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On Economic Aspects of Bad Debt Recovery

Date of publication: 25 March 2014


“Initiation of criminal proceedings is currently the only legal option enabling the bank to recover money from a beneficial owner rather than a borrower or guarantor” – says Roman Marchenko, Senior Partner, Ilyashev & Partners Law Firm.

— How do banks recover bad debt?
— First and foremost, a bank shall analyze effectiveness of the available pledge. In such case, as at any stage of lending, fraud is possible, also on the part of the bank employees. Sometimes “schemes” are invented after default. For example, we have recently completed the project for a major bank, when the subject of pledge was the property, the ownership right to which was declared in court. The borrower requested the court to set aside the relevant decision and, thus, the property was formally unpledged. People often commit fraud, because they find themselves in quite hopeless situation – high interest rates, penalties, fines… Banks understand it and, considering imperfect legislation and common case law, prefer to resolve disputable situations by mutual agreement. At some stage the bank has a chance to get some money rather than continue to accrue interest and penalties, and ultimately not to get anything if the company ceases activities, people lose job. If we talk about fraudsters, many of whom operate in the market, we need to act harshly and punish them also through criminal prosecution. However, when it comes to a bona fide debtor, who found himself in debt, say, because of the crisis, the bank will definitely have to compromise.

— When do the banks turn to debtor’s bankruptcy proceedings?
— Bankruptcy is an extreme measure, and banks try to avoid it. It also happens, because our bankruptcy laws leave much to be desired. Nevertheless bankruptcy proceedings are quite common. For example, now I am an asset manager at two major state-owned enterprises. It is Feodosia Shipbuilding Company “More” (the creditors were Oschadbank, Ukrspetsimpexbank, VAB-Bank and Piraeus Bank). We took major efforts for finding a way out of the crisis, and now the enterprise has no registered bank debts. The situation at the second enterprise – Sumykhimprom – is much more complex (the creditors are BM Bank, Industrialbank, Brokbiznesbank, Ukrsotsbank, VABank, Raiffeisen and other banks). We are talking about a billion in arrears and no prospects for its full repayment. At Sumykhimprom interest rates on debt were really extortionate, legal business cannot pay such interest. When the situation is aggravated by penalties, the company is forced to seek escape. Then the banks have to take unpopular measures. More specifically, the rehabilitation manager has the right to refuse contracts according to the law “On restoring debtor’s solvency or declaring a debtor bankrupt”. It does not infringe the bank’s right to have the debt repaid (including the interest accrued), but at a certain point the loan agreements cease to be effective. We took such measures at Sumykhimprom, and believe that for the enterprise it is one of the steps to overcome the crisis. It is important to find a balance between the creditors’ interests on the one hand and the prospects for the company and its staff, continued tax payments on the other hand.

— Bankruptcy procedure is often used to avoid responsibility both by debtors and property guarantors. What strategy shall the bank follow when counteracting fictitious bankruptcy?
— When revealing such facts, the bank shall start bankruptcy procedure and take everything under control, i.e. establish the creditors’ committee (either alone or together with other creditors), assign the asset manager and in the meantime initiate criminal proceedings. Thereto, the list of crimes is quite common: fraud, forgery, embezzlement, causing to become bankrupt, fictitious bankruptcy and other.
Initiation of criminal proceedings is currently the only legal option enabling the bank to obtain money not from the borrower or property guarantor, but from a beneficial owner or a shadow beneficiary. As part of the criminal case instituted at the bank’s initiative, the investigating agencies try to prove fraud aimed at non-repayment of loan. The fraudsters thinking, e.g. that termination of a legal entity means termination of credit obligations, become parties to the criminal proceedings, and the bank acting as a civil plaintiff can expect compensation for damages.

— How often do banks initiate bankruptcy procedures?
— If a bank concludes that its creditor is actually bankrupt and other measures proved ineffective, bankruptcy proceedings shall be initiated immediately. It will permit to get control of the company and “undo” the unprofitable transactions, such as asset withdrawal. It must be done as soon as possible, because the property may change owners several times, and the concept of good faith acquisition may begin to apply. Further, periods of limitation expire, documents are destroyed, assets decrease in value… Therefore, if the decision on bankruptcy is approved, all actions must be taken immediately, namely filing application to court, seizure of assets, change of management and concurrently engagement of the team searching for assets. For a good reason, criminal proceedings are initiated, etc. Do not give the debtor the possibility to “play” with assets and liabilities as even a bona fide debtor may start “fooling around” at some point.

— What practical steps to be taken to find the debtor’s assets, particularly if they are located in multiple jurisdictions?
— Such services are not common in Ukraine. In addition to the specialized firms, the relevant services of large banks deal with it. Then the problem is often twofold: to find the asset and to prove relation between the asset and the actual debtor. It works as follows worldwide. For example, a former owner of the Kazakh bank withdrew from the bank large amounts of money, which naturally disappeared. The money is searched by several teams of detectives and the results are quite good: assets were found in several countries, a lot of property was recovered in Ukraine and Russia. I would note that the relevant procedures are fairly well regulated in English law, namely external receivership is introduced in respect of the property. Moreover any property more or less reasonably considered to be the debtor’s assets is entered into the list of property subject to such receivership. In the case of BTA Bank the list includes more than a thousand (!) companies. If “somebody else’s” company is shortlisted, it is removed at request of its beneficial owner. It is also interesting that the court may issue a warrant to a civil search – it enables the bank lawyers to enter the bank’s premises and withdraw anything that might be considered as evidence. The external lawyer acting as a mediator is appointed. The search is carried out without the police, but if the person refuses to let the lawyers in, it entails responsibility up to two years in prison.

— Is there any similar procedure in Ukraine?
— Unfortunately, there is nothing like that in our country, except for the abovementioned criminal proceedings: investigator may seize the property and then it may be subject to enforced collection in favor of the injured party.

I believe that it is advisable to implement the appropriate mechanisms in Ukraine. Some leading Ukrainian law firms, including Ilyashev & Partners, proposed to the banks to create an action group for drafting the appropriate legislative amendments that would allow using international best practices and permit the banks to protect their rights effectively. The appropriate best practices have been developed, but they have no practical application. The bankers, the same as legislators, just do not know that the relevant practices exist. We are ready to share the relevant experience, but this work should certainly be paid – partners of law firms cannot afford to quit business for three months and write draft laws. The value of the matter is negligible as compared to the banks’ losses because of imperfect legislation. For the qualified lawyers, who are overworked, this issue is not a priority. It should be a priority for the banks, but they do not show the appropriate interest. Efficient amendment of legislation is one of the ways to stabilize the situation in the credit market.