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Partner, Head of Banking & Finance and Debt Restructuring practices, Arzinger
Cross-Border Debt Restructuring
The majority of Ukrainian corporate non-performing loans capable of restructuring have been restructured within the space of the last few years. At the same time, the current global economic situation, which is not favorable for Ukrainian exporters, gives reasonable grounds to expect new defaults in the corporate sector, especially in export-oriented industries. This creates new challenges for creditors as well as new opportunities for debt investors active in the region. It is important, in this regard, to understand the peculiarities of local legislation and debt restructuring practices so as to accommodate appropriate measures and avoid unnecessary risks. This article focuses on certain factors to be considered by foreign creditors and investors before entering the Ukrainian market.
Until October 2019 Ukrainian legislation did not provide efficient instruments for court-approved restructuring, which allowed the cramming down of dissenting creditors. Thus, consensual restructuring was considered a more preferable solution for both creditors and debtors as it gave greater certainty of outcomes and flexibility in terms of realization of contractual arrangements between parties to the restructuring process.
However, consensual restructuring creates some risks for participating creditors which have to be addressed properly. The main issue is the activity of dissenting creditors whose aggressive actions may destroy the restructuring process. In this case, it is important to understand the real possibilities for dissenting creditors at each stage of restructuring, and to what extent dissenting creditors may be pushed beyond the perimeter of restructuring.
It should be noted that the position of some dissenting creditors is predetermined by their status and applicable laws, leaving for them no options other than enforcement. For instance, the National Bank of Ukraine or the state-run Deposit Guarantee Fund may not participate in restructuring, as it is not provided for by the legislation regulating their activity. Thus, despite the restructuring initiated by their debtor, they have to opt for enforcement, causing complications for the restructuring process involving other creditors. The existence of such entities in the creditors pool should be taken into account and addressed respectively before the restructuring commences.
Another important issue is to what extent a restructuring agreement is binding on and enforceable against a debtor and the creditors who signed it. In the course of voluntary restructuring a separate standstill agreement is often concluded to pervert uncoordinated actions by creditors. However, the essence of the obligations of parties under this kind of agreement is such that its enforcement is not secured by Ukrainian law. In the vast majority of cases such an agreement is governed by English law, and disputes are referred to commercial arbitration. The practical enforceability of its provisions is rather vague. Therefore, the main focus in such case is on the reputational consequences for the offender and the possibility to claim damages in international arbitration.
The issue of securing the debtor’s restructured obligations deserves particular attention. Various options are used in practice, but the most popular are the following: (1) each creditor retains its existing security and the new additional security is registered in the name of the security agent; (2) all of the security is transferred to a security agent. In the first case, a mechanism of distribution of the enforcement proceeds by each secured creditor among all secured creditors is normally set out in the restructuring agreement. At the same time, it is worth taking into account the fact that due to the specifics of Ukrainian currency control legislation Ukrainian creditors may be limited in their ability to make such payments to foreign creditors.
The issue of selection of a security agent and the legal basis for its appointment very often causes debates in practice. The point is that the most common legal concepts used for appointment of a security agent are the concepts of trust and parallel debt. Neither of these concepts is recognized by Ukrainian law and both are rather doubtful in terms of prospects for judicial protection in Ukraine. At the same time, the joint and several creditor concept is recognized by Ukrainian law and is the safest one for creditors in terms of legal protection. However, it is not always exercisable in practice, especially in projects involving multiple creditors from various jurisdictions. Therefore, in practice creditors often have to accept the risk associated with the first two options.
Court Restructuring and Cram Down Mechanisms
The aggressive actions of dissenting creditors often become a major problem in the course of a restructuring. The English scheme of arrangement and U.S. Chapter 11 have become quite popular in global restructurings, largely due to the possibility to cram down dissenting creditors, which enables subordination of the interests of a small group of creditors to the interests of the debtor and the majority of creditors.
As mentioned above, the cram down mechanism was not available in Ukraine until October 2019. However, such a mechanism has emerged with the coming into force of the new Bankruptcy Procedures Code. Article 5 of this code provides for the financial rehabilitation mechanism which may be initiated by a debtor prior to commencement of bankruptcy proceedings. Financial rehabilitation is carried out under the financial rehabilitation plan, which may provide for (i) dividing creditors into categories depending on the type of claims and security, (ii) different conditions for satisfaction of creditors’ claims in different categories, (iii) obtaining loans for financing current activities, (iv) extension, deferral or forgiveness of a debt (a part thereof) etc.
A financial rehabilitation plan must be approved by the creditors involved at a meeting of creditors called by a debtor.
If secured creditors take part in the restructuring, the financial rehabilitation plan must be approved in each category by the secured creditors holding at least 2/3 of the total amount of the secured claims included in the financial rehabilitation plan in the respective category. In addition, the financial rehabilitation plan shall be approved by unsecured creditors holding at least 50% of the total amount of unsecured claims included in the financial rehabilitation plan in the relevant category.
An important condition is that the terms and conditions of the financial rehabilitation plan for creditors who either did not vote or voted against the rehabilitation plan should be no worse than the conditions for creditors who voted in favor of the financial rehabilitation plan.
At the same time, the law provides for the protection of creditors from concerted actions by the debtor and its related parties. Thus, the votes of creditors affiliated with the debtor shall not be taken into account when approving the financial rehabilitation plan.
The financial rehabilitation plan approved by creditors shall be ratified by the commercial court at the debtor’s place of registration. The court must adopt its decision within one month from the receipt of the application from the debtor. The financial rehabilitation plan approved by the court is binding on all creditors, whose claims have been included in the financial rehabilitation plan.
As we see, this mechanism is rather similar to the English scheme of arrangement and may well become an alternative in the debt restructuring of Ukrainian companies.
Destressed debt has always been an interesting asset as it attracts a lot of investors. However, despite the large amount of non-performing loans in Ukraine there are hardly any really interesting assets left. The majority of non-performing loans are in retail debt and uncollectible debt in the corporate sector. While it is still possible to make profit in retail, subject to a proper approach to the collection process, the chances in the corporate segment are extremely limited.
At the same time, a new round of defaults and restructurings may eventually bring interesting assets to the market.
On top of that, foreign exchange legislation, which has previously been one of the main sources of problems in the structuring of distressed debts sale, has been substantially amended and now provides for many more options to the parties in the ways through which they can fulfill their commercial arrangements.
Despite positive changes in local legislation, Ukraine still remains a country with developing economic and legal systems, which in practice materialize into risks for creditors and investors. These risks cannot be eliminated in the short term, but clear identification of respective risks and understanding of their implications allows a sober and well-balanced decision to be made.