The Alchemy of “Moratoria”

Let us start with some hard numbers in order to have more evidential basis for a discussion whether the Ukrainian state has struck a right balance between its role as a modern regulator on the one hand, and service provider / business actor on the other.

More than 17,000 State-owned enterprises (SOEs) and municipal enterprises exist in Ukraine, according to the official statistics. More than 3,000 of these are central government-run Ukrainian SOEs. Compare this to only 21 SOE in Denmark, 29 in the Netherlands, 47 in Finland, 48 in Lithuania, 51 in France, 71 in Germany, 126 in Poland, as attested by the Organisation of Economic Cooperation and Development (OECD), the developed market economies think-tank. Through its SOEs, the Ukrainian State is involved in all kinds of business, from alcohol production to hotels. Apart from this comparative disconnect, is there anything wrong with the very high number of SOEs in Ukraine?

To answer this question, let us have a look at another important number: almost UAH 800 billion are locked in unpaid court debt in Ukraine, much of it pending for a decade or even more, according to the official statistics by the Ministry of Justice (MOJ). This represents some 1/4 of the country’s annual GDP. Only about 2.7% of the aforementioned UAH 800 billion is collected annually. In other words, the real annual contribution of Ukrainian courts is merely 2.7% in terms of the actual outcome of the judicial way of solving disputes. By reverse logic, 97.3% of salaries, pensions and other claims by legitimate Ukrainian owners and creditors who win in court have constantly remained unpaid. Such a situation is clearly incompatible with either the principle of the rule of law or an effective justice system, as attested by the European Court of Human Rights in numerous judgments against Ukraine, including the notorious Ivanov and Burmich cases. One might wonder who is responsible for most of that unpaid annual 97.3% total? You guessed it right, the bulk of that responsibility lies with Ukrainian SOEs.

Another interesting number: 9 cents on 1 euro invested is the amount that creditors can expect to get back in Ukraine in case of bankruptcy (including restructuring) proceedings. Compare this with almost 90 cents on 1 euro recovered in the same circumstances in Germany, which is the top European jurisdiction in this component in the World Bank Doing Business rankings. By reverse logic, any person contemplating a financial or business relationship in Ukraine should foresee the risk of 91% of losing everything by entering into a contract. It is clear that the exorbitant cost of credit by way of the very steep interest rates in Ukraine is based largely on the assessment of that risk by the financial system. It is moreover a major factor preventing foreign direct investment (FDI).

This context clearly present challenges to the Ukrainian policy-makers, its financial and justice systems. A reasonable observer might expect policies to promote more foreseeable and transparent relationships among the business players and the society at large by building sustainable financial and justice systems in general, responsible and well-run SOEs and properly regulated bankruptcy system in particular? Instead, the evidence shows that the various Ukrainian Governments since almost 2 decades have been involved in juridico-financial engineering called “moratoria” – admittedly, innovative, but also questionable practice from the point of view of the general principles of the rule of law, or more specific anti-trust, competition or customer protection standards enshrined in EU law. Our Project experts have counted at least 12 separate moratoria statutes adopted since 2002, with 4 of them added recently in the context of Covid-19: the so-called energy and water companies debt relief law (draft law 3322), protection of foreign currency mortgage holders law (3640), and two successful bills disallowing bankruptcy proceedings against certain SOEs (2276 and 2390).

Some of the moratoria statutes protect certain business sectors, some protect against the collection of certain types of debt. What does a moratorium mean, exactly? First of all, the beneficiaries of almost all aforementioned moratoria (except one) are SOEs. For instance, in order to pay court-ordered debt, one cannot seize any SOE property - including its real property, equity, or technical equipment - except for what is left on this SOE’s current bank account. Can a reasonable observer expect that an SOE so protected would be encouraged to pay its debts? A company protected by moratoria is also not allowed to file for bankruptcy to enter restructuring (or the so-called “sanation”). The only exception is UkrOboronProm, which since 2019 has been restructuring 15 enterprises out of its consortium of more than 130 companies. Luckily for SOEs, they are also exempted from appearing on a nation-wide Debtor Register, calling into question the very purpose of its existence – namely to warn prospective partners, suppliers, customers, creditors and employees from dealing with an irresponsible business. If more transparency is good for private business, why not for SOEs?

Any money which is owed by somebody, is also owed to someone. Time is money. And a party who “wins” in court, cannot “lose” by way of political opinion to discard the court decision. Judging from the policy-making and jurisprudential practice in Ukraine, it is unclear that this basic essence for the fabric of the rule of law and the market economy is fully understood. How can one “protect” an SOE or another debtor with a privilege such as a moratorium, without at the same time punishing the other party at the receiving end, who remains unpaid by the very operation of the same moratorium? While SOEs are primary and essential beneficiaries of moratoria, the reverse beneficiaries are mostly small and medium businesses (SMEs), and private Ukrainian citizens. Moreover, are moratoria offering any other sensible regulatory tool apart from prolonging - and eventually - losing time to dispose of the debtor assets to settle its obligations?

Admittedly, not only moratoria create obstacles for the implementation of financial and court-ordered obligations in Ukraine. For instance, ambiguities exist as to what extent corporate bank accounts can be seized to collect court-ordered debt, despite a judgment by the Grand Chamber of Supreme Court from 19 May 2020. It is still unclear in the Ukrainian law and practice whether a debt obligation imposed by court is a priority or preferential debt with regard to any other external (arrears to business partners) or internal (salaries to employees) corporate obligations, unlike in many advanced jurisdictions. While in theory these restrictions from seizing bank accounts have at times been positioned as intended to protect salaries of employers of SOEs and other corporate debtors, it is clear that in practice they have been frequently used as a way to allow a debtor to set free and play the system. Many more obstacles for an effective enforcement and responsible financial behaviour in Ukraine can be mentioned, but are probably not worth considering in view of the focus of this article on the statutory moratoria and their impact. It is just enough to say that the Ukrainian courts are sometimes hindering themselves from getting higher trust of the public by frequently preventing implementation of their own decisions.

The regulatory situation has not improved with the start of the Covid-19 crisis and the emergency policy measures undertaken by Parliament since then, introducing new moratoria without establishing any clear sunset provisions. The expected impact of these policy measures will very likely be a significant increase in the duration of bankruptcy proceedings, and a decrease in effectiveness mostly because of the lost time and opportunity to settle earlier. As the reality shows, asset prices to pay for debt will in most cases be lower, not higher, come the end of the moratorium. Most importantly, these measures constitute a departure from the key principle enshrined since the entry into force of the new Ukrainian Bankruptcy Code in 2019 – namely the need to repay debt to creditors as a way of building secure and sustainable financial and justice systems. Limiting the creditor’s right to initiate a bankruptcy case in respect of the debtor is unjustified, as a matter of principle, even though the practice in advanced European jurisdictions allowed exceptional situations owing to the Covid-19 crisis. in Germany, for instance, creditor filings were not allowed until 30 June 2020, but the sunset clause has now become operational, and the relevant provisions are now extinct.

The best European practices show that, in the context of the Covid-19 pandemic, the debtor may expect some sort of temporary relief or even monetary assistance from the State, such as:

• direct employer payment schemes run by the Government, ranging from 50% to 90% of the wages and the tax package for a particular workplace, lasting for months after the end of the lockdown (Austria, Czech Republic, Germany, Lithuania, Netherlands);
• postponing the payment of taxes and social contributions (Belgium, France, Portugal, Germany);
• postponing deadlines for repayment for bank loans (Germany), with no fines or interest (Lithuania);
• postponing payment of rent to private landlords for Covid-19 affected businesses until 30 June 2020 (Germany), and State-provided compensation for subsidising rent (Lithuania);
• significant temporary or permanent reduction of VAT for some most affected businesses, such as restaurants and hotels (Czech Republic, Germany);
• allowing the banks to finance the debtor in distress caused by the quarantine with further putting those claims in the priority list with regard to other administrative expenses in bankruptcy proceedings.

However, none of these measures extend to forgiving the debtor’s underlying obligations under the contract or a court decision. Moreover, the aforementioned exceptional State-aid measures in European jurisdictions were coupled with additional requirements for more transparency about the debtor’s financial problems.

All in all, the new regulatory changes by the Ukrainian policy-makers show a certain conceptual misunderstanding of the role of the State during the times of crisis, in contrast with the prevailing European practices in reaction to Covid-19. Instead of subsidising business from its own State resources by way of monetary and fiscal policy decisions, company employee salary payment schemes and so on, the Ukrainian State is rather shifting its burden of helping the society to the private sector, effectively asking the creditors to pay for the consequences of Covid-19. The overriding moral hazard of this approach is obvious. Rather than showing the political willingness and the solidarity with private business - especially SMEs - the State is doing exactly the opposite, and paradoxically is effectively discriminating in favour of those who have done the worst in conducting business before the crisis, most notably the hundreds of SOEs protected by the moratoria.

An important principle of a well-regulated bankruptcy system is the need to restore, as soon as possible, the conditions necessary for the continuation of the debtor business. As the best European practices show, in a difficult economic situation, the efforts of all participants in bankruptcy proceedings should be directed not towards the suspension of obligations or the relevant procedures, but towards resolution – by application of effective tools already provided for by the new Ukrainian Bankruptcy Code, such as financial recovery and restructuring. Such procedures are primarily aimed at the analysis, optimisation, and preservation of the debtor’s business, and effective management of his assets. These best domestic practices are already being demonstrated by the aforementioned UkrOboronProm case, whereby the company is carefully studying and inventorising its assets, getting rid of unnecessary or excessive items, and concentrating on its core business.

A well-managed bankruptcy system also requires to clarify and make transparent the scope and extent of the debtor’s liability. The statutory moratoria achieve exactly the opposite, given that their main beneficiaries - such major SOEs as UkrZyaluiznitsya, Ukrspirt, or Khleb Ukrainy – do not even appear to be accounting and showing their court-ordered debt as an on or off-balance sheet obligation. Moreover, as mentioned above, SOEs are not forced to appear on the Register of Debtors, unlike all private debtors.

Not imposing the obligation on the debtor to pay its court-ordered debt, or to go to court to seek bankruptcy protection where it cannot pay, creates a dangerous illusion of the debtor’s solvency, which is detrimental to all the other players in the business and financial activity chain, including the debtor company’s partners, suppliers, customers, creditors and employees. The statutory moratoria have thus proven themselves as one more way of enabling a dishonest debtor to continue to perpetuate this illusion of solvency, instead of acknowledging that the debtor has limited resources, forcing it to cut down on its expenses, getting limited access to credit, and starting living by its means. Does anybody benefit from this illusion at the very end?

Besides, valid questions can be asked if any of the statutory moratoria are compliant with the EU law anti-trust and competition principles. Putting moratoria-protected SOEs into a favorable business position with regard to their purely privately-owned competitors could be considered as granting the SOEs an economic advantage which “would not have been obtained under normal market conditions”, following the established wording of European Court of Justice (ECJ). Such practices are not only generally prohibited in EU - if established, they could hardly be considered in line with the requirements of the Ukrainian State Aid Law of 2014. The State aid restrictions are also laid down in the EU-Ukraine Association Agreement (Article 262). Any exemptions from enforcement or bankruptcy should be justified as to the purpose, limited in time and narrowly construed, in order to comply with the “proportionality” standards inherent in the ECHR and ECJ jurisprudence.

The recently-approved EU Macro-Financial Assistance programme includes some indicators, requesting Ukraine to get its act together with regard to the financial discipline of its SOEs – most notably, requiring opening the market of collection of small claims against SOEs to independent Private Enforcement Officers. This is a very welcome first step towards greater accountability of SOEs.

Despite these early green shots, the current regulatory environment in Ukraine necessitates a wider discussion on the questions which have not yet been systemically tackled since the country’s independence - namely, what should be the acceptable limits in protecting State-run business in in general, and whether a moratorium is a piece of modern regulatory engineering or rather legislative “alchemy” in particular?

Finally, even a more important question prompts to be asked - to what extent the Ukrainian private sector and individuals can tolerate the obvious appearances of discrimination by the State in not only playing an excessive role in business life by reason of the exorbitant number of SOEs, but also by making SOEs a privileged business player without the requisite level of respect for an equal and fair playing field for everybody? It is to be hoped that the Covid-19 crisis and its consequences finally show the harsh reality of the economic and legal unsustainability of the statutory moratoria against enforcement and bankruptcy, setting stage for a reasonable and gradual roadmap towards lifting all of them. We have no doubt that our Project experts, other European and international partners, the Ukrainian business community and the society as a whole would be interested in helping in such an endeavour, without which it will be impossible to imagine either the genuine rule of law or a true market economy in Ukraine.

Arne Engels, Advocate, Bankruptcy Trustee (Germany) Katilin Popov, Private Enforcement Officer (Bulgaria) Dovydas Vitkauskas, Team Leader, EU-funded project Pravo-Justice (Lithuania)