Matter-of-course Function
The recent non-payment crisis is facilitating banks to find the proper solution for managing their bad debt portfolios. And legal strategy is pivotal for the performance of banks in these critical and very challenging times for the banking sector. We came armed with these questions for an interview with the partners of L.I. Group — Mykola Kovalchuk and Artur Megeria. Their matter-of-course dispute practice gave us a quite clear explanation of the situation on the ground.
UJBL: Your law firm is known for representing the interests of banks in lawsuits against debtors. What contrivances and tricks are usually undertaken by debtors in order to avoid paying their credit obligations?
Mykola Kovalchuk: Well, there are numerous contrivances and tricks of that kind. However, there are standard schemes followed by debtors in order to withstand collection and penalties, so as not to pay off debts and, consequently, to avoid giving up pledged or mortgaged property that was provided as security for the lending in question. First of all, such a trick is suspension of principal mortgage or pledge foreclosure cases due to any lawsuits initiated by debtors. For instance, a debtor may claim recognition of agreements or supplementary agreements thereto invalid. Sometimes, formal wording is purposefully included in such agreements upon execution, which is later referred to and attention drawn to in lawsuits. As a rule, such lawsuits are purely technical and are to be lost, but they give a debtor an extension of six or eight months, or even a year!
Proceedings may also be protracted and suspended if some expert examination or investigation is assigned. At the same time, opponents usually cover neither litigation expenses nor expert examination charges. This is quite a lengthy process which gives debtors opportunities to gain time and moral advantages for negotiations, reach a certain agreement with the bank on debt restructuring, discounting, and so on.
There are also innovations such as assets transfer from a debtor to another person by means of separation. We recently faced this problem in practice, when all the assets ascribed to a debtor were transferred via separation to another legal entity. Hence, such a transfer prevents the bank from collecting debts, which had arisen earlier, via standard, “classic” means.
UJBL: In other words, the transfer procedure is totally legal, thereby allowing debtors to avoid responsibility, isn’t it?
Artur Megeria: Indeed, the transfer procedure fully complies with legislation. In this case, the bank has to address both — the previous owner and the new legal entity involved, pass through all enforcement processes again, and control future proceedings invented by the debtor. This certainly causes further protraction of the entire process and increases costs.
UJBL: And which specific strategies do debtors use in practice?
À. Ì.: I should say that debtors have learnt to defend themselves quite skilfully with the help of lawyers. But basically it depends on the banks’ actions.
If valuable pledged or mortgaged assets are involved, and a bank is not willing to participate in long-lasting litigations, the bank is entitled to register its title to the pledged/mortgaged property on the grounds of a pledge/mortgage clause. This is currently wide-spread practice. This is very convenient, fast, and usually unexpected for the debtor. After such a registration the bank has more chances to agree with its debtor on restructuring, repayment, or sale of assets.
However, it should be mentioned that debtors have already grasped all these nuances with the help of lawyers! Debtors dream up various claims and so-called “internal arrangements”. For example, a bank wants to register a title to a mortgaged property which costs UAH 100 million, a relevant debtor initiates an “internal arrangement” lawsuit on collection of UAH 60,000 from such a debtor by a controlled company. And then, in the course of litigation such debtor-controlled company asks the court to seize the debtor’s entire property. If the court adopts a resolution on the seizure, this prevents the bank from registering the title and the bank, as a mortgagee, cannot exercise its right to register the title to a mortgaged property subject to the extrajudicial procedure.
It should be pointed out that the Act of Ukraine On the State Registration of Property Rights to Immovable Property and Encumbrances Thereof was recently amended to facilitate the registration procedure for banks. As of today, a bank may submit the relevant documents for registration of its right of ownership to a mortgaged property to any notary who can register such title within two hours. It cuts the legal expenses of banks. And actually, a bank’s in-house lawyers can prepare and submit the relevant documents to the notary for registration.
UJBL: How do banks react to such actions on the part of debtors?
M. Ê.: There are two major strategies that are the fastest, the most efficient and, perhaps, the cheapest. One of these is an acknowledgement of the title by means of foreclosure on the mortgaged property. Thus, a bank gets the entire property on its balance sheet and becomes the owner, which is a guarantee for obtaining such property eventually. And the second strategy is an extrajudicial settlement. This is actually the most optimal way of collecting debts, if we speak of withdrawal of pledged/mortgaged assets.
À. Ì.: The bank’s strategy depends on the debtor’s actions. If a debtor is simply avoiding making a decision or committing itself so as to win time through various lawsuits, we offer banks the fastest and the most efficient way to settle the case: registration of the title on the basis of a mortgage clause. Debtors very often initiate a self-bankruptcy procedure. In this case, first and foremost, a bank needs to act really fast, and control its property and sale thereof under the bankruptcy procedure.
There are also situations when the amount of a loan is quite big, but a pledge/mortgage covers, say, only 40% of the loan. In such case, banks have to apply other forms of debt collection. As a rule, banks endeavour to lock up the debtor’s settlement accounts subject to the judicial procedure, collect the debt from the debtor’s owner, etc. This is an effective way of encouraging the debtor to come to the bank and start negotiating on payment by instalments or partial write-off of the debt.
UJBL: What should banking lawyers take into account in the event of a debtor’s bankruptcy procedure? What corruption risks does the bankruptcy procedure entail?
M. Ê.: Before initiating a bankruptcy procedure, debtors usually increase the so-called artificial liabilities in order to have a major share in total payables. Consequently, when a creditors’ committee is established, the debtor’s representatives have the majority of votes in it and adopt fundamental decisions on the bankruptcy process. Unfortunately, our legislation provides for a very narrow list of grounds on which such artificial liabilities may be cancelled or revised. Another problem is definitely corruption, thanks to which judges do not consider such transactions carefully enough during the litigation. As a result, a resolution is adopted on the inclusion of non-existing liabilities in the creditor’s register.
À. Ì.: In terms of bankruptcy procedure, a major role is played by the bankruptcy commissioner. It is important to understand whether the bankruptcy commissioner in question is appointed at the debtor’s initiative or selected via the automated system. According to the Bankruptcy Act, a bankruptcy commissioner is appointed via the automated system. However, we have cases when judges ignore candidates selected via the automated system and appoint bankruptcy commissioners recommended by the debtors. Naturally, a bankruptcy commissioner appointed in this manner represents an interested party. Therefore, we openly warn our clients of the risk that such a bankruptcy commissioner might act solely in the interests of the debtor. This may become apparent in the bankruptcy procedure becoming protracted, non-acknowledgement of the bank’s claims, appealing against court resolutions, etc., which makes the whole process to sell the debtor’s property very long, even lasting many years. In such cases, a bank is entitled to file a complaint against the actions of such a bankruptcy commissioner and ask the court to appoint an independent, qualified, and trustworthy bankruptcy commissioner.
Unfortunately, the Bankruptcy Act does not guarantee payment of the bankruptcy commissioner’s services. According to legislation, the bankruptcy commissioner’s services must be covered by the initiating creditor. However, in practice a bankruptcy commissioner may work for a year and not get a single hryvnya for services rendered. Therefore, this issue should be resolved at the level of legislation.
UJBL: How would you comment on the situation with the collection of pledged and mortgaged property on ATO territory? What do you recommend to your clients in such extremely difficult cases?
M. Ê.: There are no special recipes for such cases as hostilities are ongoing. As of today, it is legally impossible to take any measures to gain control over any pledge or any mortgaged property located there. The only right thing to do is to file relevant claims on acknowledgement of the title or the right of collection, and receive court resolutions that will come into force when Ukraine regains actual control over government authorities in ATO territory. This is the only way that creditors can renew their rights to property in question.
À. Ì.: A reminder that courts which operated in the ATO zone have renewed their activities. Thus, the economic courts of Donetsk and Lugansk Regions perform their functions in Ukrainian territory, in Kharkov.
UJBL: How do you evaluate the measures of the National Bank of Ukraine on the withdrawal of insolvent banks from the market? Do you have any cases involving banks in which temporary administration has been introduced and the liquidation process has been started?
M. Ê.: Generally speaking, this is a positive trend, since there are numerous artificial financial organisations that do not perform their matter-of-course function. Such empty vessels must be eliminated. However, the fact that so many people have suffered sizeable loss of their entire savings due to liquidation of such financial institutions is surely a big problem and tragedy.
We are supporting a case on the return of property that was illegally alienated right before temporary administration was introduced. This property should have normally been used to cover losses.
Eventually, working with banks that find themselves under the liquidation procedure is a huge problem because no mechanism is stipulated for securing the remuneration and compensation of expenses to lawyers.
UJBL: We know that at the present time your law firm is actively developing cooperation with American investors and lawyers. You reported at the conference arranged recently by the Ukrainian American Bar Association. Do you plan to develop consulting services?
M. Ê.: We certainly do. This was precisely one of the purposes of our trip. Actually, many investors are interested in Ukraine, and not just from the United States, but from Japan, China, etc. In investing money here they have the opportunity to receive annual profits of not some 3% as they have in their home countries, but many times more. However, hostilities in the east are an enormous moral obstacle for them. And the second well-known issue is corruption.
À. Ì.: Nonetheless, we shall endeavour to attract several investors from Eastern countries by inviting them to Ukraine and showing mechanisms to protect their investments. For Easterners, personal acquaintance and contact with lawyers are very important.
UJBL: Are you considering travelling to the East?
M. Ê.: Quite possibly. Or the East could be attracted here. An appropriate event, most probably an investment forum, will be arranged.
UJBL: What are your plans to develop L.I. Group in the very near future? Shall we see the opening of new practices?
M.K. : Well, such plans include legal support of investment projects and foreign businesses in Ukraine at all stages from starting support of economic activity, including legal defence, if necessary.
As for the near future, we plan to increase the number of clients extensively and intensively in our recent expert profile: collection of bad debts, bankruptcy in the banking field, corporate disputes. Moreover, we plan to open new practices, such as tax and criminal ones.
UJBL: Can we expect the emergence of new partners in your law firm? Will you attract professionals from the market as well? Can anyone from your current team get promoted to partner status?
M. Ê.: We will certainly attract specialists from the market. To be frank, we are already negotiating on opening a criminal department. Furthermore, I believe some of our lawyers have grown up to the level where they can and must become partners and work with clients independently, attracting new contracts and making strategic decisions.
L.I. Group
Key facts:
Year of establishment 2008
Number of lawyers/partners/consultants
15/2
Core practice areas
- Dispute resolution
- Bankruptcy
- Banking and Finance
- International Arbitration
- Corporate Law
