New Law on Financial Restructuring: what to expect

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1 1 New Law on Financial Restructuring: what to expect Briefing note September 2016 New Law on Financial Restructuring: what to expect On 14 June 2016, the Verkhovna Rada (the Parliament ) passed a new Law on Financial Restructuring (the Law ) with the aim of creating a workable procedure for voluntary restructuring of debt obligations. Currently, the debt restructuring process is not formally regulated by Ukrainian legislation and is usually carried out by interested parties on a purely contractual basis. The Law has been developed by the government in cooperation with the European Bank for Reconstruction and Development and the World Bank. Its adoption has been well received by the National Bank of Ukraine (the NBU ) and other market players. Although it is yet to be seen how useful the new regime will be in practice, many stakeholders have already expressed their hopes that the Law would help to clean the banking system of non-performing loans and restart lending in the country. The Law regulates the process of initiating a financial restructuring and spells out the procedure for negotiating and approving a restructuring plan. It also introduces a number of concepts which were previously not part of Ukrainian law, such as a statutory moratorium outside insolvency and standstill agreements, to allow debtors temporary relief in the course of restructuring negotiations. Interestingly, the Law envisages financial liability for debtors and creditors for breaching the Law and non-compliance with an approved restructuring plan. In order to make restructurings under the Law more attractive, the Law also provides for certain tax and provisioning benefits for those parties which opt for a restructuring in accordance with the Law. Still, our initial view is that the Law may be rather difficult to implement. Despite introducing a number of positive novelties, it lacks clarity in many respects and adds unnecessary formalistic procedures which may complicate the process of a consensual debt restructuring. Further, as opposed to its initial draft, the Law has not improved the existing mechanism for court-approved consensual restructurings (a regime similar to the scheme of arrangement available in the UK) which, from our perspective, would be very useful. We set out below an overview of the Law, together with our high-level thoughts on the impact that the Law may have on those debt restructurings which are currently ongoing, or will take place while the Law remains effective. Key issues Reach of the Law Statutory framework agreement New supervisory bodies in consensual restructuring When restructuring is possible Consequences of framework restructuring Applicability of the Law Reach of the Law The Law introduces procedures for restructuring both the business activity and assets of a debtor, regardless of whether such assets are located inside or outside of Ukraine. The new restructuring procedures can also apply to monetary obligations of a debtor, including obligations which arise under an agreement governed by foreign law. A financial restructuring can be initiated in accordance with the Law if at least one creditor of a debtor, who has consented to the restructuring, is a financial institution. The Law permits to restructure in a single restructuring process the obligations of a number of related debtors who share a common financial institution creditor. Creditors which are not financial institutions may participate in a financial restructuring initiated under the Law only if at least one financial institution which is not a related party of the debtor participates in the restructuring. Unfortunately, the Law does not specify whether or not interested parties can opt out of the restructuring procedures prescribed by the Law, and implement a pure contractual restructuring.

2 2 New Law on Financial Restructuring: what to expect Debtors The Law defines a debtor, who may initiate a voluntary restructuring under the Law, very broadly. As a result, any business entity that has debt obligations before at least one unrelated financial institution may potentially be considered as a debtor for the purposes of the Law. However, our understanding is that it should apply only to Ukrainian legal entities and, as such, should not have any impact on debt restructurings relating to foreign borrowers. This view is also supported by the introductory comments made by the Ministry of Finance to the draft law when submitting it for consideration by the Parliament. Creditors For purposes of the Law, a participating creditor means any legal entity or individual that has a monetary claim against a debtor and has consented to a proposed financial restructuring, as well as certain authorities such as the fiscal authorities, customs authorities, treasury authorities and execution authorities. As discussed further herein, the Law assigns a special role to participating creditors which are financial institutions. Financial institutions include financial institutions created under Ukrainian law, international financial institutions, and foreign financial institutions which have extended crossborder loans to Ukrainian borrowers, provided that such loans have been registered with the NBU. The Law is silent as to whether or not a foreign financial institution that has acquired debt securities issued by a Ukrainian debtor is deemed to be a financial institution pursuant to the Law. Institutional framework Framework agreement Financial institutions participating in a financial restructuring are allowed to regulate relationships between themselves by way of entering into a framework agreement. The NBU is to develop a draft framework agreement, arrange for its review by interested parties, and publish the final framework agreement on its official web-site. The framework agreement is prescribed to be an adhesion agreement, meaning that financial institutions will be committing to it by sending to the NBU notices of adhesion to the framework agreement published on the NBU s website. The Law also allows those creditors which are not a party to the framework agreement to enter into a separate intercreditor agreement. New supervisory bodies The Law envisages that the following new bodies will be involved in supervising and administering restructurings: Supervisory Council; Secretariat; and Arbitration Committee. Supervisory Council. The Supervisory Council will be coordinating financial restructurings. It will comprise nine members, including representatives of the NBU, the Ministry of Finance, the Ministry of Economic Development and Trade, and the Ministry of Justice, as well as representatives of business and professional associations which are to be nominated by the banking and financial services committee of the Parliament. The Supervisory Council will be responsible for, amongst other things, generalising the Secretariat s reports on the process and results of financial restructurings; and approving recommendations and requirements to various documents to be filed with the Secretariat, as well as to a report on the financial and business activity of a debtor. It remains unclear what the practical value of such generalisation will be, and whether such requirements will be mandatory in the case of any financial restructuring. Secretariat. The Secretariat is to be created by the Supervisory Council. It will be responsible for information and administrative support for financial restructurings which are conducted under the Law. The responsibilities of the Secretariat will include resolving administrative and procedural issues arising in connection with financial restructurings and sharing information on the restructuring process. As with the Supervisory Council, we do not see any particular value in having this new authority involved in a consensual restructuring of private debts. In our view, involvement of the Secretariat adds unnecessary formalities to the process of restructuring, and may result in additional administrative burden and time delays. We note, though, that the Law specifically excludes the Secretariat from negotiations of restructuring terms between debtors and participating creditors. Arbitration Сommittee. Finally, pursuant to the Law, any dispute which arises in the course of negotiating restructuring terms can be submitted for resolution by the Arbitration Committee. The Arbitration Committee is created by the Supervisory Council. A dispute is heard by an arbitrator appointed by the Arbitration Committee from the list of arbitrators approved by the Supervisory Council.

3 3 New Law on Financial Restructuring: what to expect In order for a participating creditor to be able to submit a dispute for consideration by the Arbitration Committee, an arbitration agreement must be set out either: in an arbitration clause in a framework agreement between participating creditors; as a written consent of the debtor in a restructuring application; or in an arbitration clause in the creditor s consent to the restructuring. Given that the Law has not become effective yet and that the arbitration rules of the Arbitration Committee are yet to be approved, it is difficult to conclude how effective the proposed arbitration mechanism will be. However, chances are that it may be an efficient and expeditious way of resolving disputes arising in connection with financial restructurings. Creditors committees The Law permits participating creditors which are financial institutions to create a coordination committee for the purposes of exchanging information, participating in negotiations on behalf of other financial institutions, and resolving other issues relating to the restructuring. For the same purposes, participating creditors which are not financial institutions may create a separate creditors committee. Restructuring process Restructuring application A debtor which is not subject to insolvency proceedings or pre-insolvency rehabilitation can initiate a financial restructuring by filing a restructuring application with the Secretariat. Such application must: contain a written consent to arbitration by the Arbitration Committee; refer to the consent of participating creditors to the restructuring; and attach evidence that the debtor is not subject to insolvency proceedings or pre-insolvency rehabilitation. The Law requires that a restructuring consent be signed by at least one financial institution or a number of financial institutions which have at least 50 % of the total amount of claims of financial institutions against the debtor, excluding any claims of financial institutions which are related parties of the debtor. Commencement of financial restructuring The Secretariat must resolve on the commencement of a financial restructuring not later than on the next business day following receipt of a restructuring application from a debtor, provided that the supporting documents submitted by the debtor comply with the applicable requirements of the Law. The first meeting of participating creditors must be scheduled by the Secretariat on a date falling not earlier than seven business days and not later than 10 business days from the date on which the relevant financial restructuring commences. Under the general rule, the debtor shall attach a list of participating creditors to its original restructuring application submitted to the Secretariat. The debtor can later extend such list, provided that it submits the relevant notice to the Secretariat not later than two business days before the first meeting of participating creditors. It is not entirely clear what stands behind the Parliament s decision to entitle the Secretariat to resolve on commencement of a consensual restructuring. Potentially, given the Ukrainian legal tradition, this has been done in order to add more weight to the restructuring process in general, particularly taking into account that now commencement of a financial restructuring may serve as a ground for rejection of an insolvency application and application of a moratorium on satisfaction of creditors claims. In addition, if a creditor participates in a restructuring which is carried out in accordance with the Law, such creditor may be entitled to certain tax and/or provisioning benefits that otherwise might not be available. Consequences of financial restructuring Among the positive novelties introduced by the Law the most noteworthy are: staying of insolvency proceedings; and application of a statutory moratorium, following the commencement of a financial restructuring. These instruments are usually necessary to allow some breathing space to a debtor in the course of a financial restructuring and ensure the equality of participating creditors in negotiations of restructuring terms. The Law also introduced the new concept of a standstill agreement, which previously was not known to Ukrainian law. Staying of insolvency proceedings. The Law allows a participating creditor or a debtor to request a court to suspend consideration of an insolvency application submitted to the court in relation to the debtor, provided that, at the time of such request, the court has not yet decided on the commencement of insolvency proceedings against the debtor. The court suspends considering the relevant application until the financial restructuring is complete. The court may restart the suspended insolvency proceedings if

4 4 New Law on Financial Restructuring: what to expect the restructuring parties fail to agree on and approve a restructuring plan. Our reading of the Law suggests that, although a debtor or a participating creditor can apply for a stay of any insolvency proceedings, regardless of whether they have been initiated by a participating or non-participating creditor, the court will not be permitted to reject the insolvency application of a nonparticipating creditor even if a restructuring plan has been approved in respect of the debtor. However, it will be permitted to suspend the consideration of such insolvency application until a restructuring plan is approved. Moratorium. Upon commencement of a financial restructuring, a statutory moratorium starts to apply. While the moratorium remains in place, it is prohibited: for the debtor to fulfil its obligations towards participating creditors, other than in the ordinary course of business, unless otherwise agreed to by the participating creditors; to enforce security by participating creditors; for the debtor to grant any security unless it is required for the purposes of attracting new financing in the course of the financial restructuring; to acquire the debtor s property or control over the debtor s property; to offset mutual claims; and to dispose of, or enforce against, capital assets of the debtor, which are not subject to pledge (mortgage). The moratorium does not apply to non-participating creditors which are unrelated to the debtor, other than in the situation where a non-participating creditor intends to acquire or enforce against capital assets of the debtor, unless such non-participating creditor holds a security interest in those assets. The moratorium should not last for more than 90 days, and can be extended by participating creditors which are not related parties of the debtor one time only for up to another 90 days. For so long as the moratorium remains applicable, default interest stops to accrue and any statutory or contractual limitation periods are suspended. While the moratorium is in place, the debtor and its shareholders are prohibited, without the prior consent of participating creditors which are not related parties of the debtor, to dispose of property (other than in the ordinary course of the debtor s business) or decide on a corporate reorganisation of the debtor. We note that the moratorium does not prohibit creditors (including participating creditors) to continue or initiate court proceedings to obtain a monetary or enforcement judgment against the debtor. Standstill agreement. If the moratorium is terminated by a decision of participating creditors, the debtor and the participating creditors may enter into a standstill agreement to stipulate a prohibition for the participating creditors to commence enforcement actions against the debtor. Such standstill agreement may provide for, amongst others: restrictions on disposal by the debtor of funds credited to its accounts; restrictions on attracting of financing, disposal of property, or fulfilment of contractual obligations; an obligation of the debtor to open a bank account with a bank acceptable to the creditors; and restrictions on assignment by the participating creditors of their claims against the debtor. A standstill agreement cannot extend beyond the date on which the relevant restructuring plan takes effect. Restructuring plan. A financial restructuring is completed with the approval by the participating creditors of a restructuring plan. A restructuring plan must be negotiated and approved within a maximum of 180 days from the commencement of the financial restructuring procedure. If no restructuring plan is agreed within this period of time, the financial restructuring terminates. Voting process. The vast majority of resolutions of participating creditors are adopted by a qualified majority of 75% of all votes. The number of votes of a participating creditor is determined as a percentage share, determined as the principal amount of its claims against the debtor as a percentage of the total amount of all claims which participate in the financial restructuring. In order to be binding upon the debtor, its related parties and sureties as well as the participating creditors, the restructuring plan must be approved by all participating creditors. It is worth noting that related-party creditors do not vote for a restructuring plan, and their claims are not taken into account for the purposes of calculating the total number of creditors votes. If more than two thirds of the participating creditors have voted for a restructuring plan, it can be submitted for the final approval by an arbitrator of the Arbitration Committee. If the arbitrator approves the restructuring plan, it will be deemed to have been approved by all participating creditors. Cramdown. As a general rule, if an arbitrator approves a restructuring plan, it becomes binding on all participating creditors, including those non-consenting creditors that did not vote for the restructuring plan. However, the following terms of a restructuring plan approved by an arbitrator will

5 5 New Law on Financial Restructuring: what to expect not be binding on a non-consenting creditor unless the latter agrees otherwise: terms requiring the non-consenting creditor to extend additional financing to the debtor; terms prescribing to write off a portion of secured claims of such non-consenting creditor; terms providing for full suspension of accrual of interest on a debt owed to such creditor; and terms envisaging application of proceeds from a sale of collateral pledged to such non-consenting creditor in repayment of claims of other creditors. We note, though, that the Law does not extend the prohibition on writing off unsecured claims. It is also silent as to whether restructuring terms providing for an extension of final maturity are mandatory for such non-consenting creditors. Therefore, in our view, there are grounds to argue that the Law allows cramming the relevant terms down on non-consenting participating lenders. The Law does not envisage a possibility to cramdown any restructuring terms on non-participating lenders. Termination of financial restructuring A financial restructuring which has been initiated under the Law can be terminated by: the debtor revoking its restructuring application within 30 days of its submission to the Secretariat; participating creditors which have more than 50% of the claims of all creditors which are not related parties of the debtor serving a notice on the Secretariat that restructuring negotiations have been terminated without reaching an agreement; or the lapse of the 180-day period available under the Law for the completion of a financial restructuring. Clawback The Law provides that agreements or proprietary action of a debtor executed or exercised in furtherance of a financial restructuring cannot be set aside on the basis of the clawback provisions set out in the Ukrainian insolvency laws, provided that a court determines that the parties acted in good faith and did not intend to breach a lawful interest of other creditors. Liability The Law provides for certain financial sanctions which can be imposed on debtors, participating creditors and/or their related parties for a breach of any terms of the moratorium, a standstill agreement, or any other obligation in the course of a financial restructuring. The amounts of the sanctions may be very significant. For instance, passing a resolution on reorganisation of a debtor in the course of its financial restructuring may result in a fine of UAH14,500,000 (approximately US$580,000) for a debtor and/or its shareholders. Similarly, for setting off mutual claims in breach of the moratorium, a participating creditor may become subject to a fine in an amount equal to 125% of the amount of the claim so offset. The Law will become effective on 19 October 2016, and will remain effective until and including 19 October Contact details If you would like to know more about the subject covered in this publication, or our services, please contact: Olexiy Soshenko To us, please use firstname.lastname@redcliffepartners.com