Following changes to legislation last year, Valentyn Gvozdiy makes recommendations to creditors
The major part of banking litigation relates to the disputes between financial institutions and borrowers, over unpaid debt and provided collaterals. To avoid spending years in litigation that eventually may lead to a negative result for the creditor, we recommend staying in line with the latest developments in this field and court practice. It should be noted that during 2019 numerous changes were introduced in Ukrainian legislation aimed at protection of creditors’ rights and interests from unfair debtors. Here are several recommendations for financial institutions before initiating any dispute with borrowers.
Disputes over the collateral. Unfair debtors usually try to invalidate security agreements and prevent a creditor from possible foreclosure. The methods they use for this purpose have become more sophisticated in recent years. The popular one is to declare a contract invalid because of the wrong choice of security instrument. For example, the moveable property may be pledged as real estate, or vice versa, which eventually will lead to the invalidity of legal transactions.
In GOLAW’s practice, one case saw a borrower try to invalidate a pledge contract of glass furnaces, which are the real property assets because they were mortgaged as moveable property. To avoid such situations, we recommend conducting technical and legal audits of the future collateral. The signing of the credit facility agreement must be preceded by a thorough examination of the collateral with a view to determine its real value and legal features. It is vital to have an in-depth legal analysis as well. For example, we encountered a pledge agreement where supervision works were identified as collateral, which appears to be the result of poor legal audits.
Choosing the correct method of foreclosure is a crucial point as well. An inappropriate foreclosure method may result in wasted time and resources for years of court litigations. Some banks have lost their cases because they tried to acquire the ownership title on the collateral via a court decision whereas such a foreclosure method may be realised only in an out-of-court procedure (Supreme Court decision of 21 March 2018 in case no. 760/1443829/15; Supreme Court decision of 18 October 2018 in case no. 910/17423/17; and others).
Indeed, Ukrainian legislation offers few methods of foreclosure – two out-of-court and two in-court procedures. Each of them may raise longstanding court proceedings, but the difference is considerable – any disputes after the bank made out-of-court foreclosure are the mortgagor’s attempt to challenge the creditor’s action. Such disputes may also last for years with zero results for the plaintiff. During these years of litigation, the bank may already sell the foreclosed assets and receive its money back.
However, out-of-court foreclosure methods also have their pros and cons. Ukrainian legislation provides for the following out-of-court mortgage foreclosure methods: 1) selling the property by the bank to a third party; or 2) acquiring the ownership of the mortgage by the bank and then selling it. If the bank decides to sell the mortgaged property directly to the third party, the bank does not become the owner of the collateral. Consequently, an obligation to account this property in the bank’s book of records does not arise. Along with that, acquiring the ownership title on the collateral by the bank is usually the fastest method of foreclosure.
Before launching an out-of-court foreclosure, the creditor is obliged to provide the debtor with the written request for debt repayment and then wait for 30 days, unless otherwise agreed. Usually, debtors avoid receiving such creditors’ notices, which in turn allows the debtor to subsequently challenge the foreclosure in court. In similar cases, to secure the bank’s rights, GOLAW uses the special state post service that ensures receipt of the notices by the debtor under any circumstances.
Challenging foreclosure because of improper collateral appraisal. Unsurprisingly, the mortgagor usually tries to find an opportunity to challenge out-of-court foreclosure in court. The improper appraisal of collateral is a popular ground for this. The price of the collateral will be determined by the independent certificated appraiser and must meet the requirements of current legislation. As Supreme Court case law shows, violation of the national standard of appraisal may be the ground for cancelling the registration of a mortgaged property in favour of a bank (Supreme Court decision of 19 June 2019 in case no. 917/2101/17). Such price shall not be lower than the market price for the same property, otherwise the creditor will be liable to the debtor for compensating the difference between the sale price of the mortgaged property and the market price for it. That is why it is important to ensure that the price is equal to or lower than the amount of debt.
Albeit, appraisal of collateral in court foreclosure is no longer an obligatory action and can be carried out even at the stage of enforcement proceedings (the Supreme Court decision of 21 March 2018 in case no. 235/3619/15).
Bankruptcy as a tool of unfair debtors. For a long time, bankruptcy was an effective way to avoid paying off debt and legislation was favourable for this. However, on 21 October 2019, the new Bankruptcy Code of Ukraine was enforced. The code provides a number of positive changes for creditors whose claims are secured by a mortgage (secured creditors). For example, secured creditors are now party to the bankruptcy case and can initiate the bankruptcy proceedings or challenge the artificial bankruptcy initiated by the debtor. Also, they have the right to challenge the contracts entered into by the debtor after the bankruptcy proceedings have been opened, as well as the contracts concluded during the three years preceding the opening of the bankruptcy proceedings. The reason for the challenge may be, inter alia, that such contracts led to the debtor’s insolvency.
However, the success of secured creditors all too often depends on the prompt reaction to the commencement of bankruptcy proceedings. Thus, secured creditors would not be able to foreclose the collateral within 170 days after the official opening of the bankruptcy procedure. That is why it is crucial to react promptly to any debtor’s notice regarding voluntary liquidation or bankruptcy. We usually recommend to creditors that they file objections to the opening of bankruptcy proceedings and block it as soon as possible. Since such bankruptcies in many cases do not have the proper basis, so it is likely to find solid ground for its challenging.
If the mortgagor and the debtor are different persons, it is worth paying attention to the recent changes in the legislation, according to which the liquidation of the debtor being a legal entity is not an obstacle to a mortgage foreclosure. At the same time, the law establishes an important condition – the creditor must send a notice to the mortgagor about his intention to foreclose the mortgaged property before the end of the debtor’s liquidation process.
There are lots of other examples of disputes with unfair debtors and the main recommendation for creditors is to be prepared in advance and to start from the very beginning – proper drafting of the credit documentation.