfortunately, practice shows that this procedure is appealed by fiscal bodies that do not agree with pre-judicial rehabilitation plans, and there are few successful examples of pre-judicial rehabilitation.

What, in your opinion, is necessary to increase the demand for pre-judicial rehabilitation procedures?

First of all, a high-quality and balanced legislative mechanism is needed. But no less important is a professional approach to the organization of the pre-judicial rehabilitation procedure. So, it is important to check and make sure that the debtor has a resource to restore solvency for creditors who want to give a second chance. The debtor, in turn, shall correctly assess the possibilities of its business, propose the most effective measures to improve the business and a competent debt restructuring procedure. The parties’ consultants need to ensure correct mediation of the process, building confidence between the parties to the process. Obviously, this procedure will differ from a bankruptcy court procedure. So, bankruptcy professionals will have to abandon the usual algorithms of work in the competitive process. However, compliance with professional and ethical work standards still remains important.

Olena Volianska, partner, head of bankruptcy and restructuring, exclusively for “Yurydychna Praktyka”