How Creditors Can Increase Chances of Actually Recovering Debts in Bankruptcy Proceedings

Vadym Kizlenko, Attorney at Law, Counsel, Insolvency Receiver, Co-Head of Insolvency and Financial Restructuring

Source: Yurydychna praktyka 

Bankruptcy proceedings in Ukraine are usually quite lengthy and ineffective, lasting for years, with less than 10% of creditors’ claims being satisfied.

At the same time, the current legislation contains tools that allow creditors to obtain real satisfaction of their claims within a reasonable time (or, at least, significantly increase the chances of this happening).

Timely Initiation of Bankruptcy as the Key to Controlling the Procedure

First of all, there is no need to delay the initiation of bankruptcy proceedings. If you have monetary claims against the debtor, you should promptly apply to the court with a petition to open bankruptcy proceedings against your counterparty. This will give you the right to propose to the court a candidate for an arbitration manager, who will subsequently perform the functions of an asset manager. This is important because the completeness of the satisfaction of creditors’ claims directly depends on the quality of the property manager’s work (conducting financial analysis, reviewing creditors’ claims, taking actions aimed at returning the debtor’s assets that were left in his possession during the “suspicious period”).

Often, debtors, understanding the potential risks of real debt collection (through enforcement proceedings or bankruptcy proceedings), initiate so-called “friendly” bankruptcies. The debtor creates a debt with a “friendly” creditor that actually exists only on paper, while in reality, the business transaction (supply of goods, provision of services, etc.) did not take place.

Judicial Control at the Stage of Opening Bankruptcy Proceedings

According to established judicial practice, at the stage of opening bankruptcy proceedings, only the applicant (initiating creditor) and the debtor may present their arguments. Other persons (in particular, those who have monetary claims against the debtor) are not parties to the case at this stage and do not have procedural rights, in particular with regard to raising objections to the application for the opening of bankruptcy proceedings.

At the same time, a decision to open bankruptcy proceedings may be made only after verifying the debtor’s ability to fulfil its financial obligations that have become due, which includes verifying the validity of the applicant’s (initiating creditor’s) claims against the debtor and their compliance with the concept of a “monetary obligation”.

Such a detailed verification is an important element of judicial control when opening bankruptcy proceedings and is aimed at preventing the commercial court from recognizing monetary claims against the debtor based on fictitious debt. The unjustified opening of bankruptcy proceedings, for example, as a result of the recognition of fictitious monetary claims of the initiating creditor against the debtor, results in the violation of the rights of other creditors and the public interest in preventing fictitious bankruptcy, etc.

In such circumstances, even without having the procedural status of a party to the case, the creditor should inform the court about the fictitious nature of the monetary obligation or other grounds that make it impossible to open bankruptcy proceedings.

How Creditors Can Counteract the Initiation of Fictitious Bankruptcy Proceedings

In order to acquire the procedural right to object to the claims of a “friendly” creditor, you can file your own petition to initiate bankruptcy proceedings. In accordance with the provisions of the Bankruptcy Code of Ukraine, if several applications for the opening of bankruptcy proceedings are received by the court, they are considered by the same panel of judges in the order in which they were received.

If you become aware that bankruptcy proceedings are being initiated against your debtor at the request of its “friendly” creditor, it is advisable to file your own petition for the initiation of proceedings before the date of the preparatory hearing. In this case, you will be able to object to the initiation of fictitious bankruptcy and insist on the initiation of proceedings at your request. If the outcome is negative, you can appeal the decision in the appellate and cassation courts.

Control of Other Creditors’ Claims in Bankruptcy Proceedings

Another aspect to pay attention to in bankruptcy proceedings is the claims of other creditors (except for the initiating creditor). Here, debtors often abuse their rights. If the claims of the initiating creditor are important in terms of the candidacy of the arbitration manager, the claims of other creditors are important in the context of the majority of votes at the creditors’ meeting and in the creditors’ committee.

In accordance with Part 6 of Article 45 of the Bankruptcy Code, a creditor has the right to receive information from the property manager regarding the claims of other creditors. Such a creditor may submit objections to the property manager, the debtor, and the court regarding the recognition of the claims of other creditors.

After the opening of bankruptcy proceedings, the creditor should take an active position regarding the claims of other creditors – familiarize themselves with the relevant statements, analyze them, and, if there are grounds, object to the recognition of such claims and recognize the relevant transactions as fraudulent.

Ilyashev & Partners Law Firm has a successful case where the client had creditor claims against the debtor of approximately UAH 30 million, but in percentage terms, this was only 1% of the total amount of debt recognized by the court. In the client’s interests, we challenged in court the transaction on the basis of which the debtor’s friendly creditor received the majority of votes at the creditors’ meeting, and obtained a decision in our favour. After the work of the Ilyashev & Partners Law Firm team, the client’s claim was purchased at par value.

Return of Debtor’s Assets: Challenging Transactions

After approval of the register of creditors’ claims (formation of liabilities) of the debtor, special attention should be paid to the debtor’s assets, including those that were left in its possession three years before the opening of bankruptcy proceedings.

In accordance with the provisions of the Code of Ukraine on Insolvency Proceedings, in bankruptcy proceedings, the court may, at the request of the insolvency administrator or creditor, invalidate transactions or refute the debtor’s property actions for three years before the opening of bankruptcy proceedings if they violated the rights of the debtor or creditors.

In addition to general grounds, transactions may be invalidated in bankruptcy proceedings on the following grounds:

• the debtor fulfilled its property obligations before the established deadline;
• the debtor assumed obligations before the opening of bankruptcy proceedings, as a result of which he became insolvent, or the fulfillment of his monetary obligations to other creditors became impossible in whole or in part;
• the debtor disposed of or acquired property at prices lower or higher than market prices, provided that at the time of assuming the obligation or as a result of its performance, the debtor’s property was (became) insufficient to satisfy the creditors’ claims;
• the debtor paid another person or accepted property in fulfilment of monetary claims on the day when the number of creditors’ claims against the debtor exceeded the value of the property;
• the debtor assumed collateral obligations to secure the fulfillment of monetary claims;
• the debtor disposed of property free of charge, assumed obligations without corresponding property actions by the other party, or waived his own property claims;
• the debtor entered into a contract with an interested person;
• the debtor entered into a gift agreement.

The qualifying feature for recognizing a transaction as invalid in bankruptcy proceedings is the debtor’s actions that make it impossible to repay the debt. In other words, the debtor evades its obligations to creditors.

The Procedure for Disposing of the Debtor’s Property: What Determines Its Effectiveness

The main objectives of the procedure for disposing of the debtor’s property are:

• preservation of the debtor’s assets (if there are grounds for doing so, their recovery from third parties);
• formation of the debtor’s liabilities (approval of the register of creditors’ claims);
• conducting a financial analysis and determining the next judicial procedure (usually reorganization or liquidation).

The quality of the property disposal procedure and, as a result, the number of monetary claims satisfied depend on the professionalism of the arbitration manager and the active position of creditors.

If there are grounds, the parties to the bankruptcy case may develop a reorganization plan and petition the court to initiate the relevant procedure. In practice, the vast majority of bankruptcies end in liquidation, the main objective of which is to satisfy creditors’ claims as much as possible.

Subsidiary Liability for Causing Bankruptcy in Judicial Practice

In liquidation proceedings, the satisfaction of creditors’ claims directly depends on the possibility of imposing subsidiary liability on the guilty parties. Subsidiary liability is applied for causing bankruptcy to a person whose actions and decisions led to the absence of both funds in the accounts and property of the bankrupt. Such liability is not linked to the existence of a criminal conviction. For it to be applied, the court must establish the constituent elements of an economic offence: the object, the objective side, the subject, and the subjective side of the offence.

In addition to the debtor’s officials, persons who have committed, agreed to transactions, or committed property actions under invalid (fraudulent) transactions may be held subsidiarily liable for the losses caused to the debtor by such property actions.

Subsidiary liability for causing bankruptcy is a relatively new legal institution, which, since the beginning of 2018, has been actively applied in court practice when considering bankruptcy cases. Subsidiary liability for causing bankruptcy is an important and mandatory element of the liquidation procedure.

The amount of subsidiary liability is determined by the difference between the amount of creditors’ claims and the liquidation estate. The amounts collected are included in the liquidation estate and may only be used to satisfy creditors’ claims in the order of priority established by this Code.

A mandatory condition for bringing subsidiary liability is the presence of signs of driving the debtor into bankruptcy. It should be noted that the relevant conclusion (analysis) is made in the property disposal procedure, which once again confirms that the outcome of the bankruptcy procedure depends on the quality of work at all stages of bankruptcy.

If bankruptcy proceedings have been initiated against your debtor, you should not give up on the debt and assume that it is impossible to recover it. You need to take an active position, not rely on the discretion of the court and the arbitration manager, but act to appeal the inflated debt, return the property that was illegally removed from the debtor’s ownership, and bring those responsible for the bankruptcy to joint and several liability.