Restructuring in Ukraine – ‘terra incognita’
February 2015 | EXPERT BRIEFING | BANKRUPTCY & RESTRUCTURING
The complicated financial and economic situation in Ukraine has been dramatically exacerbated by the aggression of the Russian Federation in the eastern regions and annexation of Crimea. Accordingly, some big Ukrainian borrowers will face significant problems with fulfillment of their loan obligations in 2015. These issues may include defaults under Eurobonds, as well as bilateral and syndicated loans. Therefore, in 2015 we will inevitably face large-scale, in local terms, corporate debt restructuring processes. Taking into account the current market situation, as well as the trends observed, it would be prudent for lenders to start talking to their borrowers in Ukraine in order to define the level of the default risk and consider ways to avoid it.
Unlike in developed economies, legislation and business in Ukraine are not advanced enough to ensure the smooth flow of restructuring processes. As a result, many legal and financial instruments that are customary for such matters in developed countries are simply not available in Ukraine. The scarcity of legal regulation and lack of experience of complicated cross-border restructuring projects will affect the process of restructurings. Therefore, companies should consider, at a very early stage, setting appropriate objectives and so should determine the ways and deadlines for meeting them. Practice shows that this is one of the most important factors related to successful restructuring, as it allows understanding the real picture and avoiding misconceptions regarding the terms and prospects of restructuring.
In many respects the Ukrainian business community is still very young; many business owners within the country are first generation ones. This has both advantages and disadvantages.
The likelihood that many Ukrainian business owners will likely treat their businesses as their brainchild and are therefore likely to take all necessary steps to save their firm, no matter how difficult the situation is, is likely to be a major advantage. However, many owners are extremely reluctant to entrust their companies to independent management and will attempt to control every facet of the business themselves. This may trigger conflicts, if creditors are willing to remove the current management from the debtor’s control and appoint their management or simply appoint a restructuring manager.
Generally speaking, in Ukraine, as in other countries, there are two main causes of defaults and the resulting need for debt restructuring. The first cause is the result of objective circumstances in the country in general or in separate industry sectors, which adversely affect the borrower’s business and prevent it from meeting its debt obligations. The second cause relates to abuses on the part of the owner of the business or the borrower’s management, which eventually lead to the borrower’s failure to meet its obligations. A combination of the two causes is also a distinct possibility. For example, abuses on the part of management, which would not affect the stability of the business under favourable market conditions, are detrimental to the borrower in times of crisis.
In the first instance, borrowers tend to keep in contact with the creditors and try to do their utmost to save the business. In such cases, the parties’ ability to find a compromise and negotiate is crucial for the outcome.
Cases related to illegal actions of owners or managers are the most complex ones in terms of negotiation and compromise. Furthermore, the problem is aggravated by the fact that owners are often unwilling to preserve their business or control over it, as they understand that they will no longer be able to enrich themselves at the expense of the business, subject to the creditors’ total control. This situation is extremely difficult for creditors, since even obtaining legal control over the borrower and appointing new management does not guarantee successful restructuring, as maintaining a large borrower’s business is extremely difficult. This is due to the wide scope of business, complex schemes of commercial relations with partners and affiliated companies, claims existing against the debtor on the part of companies controlled by the borrower’s owners, etc. Therefore, cooperation from the owners and old management is a must for a successful restructuring, at least at the initial stage after new management is appointed.
We should also make a special mention of the lack of a large-scale restructuring culture in Ukraine. The few successful restructurings completed within the last five years were not instrumental in forming a code of creditors’ conduct in restructurings with numerous creditors within Ukraine. The problem is evident in processes involving Ukrainian and foreign banks. While restructuring is nothing unfamiliar to foreign banks and their subsidiaries in Ukraine, it often appears to be new and not quite understandable for some Ukrainian banks. This is also due to the fact that large-scale restructurings are normally conducted under English law, with the use of contractual tools that are not provided for by Ukrainian laws, while all documentation and negotiations are in English, which is not every bank employee’s strong point.
Banks may also experience difficulties in agreeing on a single approach to the restructuring process and the conditions it should be carried out under. One of the main reasons for this is the absence of best practices and common standards of restructuring in Ukraine.
Unfortunately, existing Ukrainian legislation complicates rather than simplifies the restructuring process. The most serious limitations, which significantly narrow the range of possible restructuring tools, are set out in the currency legislation and are mainly established by the National Bank of Ukraine (NBU). The limitations include limiting the maximum amounts of payments on loans from non-residents, requiring the registration of loan agreements and most amendments thereto with the NBU, a lack of court protection for standstill arrangements and inter-creditor agreements, limited possibilities for using security agents in Ukraine, the exclusive list of grounds for payment abroad which precludes certain payments in the process of restructuring, and the lack of a contractual debt subordination concept.
These and some other limitations complicate the structure of the contractual basis used for debt restructurings of Ukrainian borrowers and require bringing obligations on certain payments up to the foreign level.
Special attention should be paid to securing borrowers’ obligations to creditors. As practice shows, a borrower and its affiliated companies have no liquid assets free from encumbrances when default is declared or restructuring is applied for. Apart from that, most companies of the borrower’s group act as sureties for obligations of other companies of the group, so that their total obligations are greater than the value of their property and cash flows. In this regard, an important question is whether secured creditors are willing to share their security in favour of other (unsecured) creditors, and if so, on what terms. It should be separately mentioned that, subject to good business conditions, owners of large companies usually manage to avoid providing personal guarantees for obligations of companies owned by them. However, at the stage of restructuring, particularly if the aggregate debt amount exceeds the value of any underlying collateral and pledgeable property, such a security instrument is highly desirable and should be insisted on. Moreover, both the legal owner of the business and the members of his or her family, who may be owners of valuable assets and corporate rights in other businesses, should be considered for this purpose.
To date, the role of legal counsel is not merely to formalise the agreements reached by the parties to a restructuring, but also to actively participate in negotiations among the creditors, as well as between the creditors and the debtor. Lawyers often act as intermediaries between the creditors’ coordination committee and other creditors, by urging the latter to coordinate the efforts of all creditors in the restructuring process. In this regard, it is important for legal counsel to have sufficient authority and credibility in the eyes of creditors and have no conflict of interest with creditors on other projects, which is quite a sensitive issue for Ukrainian banks.
Oleksander Plotnikov is counsel at Arzinger. Mr Plotnikov can be contacted on +38 044 390 55 33 or by email: email@example.com.
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