You're reading: Business Sense: Abuses rampant in bankruptcy law

The transparency of bankruptcy procedures is among the key recommendations from the International Monetary Fund aimed at improving Ukraine’s investment climate. Effective bankruptcy procedure is vital for improving the investment climate and bringing resources into the country, as investors wish to know that they have the possibility to quickly return assets that are no longer used efficiently back into the economic cycle.

The bankruptcy procedure in Ukraine is far from perfect. Adopted 10 years ago, current legislation in the field no longer corresponds to the economic and social reality and existing market needs. It is bulky, complicated, non-transparent and allows freedom of interpretations that can be used for abusive practices.

The law on bankruptcy has been heavily amended since its introduction, but its base was poor from the start. There is no use in solely fortifying the walls. A new foundation has to be built. The inefficiency of the current law on bankruptcy shows itself in many ways. Let us turn to some figures to illustrate the case.

For example, in Ukraine, only 9 percent of bankruptcy cases conclude with re-establishing of debtor’s solvency, compared to 60-85 percent in developed countries. Only 9 percent of creditors’ claims in Ukraine are satisfied, compared to 31 percent in Eastern Europe and Central Asia. At the same time, the bankruptcy procedure in Ukraine costs 42 percent of the total business value compared to an average 13 percent in most countries. Additionally, the imperfect legislation means that the bankruptcy procedure often drags on, so it can take years to complete.

Another big problem is that loopholes in the legislation are sometimes used for corporate raids, as well as avoiding tax obligations and payments to creditors. All these facts are clearly stated in the World Bank’s Doing Business 2010 report, where Ukraine is rated 145th of 183 countries in the “closing business” section. This is also the opinion of many businesses in Ukraine, which perceive the bankruptcy procedure as a scheme for shadow privatization dealings. There are cases where debt at a state-owned company has been created artificially in a conspiracy between the company management and a creditor, allowing the creditor then to obtain all the assets of the company as a payment of the debt.

Last year provided further evidence that the bankruptcy procedure is outdated and is no longer perceived effective by market players. While economic recession forced many companies and entrepreneurs to close their businesses, the official number of bankruptcy cases, according to the state department on bankruptcy, actually decreased by 30 percent.

Giving it a little thought, this decrease clearly shows that the bankruptcy procedure is discredited among both debtors and creditors, and they try to resolve their conflicts without entering the procedure, such as through an amicable settlement.

The institution of bankruptcy commissioners further complicates the situation. These are people that influence the interpretation of the law on bankruptcy and “determine” its implementation in each individual case. Due to imperfect state regulation policy of this profession, formal qualification requirements, and absence of responsibility for their actions, the profession is now flooded with incompetent workers that get a license for one-off participation in a specific bankruptcy case and are often friendly towards one of the parties.
All this negatively affects the transparency of the bankruptcy procedure in particular, and the business climate in Ukraine in general.

Given that the bankruptcy procedure is long, expensive, exhausting and ineffective, Ukraine needs urgent, essential changes to legislation. Aimed at developing long-term national economic programs and understanding the key role of bankruptcy in forming an effective economy, the Foundation for Effective Governance, a non-governmental organization funded by Rinat Akhmetov, Ukraine’s richest man, has initiated a working group to develop a new law on bankruptcy in cooperation with parliamentary deputies from the Committee on Economic Policy. This group includes legal experts, judges, bankruptcy commissioners, public officials, non-governmental organizations and international organizations, such as the World Bank.

It has taken the expert group about a year to examine the situation, analyze existing problems and consider the world’s best practices in bankruptcy legislation, and also take them into account when drafting a new law. The result of their work is a completely new document with the potential to significantly improve the bankruptcy procedure, that is – make it shorter and more transparent, minimize the opportunities for abusive practices, remove inconsistency in the legislation, and establish self-regulating organizations for bankruptcy commissioners that will increase their professional responsibility. This will assist in bringing the procedure in compliance with the world’s best practices and standards, thus making another big step towards a better investment climate in Ukraine.

Each country has its own path of development, and the draft law will help find consolidated opinion that will meet the expectations of all market players. The draft law is a systematization of experience to date. It is designed as a launch pad for wide public discussions that will result in a document incorporating the realities of today’s market for the benefit of all parties.

The Foundation for Effective Governance now waits for comments from local and international experts, and once they are incorporated in the draft, the document will be presented to the public. One thing we can be sure of – there’s no more time to spare, thus we encourage all related parties – businesses, public authorities, and experts – to join this conversation and actions that will help improve Ukraine’s investment climate.

Andriy Lobatch is a senior project manager at the Foundation for Effective Governance, a non-governmental organization aimed at developing economic reforms. He can be contacted at [email protected]