OPINION: Mechanisms that regulate bankruptcy of individuals

The Draft Code of Ukraine on Bankruptcy Procedures regulates innovative procedures of debt relief to individuals. In particular, the procedure itself is designed as a privilege for the debtor to go through certain legal procedures and not only restore solvency, but also to preserve the reputation of a conscientious borrower.

Sergiy Donkov, senior associate, tells about the new mechanisms regulating bankruptcy of individuals exclusively for  “Yurydychna praktyka”.

OPINION: Mechanisms that regulate bankruptcy of individuals

In Ukraine, within the expert community, there is a rather ambiguous approach to the development of the institution of bankruptcy of individuals. Nevertheless, the parliament has been offered to form out this institution at the legislative level over the past several years. In particular, this refers to the following legislative drafts “On Restructuring the Debts of an individual or Declaring It Bankrupt” (registration No. 2353a), “On Amending Certain Legislative Acts of Ukraine Regarding the Settlement of the Bankruptcy Proceeding of an Individual with the Purpose to Ensure the Economic and Social Stability of the Society” (registration number 2714), etc. Another legislative draft aimed at a full-fledged introduction of the institution of restoration of the solvency of an individual was submitted by a group of people’s deputies to Parliament for its consideration at the end February this year. The point at issue is a draft of the Code of Ukraine On Bankruptcy Proceedings (registration No. 8060) (Code).

In the previous issue of the “Yurydychna praktyka”, we talked already about the first book of the Code, in which the actual Law of Ukraine On Restoring the Solvency of a Debtor or Declaring It Bankrupt” was set out in a new edition.

The second book of the draft “Restoring the Solvency of an Individual” provides completely new mechanisms, regulating the bankruptcy of individuals.

“The legal mechanisms for resolving the debt problems of insolvent citizens proposed in the second volume of the draft of the Code on Bankruptcy Proceedings are not only timely, but also necessary for the economy of Ukraine. The institution of the bankruptcy of individuals appeared much earlier than the institution of corporate bankruptcy. The basic principles of the legal system of relations between creditors and debtors, who are not able to pay off their debts, were developed as early as in ancient Roman law. At all times, the humanity was very strict about debtors who could not fulfil their obligations. Insolvency was regarded as a violation of public policy and equated with a crime. They used tortures to the debtors or the debtors were handed over to slavery, or received a mark on dishonour”, says Serhii Donkov, a senior lawyer of the Law Firm EVRIS.

He also notes that domestic legislators have implemented in the legal system of Ukraine the most humane and progressive legal mechanisms for resolving insolvency problems used in world practice. In particular, the recommendations of the World Bank were taken into account when working out the legislative draft. The draft of the Code provides for the possibility of pre-trial settlement of the relations between creditors and debtors, and it offers two main judicial procedures: debt restructuring and satisfaction of creditors’ claims by selling the property of debtors.

“The procedure for the bankruptcy of individuals has been designed as a privilege for a debtor to undergo certain legal procedures and not only restore the solvency, but also maintain the reputation of a bona fide borrower”, says the lawyer.

It should be noted that the legislative draft offered a number of mechanisms aimed at preventing abuses by individuals. Vladyslav Filatov, a partner of Sokolovsky and Partners Law Firm, the head of the anti-crisis asset management and bankruptcy practice section, explains that criteria for the honesty and fidelity of a debtor have been developed and they are verified and established by the court at the stage of initiation of the bankruptcy case, in the process of its consideration and taking a decision on debtor’s release from payment of debts.

“In case of revealing facts and dishonest actions of a debtor in relation to creditors, a debtor does not receive a positive effect from applying bankruptcy proceedings to him, and is not released from paying debts”, stresses Mr Filatov.

Particularly, para. 4 of Article 131 of the draft provides for cases, when the court refuses to initiate the proceedings in the case on bankruptcy of an individual person following the results of its preliminary hearing. A bankruptcy case cannot be initiated if a debtor has any outstanding conviction for economic crimes, including those related to bankruptcy, or was held liable for administrative offenses in the economic sphere during the previous three years. Another factor that affects the refusal to initiate a case is declaring an individual as bankrupt during the previous five years.

In addition, as Vladyslav Filatov noted, one excludes the possibility to release individuals from their debts after the completion of judicial procedures in the bankruptcy case, if one fails to provide the information necessary for the investigation of the bankruptcy case or provides false information to a bankruptcy commissioner; carries out actions aimed at concealing and/or destroying the property; bilks or maliciously fails to pay debts; creates artificially the debts; gives priority to one creditor or creditors at the expense of other creditors. Such actions of a debtor can be verified for a previous three-year period prior to filing an application to initiate proceedings on a bankruptcy case.

The legislative draft provides for a separate article, regulating the restrictions imposed on persons who were previously declared bankrupt. So, it is determined that within five years after recognition of an individual as bankrupt, bankruptcy proceedings cannot be opened upon his application. This rule does not apply only, when a debtor initiates a simplified procedure for restructuring the debts of a debtor.

If any bankruptcy proceedings re-commence at the request of a creditor within the five-year period after a debtor was declared bankrupt, the rules governing the release from debts shall not be applied to such an individual. Nevertheless, this provision also contains exceptions: this rule shall not apply to individuals who repaid all debts in full.

“Within five years after a debtor was declared bankrupt, an individual cannot assume obligations under loan agreements and credit contracts, nor can he enter into any contract of suretyship, transfer property as a pledge without specifying this fact”, the article regulates another restriction.

The same period of five years is established concerning the obligation of individuals to mention this fact at their registration as an individual entrepreneur.

Another significant restriction concerns the prohibition to engage in independent professional activities as lawyers, private notaries, bankruptcy commissioners, private bailiffs for five years from the time an individual is declared bankrupt.

Returning to the restructuring of debts, we shall note that the draft also establishes a number of restrictions. Debts on payment of insurance premiums for compulsory state pension and social security insurance are not subject to restructuring. The tax debt, which arose three years prior to the making of a decision to open proceedings on a bankruptcy case of a debtor, is considered to be an uncollectible debt in the procedure for restructuring the debts of a debtor and is written off. And the last third restriction stipulated by the legislative draft concerns indebtedness under credits obtained by a debtor for rest, entertainment, acquisition of luxury goods, as well as debts, arising as a result of gambling, betting, etc.

“After conscientious fulfilment of the restructuring terms or once a five-year rehabilitation period passed after being declared bankrupt, a citizen can be released from debts and fully restored in his rights”, sums up Serhii Donkov.

Another important aspect, which the authors of the legislative draft draws attention to, is the obligatory participation of a bankruptcy commissioner in cases of bankruptcy of individuals. This is discussed in Article 123 of the Code, which stipulates that a bankruptcy commissioner for the execution of the powers of a restructuring manager shall be appointed by the economic court from among the bankruptcy commissioners entered into the Unified Register for Bankruptcy Commissioners, whose office location is in the territory within the jurisdiction of the relevant economic court.

At the same time, according to Dmytro Tilipskyi,  senior lawyer at EQUITY Law Firm, it is the opinion of the authors of the legislative draft that this measure should be a certain guarantee in protecting the debtor’s rights. “However, in practice, the courts usually determine the obligatory participation of a bankruptcy commissioner in a bankruptcy case and do not hold hearings in his absence”, he notes.

In general, as experts say, these innovations are very timely. According to Mr. Tilipskyi, the introduction of the institution of bankruptcy of individuals is certainly a step forward and, if the draft is passed, will be the first attempt to settle these complex legal relationships. At the same time, the draft still needs to be seriously improved both from the point of legal writing and systematization rules, and from the point of the scope of the document, including regarding the extension of the Code to the existing bankruptcy proceedings.

As Vladyslav Filatov notes, the introduction of a system of legal regulation of insolvency of debtors – individuals – is the liquidation of a huge gap in the legislation of Ukraine. “There is an urgent need for a civilized, fair, understandable, formally expressed and executable approach to resolving the debt problem of an individual. This situation requires the resolution of the contradictions between him and the creditors. In developed countries, special legislation operates in such cases and procedures are implemented by a professional under the supervision of the court. Thus, the introduction of such legal mechanisms in Ukraine is not something extraordinary or unknown, but is dictated by economic, financial, time and other factors”, he summarizes.

These legal relations require urgent legal regulation, and the draft provides a debtor with an opportunity to legally restructure debts or liquidate them, which debtors and creditors, having such mechanisms, will certainly take advantage of, Mr. Filatov believes.

It should be noted that the draft of the Code of Ukraine on Bankruptcy Proceedings has been adopted in the first reading on March 20 this year. Most practicing lawyers, experts and bankruptcy commissioners unanimously declare that the document, despite its revolutionary innovations, especially in the field of bankruptcy of individuals, shall be substantially refined. It is difficult to predict what it turns out to be, but it is assumed that within a few months it will be prepared for the second reading and adopted as a whole.


Svitlana Tarasova  

«Yurydychna praktyka» #13, 27.03.2018