NEWSLETTER

ON ENTERPRISE RESTRUCTURING

#8 April 2001

Dear reader,

The number of Ukrainian enterprises that require operational or financial restructuring is continuously growing. Apart from general economic problems created by inefficient and loss-making enterprises, we should not forget millions of people employed at them. And well being of a hundred or several thousand peoples, be it shareholders or just employees, depends on the situation at a specific enterprise. Therefore, the most important issue for us is the issue of competent management of an enterprise during its restructuring, so that eventually the enterprise’s operations become stable and profitable, and all employees receive adequate pay for their work.

Competent and in-depth understanding of enterprise restructuring principles is the most important issues for Ukrainian economy. For many enterprises that are trying to restore their solvency, attract domestic or foreign investment and finally improve their competitiveness, the first step may be in applying the Law of Ukraine “On Restoration of Solvency of the Debtor or Declaring It Bankrupt”. And this task requires not only willingness but also reliable information and dissemination of successful experience of restructuring. Therefore our Bulletin continues to inform you on activities of Financial Restructuring Project.

Wishing to cover a broad audience of arbitration managers and solvency restoration practitioners we introduces new approaches in selection of information. From now on, we will provide an opportunity for renown experts, enterprise managers, arbitration managers, and practitioners, to speak on important issues of restructuring, as well as, share their own experience.This will give us an opportunity to obtain information straight from the sources. We invite your co-operation, and your articles, opinions and suggestions, will be most welcome.

In this issue’s “Interview” section we offer a story of Mr. Victor Petrenko, Chairman of the Supervisory Board of GalychSugar about the thorny path of this enterprise to signing of amicable settlement agreement with its creditors. In his interview, you will also find recommendations to the enterprises that found themselves in the situation of insolvency regarding use of the Law.

Arbitration manager, Igor Pichugin, tells about bankruptcy of agricultural enterprises on the example of the case of Military Breeding Station “Chutove”, and Mikhailo Sineokiy, arbitration manager from Dnipropetrovsk, continues on this subject using the experience he acquired when working on the bankruptcy case of Shevchenko Farms’ Association.

In “News of Legislation” we offer for your attention the new wording of Article 36 of the Law of Ukraine “On Restoration of Solvency of the Debtor or Declaring It Bankrupt”.

 Sincerely, 

Olga Makara

PR and Media Coordinator

Viktor Petrenko: “ …it makes no sense to wait passively for “lethal” outcome…”

On March this year, the salvation procedure of one big sugar sector enterprise from Ivano-Frankivsk oblast was completed through signing of the amicable settlement agreement. We have a story from Mr. Victor Petrenko, Chairman of the Board of Galichsugar, candidate of technical sciences, associated professor of the Ivano-Frankivsk State Technical University of Oil and Gas, Department of Enterprise Economics.

2. What is your assessment of the situation at your enterprise in 1999(on the moment bankruptcy proceedings were initiated against GalichSugar)?

   According to the results of 1998 season, GalichSugar once again sustained losses in the amount of UAH 5.3 millions, after which, on the initiative of production and commercial firm Kvarta, of one of the majority shareholders the shareholders meeting reelected the Supervisory Board and decided to analyze the possibilities for taking the enterprise out of its permanent crisis.

   Based on provisional analysis the Supervisory Board decided to create a anti-crisis management group and develop a crisis management program to be implemented during the 1999 season. This program was developed and we even sent out letter to the main creditors requesting them to participate in coordinating the anti-crisis and debt restructuring strategy. The total debt at that time was over UAH 25 millions.

   However, in October 1999 one of the creditors initiated bankruptcy proceedings, which forced the Supervisory Board to search for alternatives using the recently passed Law “On Bankruptcy”.

3. Was it typical for the sugar sector enterprises, or it may have been caused by some specific subjective reasons?

   It’s rather that conditions that contributed to evolving the crisis situation in the beat sugar sector are typical, which is proven by the systemic character of the crisis. Only in 2000 alone bankruptcy proceedings were initiated against 36 sugar mills in all beat growing oblasts of Ukraine. If in 1999 out of total 192 sugar mills 21 stood idle, in the season of 2000 this figure was 48, and half of them were loss making, which gave reasons to predict the growth in the number of bankruptcy proceedings against sugar mills.

   However, every sugar mill had its own subjective factors, and in the first place I would mention incompetent management at micro level, i.e. at the sugar mills themselves, as well as the fact that economic, marketing, legal departments of these mills were not yet ready to operate in market conditions.

4. Do you believe it was possible to repay debts under the “old” Bankruptcy Law?

   In my opinion, the enterprise had no chances to avoid bankruptcy under the “old” Law. Liquidation was the only possible scenario when the debt was several times the liquidation value of the enterprise. In this case the state would lose 30% of its shares, “Kvarta” – 38.7%, and small shareholders (over 5 thousand individuals) would lose the rest. I am not going to speculate about other alternatives, but I would like to emphasize that given the current macroeconomic situation and systemic crisis in the sector the mil, like many similar enterprises, could stop its operations without any hope for their resumption. The analysts argue that out of total 192 sugar mills only 990-100 can survive the transitory period and be operable in the future. Therefore it was unthinkable to stop the mill at that time.

5. How did you find out about USAID Financial Restructuring Project? (What made you to go for cooperation with FRP?)

   My colleagues from FRP Ivano-Frankivsk Training Center that opened at the end of 1999 told me about this USAID Financial Restructuring Project. On the invitation of my colleagues I participated in the familiarization seminar, after which I had a conversation with Mr. Richard Wolfe, one of the FRP managers, and was able to convince him to cooperate with our enterprise and our crisis management group, who at that time completed preparatory work and developed the program for taking the enterprise out of crisis. After the visit of FRP experts to the enterprise and provisional screening of our proposals we signed an agreement on cooperation.

6. Did you have any doubts as to success of this cooperation?

   When threatened with bankruptcy with further liquidation and without any other alternatives, any positive steps to avoid it [bankruptcy] may be called a success. One has to start making these steps, because a passive onlooker’s position is not going to bring any success, and active resistance to crisis gives you a certain chance. And we used it.

7. What did you expect from this cooperation and did you expectations come true?

   We were hoping to get methodological and organizational assistance in financial and economic diagnostics of the enterprise, and most importantly – support in the solvency restoration ideology that we opted for. We received this assistance and we are very much thankful for it to US and Ukrainian Project experts.

   I would like to say a few words on Corporate Restructuring Model developed by the Projects specialists. Utilization of this Model during diagnostic stage provided an opportunity to estimate the real condition of the enterprise with it’s problems and perspectives, to find out what is the price of those problems and what are the ways out.

8. How was finical and economic side of your business changing during the proceedings?

I would like to quote several figures. If in 1996 season the losses were over UAH 3 millions, in 1997 -–over UAH 4 millions, in 1998 – over 5.3 millions, then in 1999 season when we made the first steps in implementation of anti-crisis program, and that was when the bankruptcy proceedings were initiated, we managed to bring the losses down to UAH 2.4. And at the same time we were paying our payables and salary arrears from previous seasons.

Conversion of our case to the new Law allowed us to use some of its advantages, namely:

• convert to bankruptcy proceedings led by the debtor’s manager;
• introduce moratorium on the debts to historic creditors;
• receive a bank credit;
• get ready to the new processing season.

As a result, the 2000 season, although the beat crop in that year was the lowest for the last 50 years, was quite good for the enterprise. The sugar mill paid the creditor bank, earned profit, made all current payments to all budgets and non-budget funds (over UAH 2.1 millions), which helped us to convince the creditors that the enterprise has the potential to fulfill the amicable settlement agreement which took us several months to substantiate.

Of course, the Law is not perfect. In the professional literature you can find different opinions on its efficiency, strong and weak points, or obvious deficiencies. However, the fact that it can help in restoring solvency of a potentially viable enterprise is its greatest advantage, and this was proven on the example of our enterprise. We only have to comply with the terms and conditions of the amicable settlement agreement so that the creditors may not have any reasons for resuming bankruptcy proceedings.

I believe that use of the main procedures of this Law requires a radically more active approach of the government agencies and arbitration courts.

The main instruments that we used to the full extent were:

amicable settlement agreement as a no-alternative solution to avoid liquidation scenarios in bankruptcy proceedings;

creation of “ majority” in the creditors committee that allows to make the necessary and acceptable to all decisions.

10.  What were your own ideas and “know-how” for solvency restoration?

Among the novelties that we used in bankruptcy proceedings were:

use of the well known “business reengineering” concept of M. Hammer and J. Chumpey (1993), which lies in fundamental review and radical re-designing of the business and its most important processes;

development and implementation of special “creditors motivation strategy”;

11.  Our readers would like to learn about the problems you faced and how you resolved them. Can you please share your positive experience?

The main problems for us were, as a rule, not the creditors but the state agencies – the STA, the Pension Fund, the State Property Fund, who, in spite of respective provisions of the Law often tried to avoid talking any active actions that they were required to take by the Law. It’s quite amazing that we received full support of the top officials of these agencies, and it were the lay staff of these agencies that resisted us (most remarkably, even lawyers) who saw in our proposals to restructure and forgive debts almost the criminal intents to cheat the state. It turned out that for a state agency clerk it is easier and no headache if the state in the process of bankruptcy loses its equity share that is several times the size of the debt that needs to be restructured or forgiven! Even after the court ruled to terminate the proceedings and approve the amicable settlement agreement, one of the district STA keeps the enterprise’s bank account frozen and requires full payment made referring to the “absence of the mechanism” for debt restructuring and forgiveness. I must say that we did not acquire any positive experience in this case.

This amicable settlement agreement (approved by ruling of 23.03.2001 in case Noá-6/457) is the result of assiduous work of Economic Development Corporation (Chairman of the Board A. Popadyuk), “Kvarta” (Director O.Shevchenko), GalichSugar, advisors and members of the Supervisory Board not only according to the text of the agreement, but also by the ideology of its drafting and implementation in the process of negotiations with the creditors, their committee, arbitration court etc.

I am not in a position to assess this agreement because I am one of its drafters. I believe that it should be assessed by the State Property Fund, “Kvarta” and over 5 thousand of small shareholders, whose property (who held respectively 30%, 38.7% and 31.3% of shares on the moment of initiation of proceedings) was not only kept intact , but we also managed to demonstrate that it has a huge future potential.

To be more active in use of such procedures as a debtor-led bankruptcy and different solvency restoring options because it makes no sense to wait passively for “lethal” outcome.

The enterprise does have some prospects. It is clear that whether these prospects are realistic depends on thorough and competent actions of the management, mastering by them modern managerial technologies, development of cooperation with raw material suppliers and many more factors.

We published some generalized opinion as to the reasons for such crisis in the sector, possibilities and ways for restoring its potential with the use of positive experience that we acquired in the process of avoiding bankruptcy of GalichSugar, as well as the typical problems faced by the sugar sector enterprises in magazine “Ukrainian Sugar” , issue 3(20) , 2000 . p7-9.

New Law on restoration of solvency as a means of revival of agricultural production in Ukraine

Igor Pichugin, arbitration manager, license of Ministry of Economy of Ukraine No 130 of October 24, 2000, appointed to serve as arbitration manager in five cases.

There is no doubt that agricultural production in Ukraine is experiencing a deep crisis and majority of agricultural producers are effectively bankrupt. Ukrainian Government provides various relieves and privileges for them, regularly writes-off their old debts and takes other measures to restore solvency of chronically ill agricultural producers.

The Law of Ukraine “On Restoration of Solvency of the debtor or Declaring It Bankrupt”, and its final provisions in particular, established moratorium on bankruptcy proceedings against agricultural producers till February 20, 2001 (respective changes to the Law were made in the Law of Ukraine “On stimulation of development of agriculture for the period of 2001-2004”), which did not make the creditors extremely happy. However, the proceedings against agricultural producers that were initiated before this Law became effective are not affected by moratorium. How to help agricultural producers against whom proceedings were initiated under the “old” Bankruptcy Law, how to make that these enterprises are not worse-off than those that “got lucky” and against whom proceedings were not initiated, how to reach a compromise between the creditors and the debtor – answers to all these questions can be found in the Law of Ukraine “On restoration of Solvency of the Debtor or declaring It Bankrupt”.

 The bankruptcy proceedings against Military Breeding Station “Chutove” were initiated in 1998. The proceedings were once adjourned to give a possibility to the debtor to pay its creditors. Until the end of 2000 the debtor did not provide any documents confirming repayment of debt. On October 10, 2000 guided by Article 86 of Administrative Procedural Code of Ukraine, paragraph 5 clause 1 section VII of the Law of Ukraine “On Restoration of Solvency of the debtor or declaring It Bankrupt”, Poltava Oblast Arbitration Court ruled to commence liquidation of the debtor and appointed me to serve as arbitration manager (liquidator).

Military Breeding Station “Chutove” is involved in cattle breeding and plants cultivation. Number of employees – 129. In 2000 output was UAH 1 070.00 thousand, sales – UAH 1 300.00. In 2000 the enterprise received some profit mostly due to increase of provided transportation services. Its receivables decreased by UAH 333.00 thousand (at the beginning of the year - UAH 1 935.00 thousand, and at the end of the year – UAH 1 602.00 thousand). The accounts payable (claims allowed under the creditors’ claims register) were UAH 652 thousand, including: Priority 2 – UAH 399 thousand, Priority 3 – UAH 29 thousand, Priority 4 – UAH 223 thousand.

Being aware of the social factor (very few enterprises in Chutove district) as well as very slim chances for the creditors to get back their money in the event of liquidation, they, together with the arbitration manager, decided to sign amicable settlement agreement. The debtor and the creditors signed bilateral schedules of payments.

The new Law allows signing amicable settlement agreement at any stage of bankruptcy proceedings. Therefore, in this case, signing of amicable settlement agreement at the stage of liquidation takes in to account in the best possible manner the interests of the debtor, its employees and creditors, and gives them not only the hope for cooperat5ion with the debtor but also the hope to get paid before 2004, which, undoubtedly, is very important and useful for the country as a whole.

Not all laws are futile

Mihail Sineokiy - Arbitration manager (private entrepreneur). In May 2000 completed the FRP training course and received certificate. Starting from 2000 acted as arbitration manager in 17 cases that involved property administration, liquidation and liquidation under Article 52.

It’s been over a year since the Law of Ukraine “On restoration of Solvency of the Debtor or Declaring It Bankrupt” came into effect. Over this time the practice of application of the Law has shown that the Law can work and bring practical benefits both to the debtors and their creditors, and one of its positive features is the choice of different versions of the procedures to reach the objectives of the interested parties. Here is one of such practical examples.

In 1999 Zaporizhzhya Oblast Arbitration Court initiated bankruptcy proceedings against Shevchenko Farms’ Association. Since the debtor was not able to pay its creditors, the court ruled to declare the debtor bankrupt and commence liquidation. This was the beginning of the very familiar for our reality “collisions” in the life of the enterprise.

Irrespective of the fact tat liquidation of the debtor was commenced under the Law of Ukraine “On Bankruptcy”, Shevchenko Agricultural Co-operative was registered as successor of the debtor. Then, without completion of liquidation of either the debtor, or the newly created Agricultural Cooperative, there was registered Lukashevo LLC as the successor of Shevchenko Agricultural Co-operative. Lukashevo LLC repays a part of the debt of Shevchenko Farms’ Association (the debtor) and joins the bankruptcy proceedings as a creditor and becomes appointed the head of liquidation commission.

All this brought in a lot of confusion in the proceedings, about 100 employees of “underliquidated” enterprises did not know who their employer was, complaints starting to come in from all participants of the process and liquidation came to a standstill. Late summer – early autumn 2000 Lukashevo LLC gathered in the crops, however, it was not clear who is got to get ready for the spring season. The procedure has to be finished by the end of winter.

In November 2000 the interested parties reached an agreement with an investor, Promtekhresurs LLC, who was ready to buy out a part of property of Shevchenko Farms’ Association, and by doing so provide funds for payments to the creditors, and then the agricultural enterprise as a founder and use the bought out property as its contribution in the authorized capital. However, since it was not clear who was the owner of the property, the investor was not sure that there will be no disputes regarding legitimacy of this purchase. In addition, the investor did not want to spend its money on payments to the Pension Fund, and the Pension Fund could not forgive this debt under the “old” Bankruptcy Law.

In spite of the fact that the new Law introduced moratorium on bankruptcy proceedings against agricultural enterprises, it did not terminate the proceedings initiated under the old Law with conversion of proceedings to provisions of the new Law.

Based on this the parties decided to convert the proceedings to the new Law. The following options were considered:

1. Sanation of the debtor with sale of a part of property.
2. Amicable settlement agreement.
3. Liquidation.

Liquidation option was rejected on social and psychological reasons, because many were scared of the word “liquidation” itself. Sanation was no good since it quite a lengthy procedure. Therefore, to speed up the process it was decided to initiate bankruptcy proceedings under the Law of Ukraine ” On restoration of Solvency of the Debtor or Declaring It Bankrupt” with a view to signing an amicable settlement agreement, which enabled the representative of the Pension Fund agreed to write-off the debt to the Pension Fund, and it was a large part of the total claims. At the same time the court ruled to recognize Lukashevo LLC as the successor of the debtor, which made it possible to liquidate both Shevchenko Agricultural Co-operative Shevchenko Farms’ Association having resolved by doing so the issues of ownership on the debtor’s property. To provide additional guarantees to the parties to the amicable settlement agreement the contract on sale of part of the property to the investor was made as an addendum to the amicable settlement agreement and became effective on the moment the amicable settlement agreement was approved by the court. The buy-out of property by the investor allowed to pay the creditors.

Therefore the case that was dragging on for one and a half years was completed in one and a half months. All parties were satisfied and not single employee laid off. Since the case was closed and the issues of successor resolved, the STA that was late to join the proceedings and therefore was not included in the list of creditors, also was able to write-off the debt of the enterprise to the budget under the new Law on writing-off the debts to the budget. At the moment Lukashevo LLC has started the spring season.

LEGISLATION NEWS

Changes to amicable settlement agreement provisions

On April 1, 2001 the amended Article 36.2 of the Law of Ukraine “On Restoration of Solvency of the debtor or Declaring It Bankrupt” came into effect. If previously the tax debt that arose during two full calendar years that preceded filing was to be written-off, now this time is extended to three years, and the time for payment of debt in instalments is not regulated by law at all (previously the time during which the debt that arouse over the last two years could be paid in installments was limited by 6 years).

Below is the complete text of amended Article 36 of the Law of Ukraine “On Restoration of Solvency of the debtor or Declaring It Bankrupt”.

Article 36. Requirements for concluding an amicable settlement agreement

1. An amicable settlement agreement may only be concluded regarding secured claims, claims of the second and lower priority levels provided for in Article 31 of this Law.
2. If terms and conditions of amicable settlement agreement concluded under Article 35 of this Law provide for deferral or payment of debts in installments, or their forgiveness (writing-off) in full or in part, a collection authority shall agree to satisfaction of a art of tax and duty (mandatory payment) obligations in accordance with conditions of such amicable settlement agreement for the purpose of restoring solvency of the enterprise. The tax debt that arose before three full calendar years before filing a petition to initiate bankruptcy proceedings with a court of arbitration, is deemed a bad debt and shall be written-off, and the tax obligations or tax debt that arose during the last three calendar years that preceded filing of bankruptcy petition with a court of arbitration shall be paid in installments (deferred) or written-off on conditions of amicable settlement agreement. The amicable settlement agreement is signed by the head of the tax authority at the domicile of the debtor.

Creditors who did not participate in the voted or voted against amicable settlement agreement shall enjoy the same treatment as the consenting creditors of the same level of priority.

LEGISLATION NEWS

Changes to amicable settlement agreement provisions

On April 1, 2001 the amended Article 36.2 of the Law of Ukraine “On Restoration of Solvency of the debtor or Declaring It Bankrupt” came into effect. If previously the tax debt that arose during two full calendar years that preceded filing was to be written-off, now this time is extended to three years, and the time for payment of debt in instalments is not regulated by law at all (previously the time during which the debt that arouse over the last two years could be paid in installments was limited by 6 years).

Below is the complete text of amended Article 36 of the Law of Ukraine “On Restoration of Solvency of the debtor or Declaring It Bankrupt”.

Article 36. Requirements for concluding an amicable settlement agreement

1. An amicable settlement agreement may only be concluded regarding secured claims, claims of the second and lower priority levels provided for in Article 31 of this Law.
2. If terms and conditions of amicable settlement agreement concluded under Article 35 of this Law provide for deferral or payment of debts in installments, or their forgiveness (writing-off) in full or in part, a collection authority shall agree to satisfaction of a art of tax and duty (mandatory payment) obligations in accordance with conditions of such amicable settlement agreement for the purpose of restoring solvency of the enterprise. The tax debt that arose before three full calendar years before filing a petition to initiate bankruptcy proceedings with a court of arbitration, is deemed a bad debt and shall be written-off, and the tax obligations or tax debt that arose during the last three calendar years that preceded filing of bankruptcy petition with a court of arbitration shall be paid in installments (deferred) or written-off on conditions of amicable settlement agreement. The amicable settlement agreement is signed by the head of the tax authority at the domicile of the debtor.

Creditors who did not participate in the voted or voted against amicable settlement agreement shall enjoy the same treatment as the consenting creditors of the same level of priority.