Concern for the future
"One of the key prerequisites for a successful financial restructuring is an independent evaluation of the value of the debtor's business and its prospects", — Andrey Pronchenko, Managing Partner at PwC Legal Attorneys Association, assures
— To what extent are legal services related to financial restructuring in demand?
— The demand for such services is not so large-scale, but a fundamental change in the situation is expected in the near future. On October 19, 2016 the Law of Ukraine "On the Financial Restructuring" came into legal force. The Law regulates the terms of the procedure for voluntary financial restructuring of a debtor.
Prior to the coming into force of the mentioned Law debtors and creditors had rather limited tools for restructuring at their disposal. Often it comes down to the signing of an additional agreement to the loan agreement in which the terms of debt repayment (both the principal part of the loan and interest on it) were revised or the interest rate was reduced.
If agreement with the borrower was not reached, then according to the Law of Ukraine "On Restoring Debtor Solvency or Declaring a Debtor Bankrupt" the debtor could resort to the procedure of pre-judicial recovery. In this case the negotiations were held with the creditor committee and on the parties reaching agreement a recovery plan was approved by a court.
— What are the distinguishing features of financial restructuring according to the new law?
– This is mostly a negotiating procedure without the involvement of a court. If the debtor and the financial institution agree on the application of this mechanism, the debtor at his own option and discretion (with certain restrictions) can engage other creditors – non-financial institutions, including the tax authorities. The debtor can also perform the restructuring with respect to such creditors. But if there are unrecovered creditors, then the debtor continues to perform its obligations towards them.
The Law provides for restructuring of both the debt and certain debtor's assets and business as a whole. For the time when the financial restructuring plan is negotiated the moratorium remains in effect between the debtor and creditors.
According to our estimates the proposed tools are rather interesting both in terms of financial institutions and from the perspective of the debtor. Extrajudicial restructuring proceeding and the absence of money limits for the initiation of the restructuring of not only the loan agreement, but also the entire business are among its apparent advantages.
— Does this law solve those situations arising under proceedings for bankruptcy, when the parties cannot reach an agreement?
— Such a solution is provided for. However, practice will show the extent to which it will be successfully implemented. An important condition for successful restructuring is the interest of both parties. Since the procedure is voluntary and is initiated by the debtor, not by creditors, there should be fewer difficulties. It should be emphasized that one of the key prerequisites for the commencement of the restructuring procedure and reaching agreement is an independent evaluation of the value of the debtor's business and its prospects. Such evaluation should be not only legal or economic, but a comprehensive one.
— Is the issue of restructuring of debt owed to the tax authorities regulated by the law?
— Yes. The tax authorities refer precisely those creditors that may be involved in the restructuring, and depending on the size of the tax debt their role can be both active and passive (in the latter case their opinion can be not that important). At the same time, the way the tax debt restructuring regulation will relate to the provisions of the Law "On the Financial Restructuring" and how the tax authorities will act in these situations remains an open question.
— What about the taxation of restructured liabilities? How, for example, will the writing down of part of a debt be shown in the financial statements of the debtor and creditor?
— Indeed, an important component of the successful implementation of the legislation on the financial restructuring in other countries, where a similar mechanism was implemented, always was favorable tax rules. At the same time, tax concessions are provided for both parties of the restructuring process – the debtor and the creditor. Ukraine was no exception.
Thus, according to this law, the debtor is exempted from the taxation of income arising from the relief or cancellation (forgiveness) of the part of debt under the restructuring of its debt to creditors.
The main advantages for the creditor within the restructuring period are related to the preferential rules of tax accounting of reserves for the coverage of potential losses. In particular, in case of writing off or forgiveness of a debt the bank will be able to use the previously formed reserve and not include the amount of forgiven or written-off debt in its taxable income. In this case the bank does not need to prove the compliance of such debt to unrecoverable debt criteria specified in Article 14.1.11 of the Tax Code, which is required by the general rules. In view of this the opportunity to restructure the existing liabilities will, in our opinion, allow banks to get rid of "bad" debts on the balance sheet without incurring negative tax consequences.
— Which of the debt restructuring mechanisms applied abroad would it be efficient to introduce in Ukraine?
— One of the examples of such legal institutions, which are widely used, particularly in the UK, is the introduction of the institution of independent managers. Notably, these are not court-appointed managers (e.g., insolvency officials), but specialists (individuals or consulting firms specializing in providing such services), who are selected directly by debtors and creditors or by only the creditors.
The provisions of the Law of Ukraine "On the Financial Restructuring" do not directly provide for the possibility of using such tool in our country. Though, in our opinion, this concept could be of interest to the majority of creditors, first and foremost to the banks. Certainly, such requirement on the change of management may be the subject of agreement under the restructuring process; however, it is not easy to implement it in the current legal framework. Undoubtedly, one can issue a power of attorney to the manager; however, it seems more appropriate to record this decision in all registries.
Even now it is clear that changes to corporate legislation are necessary for successful implementation of the law.
— To what extent are the provisions of the law on the financial restructuring applicable to the international obligations of Ukrainian borrowers?
— The law expressly stipulates that the parties to a financial restructuring may be foreign legal entities, which are financial institutions. Therefore, the law can also be applied to international obligations. But, furthermore, the agreements of Ukrainian borrowers with foreign creditors are usually subject to foreign law. Consequently, a wider range of restructuring options is available to them.