The Amended Ukrainian Insolvency Law: Key Issues

by Olexiy Y. Soshenko, Andrii L. Grebonkin

In the course of restatement of Ukraine’s insolvency law (the Insolvency Act) that came into effect on 19 January 2013, several significant amendments were made. The changes were an attempt to create a more streamlined and efficient insolvency process and to remedy some of the real and perceived defects in the current law. In doing so, legislature implemented some fairly significant changes to the Insolvency Act which impact both debtors and creditors.

A summary of the most significant amendments to the Insolvency Act is set out below.

New concept of hardening periods

Before 19 January 2013, due to deficiencies in the drafting of the law, there was in effect no actual period during which transactions entered into by a debtor prior to the commencement of insolvency could be set aside. The amended Insolvency Act remedied this and introduced a new procedure for determining which transactions made before the commencement of insolvency may be set aside.

Under the new rules, a court will now be able, following an application from the insolvency manager or any creditor, to invalidate any transactions made by a debtor during a one-year period prior to the date of the commencement of insolvency proceedings, if such transactions resulted in the debtor:

— alienating assets, incurring undertakings or waiving proprietary claim(s) without consideration;

— performing obligations before they became due (this would not include an acceleration or mandatory prepayment of a loan but it would include a voluntary prepayment of a loan);

— entering into obligations as a result of which it became insolvent;

— alienating or acquiring assets not at their market value and as a result of which it became insolvent;

— making any cash payments or receiving payments in kind when the sum of creditors’ claims exceeds the value of the debtor’s assets; or

— granting security.

The amended law does not impose any additional criteria for the invalidation of such transactions. For example, it does not expressly require evidence that the transaction resulted in preferential treatment.

The result of such invalidation will be that the relevant creditor will need to release the security (if any) or return the assets it received from the debtor or compensate the debtor for the market value of such assets (should it be impossible to return them in kind) and, in the case of a loan, the debtor would need to repay the loan to the creditor. We note that if a loan agreement is invalidated on this ground, any Ukrainian law security and/or guarantees/sureties provided in connection with that loan would fall away.

The law does seek to address creditors’ concerns in relation to these issues by determining that any creditors who have claims against a debtor as a result of the invalidation of their transaction will rank in the first rank of creditors irrespective of whether or not they had security. This would mean that even though a creditor’s security had fallen away, such creditor would rank pari passu with other secured creditors.

However, the provisions are poorly drafted in the sense that they do not carve out preferential transactions. For example, if a shareholder has an unsecured loan to the debtor (which would normally qualify for the fourth rank of priority) and such loan is invalidated pursuant to the above provisions, then claims of such shareholders would be elevated to the first rank as well.

A further consequence of this provision is that if a creditor’s security has fallen away, even though their claim will rank in the first priority, the law is unclear as to whether such creditor will continue to be treated as a “secured creditor”. The most likely scenario is that they would not, and as a consequence the creditor would lose its secured creditor status, including the right to block any rehabilitation plan or amicable settlement agreement.

“Piercing the corporate veil”: liability of directors and shareholders and persons with control

The amended law allows both shareholders and directors of the debtor to be liable in certain circumstances to creditors of the insolvent debtor. Accordingly, any director or shareholder of a debtor or any other person which has control over the business or corporate governance of that debtor can be liable in the debtor’s bankruptcy if:

— the assets of the debtor are insufficient to satisfy the creditors’ claims in full; and

— the actions of such director, shareholder or any other person resulted in the debtor’s bankruptcy.

No guidance is given in the law as to what actions may give rise to such liability. Furthermore, the reference to “any other person” in the category of those who may be liable arguably extends liability to those acting as “shadow directors”.

Creditors will, therefore, need to be very careful that they cannot be deemed to have control over the business of a debtor in order to avoid being liable to other creditors.

Changes to the “30-day” rule

Before 19 January 2013, unsecured competitive claims had to be submitted to the court within 30 days of each publication of the commencement of insolvency and the commencement of the liquidation phase of any insolvency, otherwise such claims were automatically discharged.

A positive development under the amended law is that a failure to submit a claim within the 30-day period will no longer result in the claim being discharged, but simply that its ranking will drop from the fourth rank (which is the rank applying to unsecured creditors) to the sixth (alongside all other claims not assigned a higher rank).

We note that there is an exception to these rules where there is ongoing litigation in relation to a claim at the time that the debtor enters insolvency. In this case a court will suspend the litigation and the claimant will need to submit a claim within 30 days after the insolvency announcement is made. Failure to do so will result in the automatic discharge of such a creditor’s claim.

Secured creditors are required to submit claims within the above periods in relation to the unsecured portions of their claims.

Insolvency publications

From 19 January 2014 all official insolvency publications will be posted on the web site of the High Commercial Court of Ukraine. Currently there is no official online publication.  Official insolvency publications are now published in certain specified forms of printed media.

Changes in the status of secured creditors

The amended Insolvency Act introduced a number of new rules for secured creditors, including the following:

— Secured creditors, if they can obtain the consent of the insolvency court, will be able to enforce their security after the commencement of insolvency proceedings, irrespective of the moratorium contemplated in the law.

— Secured creditors (together with current and preferential creditors) are explicitly prevented from voting at creditors’ meetings.

— Under the amended law, in addition to the currently existing right to veto in respect of any amicable settlement agreement, secured creditors will now have the right to veto any rehabilitation plan if it is prepared during the rehabilitation stage.

— Should any secured creditor not agree with a rehabilitation plan or amicable settlement agreement, the other secured creditors will now be able either to sell some of the collateral and satisfy the claim of such dissenting creditor or to buy their claim.  The same options will exist for unsecured creditors if a secured creditor does not agree with a rehabilitation plan.

Apart from the secured claims that are not subject to rankings (i.e., the proceeds received as a result of the sale of collateral are applied towards satisfaction of the secured creditors’ claims), in general, the statutory rankings in insolvency remain the same, namely:

Rank 1: salary claims and expenses incurred in connection with insolvency proceedings;

Rank 2: other payments due to employees, pension and social insurance tax claims;

Rank 3: other claims for taxes;

Rank 4: unsecured creditors’ claims;

Rank 5: claims of employees to receive distribution from the share capital of the debtor; and

Rank 6: other claims.

Set-off

Under Ukrainian civil law, a party to a transaction may set off, without the consent of the other party, any claims which are of the same type if both claims are outstanding.

The amendments to the Insolvency Act introduce two additional requirements applicable to set-off during insolvency, namely:

— the relevant creditor will need to consent to such set-off; and

— such set-off should not “breach the rights” of other creditors.

We note that there is no guidance on what “breach the rights” means, and as such this may have an impact on netting arrangements in derivative transactions and banks setting-off or combining accounts in the insolvency of a debtor.

Expedited insolvency restructuring

The amendments to the Insolvency Act introduced a new procedure to allow for the expedited restructuring of a debtor. Such procedure will allow the debtor, with the approval of the majority of creditors by value, to reach an expedited restructuring under the authority of the insolvency court, in effect overriding any dissenting minority creditors.

The expedited process would work as follows:

— A debtor or a creditor, acting with the consent of the majority of creditors, can apply for this procedure if (i) both the debtor’s shareholder(s) and those creditors controlling at least 50% of the debtor’s indebtedness consent, and (ii) a restructuring plan is pre-approved by both creditors controlling at least 50% of the entire indebtedness of the debtor and each secured creditor of the debtor.

— After such approval has been obtained, the plan is submitted to the court for its approval.

— Upon the approval of such a plan by the court (which should occur one month after its submission), a moratorium on satisfaction of creditors’ claims will be imposed although no formal insolvency proceedings will be commenced. The parties involved may immediately start carrying out the restructuring plan.

— The expedited restructuring procedure must be completed within 12 months and there is no ability to extend such period.  During this period it will also not be possible for a court to commence any other insolvency or restructuring proceedings against this debtor.

— A restructuring plan for the expedited insolvency procedure will be able to include a waterfall of claims which is different from the statutory rankings provided in the Insolvency Act.

Replacement of assets as a new restructuring method

The amended law introduced a procedure for the replacement of a debtor’s assets as one of the rehabilitation options. In order to be able to implement the replacement of assets, the creditors must ensure that such arrangement is included in the rehabilitation plan which is approved by the court.

This would work by permitting a debtor, during the rehabilitation phase, to incorporate a subsidiary and become its sole shareholder. In return for the shares in such entity, the debtor will be able to contribute all its assets and liabilities (save for any liabilities to competitive creditors) to the share capital of such an entity. Subsequently, these shares may be sold and the proceeds received from such sale used for the satisfaction of claims of any competitive creditors.

While this procedure may ease the process of realising proceeds from the sale of assets and satisfying creditors’ claims, it is likely to require significant work to be carried out.

Implementation of the UNCITRAL Model Law on Cross-Border Insolvency

The amended law implemented the provisions of the 1997 UNCITRAL Model Law on Cross-Border Insolvency. Subject to the existence of a relevant treaty between Ukraine and an applicable country this will, among other things, allow foreign insolvency practitioners to apply to Ukrainian courts for freezing orders and for the recognition of foreign insolvency proceedings in Ukraine. In addition, Ukrainian courts will be obliged to cooperate with foreign insolvency courts and provide relevant legal assistance in relation to any foreign insolvency proceedings. It is yet to be seen how these provisions will be implemented in practice.