Экономические науки/3.Финансовые отношения

Mamalinova N.G., scientific adviser Aitbek S.K.

Karaganda Economic University of Kazpotrebsoyuz, Kazakhstan

BANKRUPTCY PROCEEDINGS IN KAZAKHSTAN

A market economy operates according to certain rules and provides opportunities for companies to become prosperous. A market economy does not have a place for companies that lag behind. Formal adherence to market criterion of resolving crisis situations in an organization which is usually the elimination of all insolvent institutions will inevitably lead to mass unemployment, lowering living standards and increasing income differentiation. All this leads to an increase of social tension and presents insurmountable obstacles to economic growth.

An alternate solution to crises is the institute of bankruptcy. It restores the viability of the organization by helping the company overcoming financial difficulties. Furthermore, the institute of bankruptcy eliminates non-viable elements of the market.

A comparative analysis of national models of organizations insolvency in the world economy indicates that the bankruptcy institute in France and in the United States focuses on protecting the interests of the debtor. The priority is given to an organization that operates and functions as a company; therefore, its cessation through elimination is the last measure to undertake. However, a strict rule used by the French is to support the organization's activities in any case. While reducing the share of assets that creditors expect from the liquidation process of the insolvent debtor weaken the entire economic system as a whole. In addition, using the model allows the debtors to abuse their rights. Corporate governance issues of "Enron" in the U.S. can serve as an example [1].

In the legal systems of Great Britain and Germany, bankruptcy is a way of debts repayment at the expense of the liquidation and sale of bankruptcy estate. For instance, in Germany the process is aimed at maximizing the debtor's assets for their distribution among its creditors. Along with unfavorable market conditions, lack of opportunities for funding due to banking crisis, the bankruptcy law of 1999 caused significant number insolvent companies in Germany. According to the law, explicit encouragement was given to terminate the organization because creditors were interested primarily in the sale of assets of the company that was experiencing a difficult situation rather than in its recovery. Thus, as international experience shows the national models of organizations insolvency regulation and rights distribution in favor of debtors or creditors is largely a political choice by the states and governments [2].

Kazakhstan's independent economy, which is only 20 years old, is characterized by the use of neutral models of insolvency regulation, which combines both debtor’s and creditor’s interests protection. For example, bankruptcy system in Kazakhstan cannot accept only the interests of the creditors, as it can be done in some economically developed foreign countries. The bankruptcy should facilitate the implementation of the macroeconomic strategy of the state, helping to preserve the productive capacity of the country and not to be destructive but a creative force.

It should be noted that effective functioning of the institution of bankruptcy in the national economy is possible only if there is a qualitative legislation on insolvency and mechanisms for its implementation are established. The law of the Republic of Kazakhstan "On Bankruptcy" of 1997 is the third part of legislative documentation (the first law was passed in 1992, the second - in 1995) that regulates bankruptcy procedures.

Initially, since the introduction of the institution of insolvency, the most dysfunctional organizations went through the bankruptcy process in Kazakhstan. These organizations did not have to restore the solvency of the debtor and the continuation of their operations: a large percentage of bankruptcies accounted for the organizations with no assets through the sale of which the creditors claims could have been met, as well as absent debtors. Absent debtor – is a debtor, whose physical location, as well as the location of the founders, members, managers and officials, without whom the entity cannot operate, is not identified during six months. The national budget for the program 003 "Implementation of procedures for liquidation and bankruptcy" each year provides funds to carry out liquidation procedures of the insolvent debtors. As a result, objectives of the procedures to eliminate insolvent institutions are not achieved. As a result, entrepreneurs had the stereotypical attitude to the Law of the Republic of Kazakhstan "On bankruptcy", which can be used as a way to close the organization through the sale and concealment of property.

The practice of the institution of bankruptcy demonstrates that business entities do not consider bankruptcy as a mechanism for recovery. For instance, in Kazakhstan in 2011, the rehabilitation processes were introduced at only 15 organizations (0.7% of the liquidated), in 2012 - 43 organizations (2.0% of the liquidated) [3].

The institute of bankruptcy must reduce the number of negative effects in the event of insolvency, and ensure financial recovery, restructuring and liquidation of insolvent organizations. It must protect the rights of creditors as well as the interests of owners. In addition, it requires further development in the policy of the state in regulating the processes of bankruptcy. The urgency of improving the mechanisms of bankruptcy also depends on ongoing changes in Kazakhstan's economy in a globalized world.

Now due to the crisis in the global economy, a number of competitive enterprises have difficulties with loan repayment and loan servicing. This creates a risk of bankruptcy, default by lenders, investors and counterparties, default of tax obligations and a negative impact on banks' loan portfolio. In turn, deterioration of banks’ financial position reduces the possibility of crediting the real sector and may ultimately hinder economic growth.

This suggests that it is the time that entrepreneurs caught in difficult circumstances, are provided with effective tools of financial restructuring and rehabilitation stipulated in the bankruptcy law. Thus, over the last one and a half years more than 70 debtors have gone through the procedure of rehabilitation and 30 out of which restored their paying capacities. 84 organizations are now in a rehabilitation procedure and more than 13 000 workers are fully employed and in addition to that 8 organizations that successfully completed the rehabilitation in 2012 saved more than 1,000 jobs. It should be mentioned that majority of organizations that went through the rehabilitation procedures were municipal and public, but recently this procedure has become popular among the other forms of business organizations.

The use of rehabilitation procedures by the institute of bankruptcy provides the debtor with the following advantages:

1) growth of debt stops once the rehabilitation procedure is introduced. Forfeits (fines and penalties) for all types of debt of the debtor, including bank loans, are not charged.

2) repayment of deferred payables is carried out according to the repayment schedule according to the 3-year rehabilitation plan. In addition, the repayment of deferred payables is carried out on the first day after the administration of the rehabilitation process, and after 4 months, i.e. after the approval of the register of creditors. This gives the company time to create a working capital.

3) during the rehabilitation procedure the company continues carrying out its economic and financial activities, including participation in tenders.

4) rehabilitation procedure applies to business: legal entities and individual entrepreneurs.

5) claims of creditors are satisfied within the period of rehabilitation procedure.

It should be noted that the introduction of rehabilitation procedure has several advantages to the banks: a guaranteed return of borrowed funds within 3 years, participation in the committee of creditors and monitoring the conduct of the rehabilitation process. It follows that the introduction of the rehabilitation process will help stabilize the economic development and reduce social tension in the country.

Practical experience shows that the model of insolvency in Kazakhstan plays an important role in the national economy. It involves many of the structures of different levels of government: the Ministry of Finance of the Republic of Kazakhstan, the Committee on the Insolvent Debtors within the Finance Ministry and its territorial agencies - the departments, the Ministry of Justice of the Republic of Kazakhstan, organizations of professional managers in bankruptcy procedures, specialized economic courts, and other state and commercial organizations.

The new Law of the Republic of Kazakhstan “On Rehabilitation and Bankruptcy” came into force on 26 March 2014 (the “New Bankruptcy Law”). The New Bankruptcy Law replaced the Law of the Republic of Kazakhstan “On Bankruptcy” dated 21 January 1997 (the “Old Bankruptcy Law”). Concurrently with the New Bankruptcy Law, the Law of the Republic of Kazakhstan “On Introduction of Amendments into Certain Legislative Acts of the Republic of Kazakhstan on Questions of Rehabilitation, Bankruptcy and Taxation” (the “Bankruptcy Amendments Law”) came into force [4].

The new laws generally preserve the approach taken towards bankruptcy under the Old Bankruptcy Law. However, creditors of a Kazakhstan entity should assess new insolvency-related risks arising from certain changes made under the new laws, including with respect to early termination and bankruptcy set-off, acquisition of an equity stake in a bankrupt entity, enforceability of indemnity provisions and default interest payments, and extension of “claw-back” provisions.

Early termination and bankruptcy set-off

Contrary to the Old Bankruptcy Law, the New Bankruptcy Law:

- provides that initiation of bankruptcy proceedings may not serve as a basis for unilateral termination of a transaction by a counter-party of the debtor; and

- makes invalid any provision executed prior to the initiation of bankruptcy proceedings with respect to one of the parties that an agreement between the parties shall terminate if the bankruptcy proceedings have been initiated.

Further, the New Bankruptcy Law explicitly provides that a creditor and a bankrupt entity (or an entity which is under rehabilitation) may not freely set-off their liabilities after the initiation of bankruptcy/rehabilitation proceedings (i.e. after a court orders to commence a bankruptcy/rehabilitation case).

Accordingly, there is a significant risk that early termination provisions in an agreement governed by foreign law to which a Kazakhstan entity is a party will not be recognized in Kazakhstan in case of the bankruptcy of the Kazakhstan entity. As an example, ISDA Master Agreements usually contain a provision that the agreement is deemed to automatically terminate in the event of the bankruptcy or insolvency of the counterparty. Such provisions, in turn, trigger close out netting and set-off provisions. If early termination provisions are deemed not enforceable in the event of the bankruptcy of a Kazakhstan counterparty, then the application of any close out netting/set-off provisions that are to be triggered would also be questionable. Similarly, provisions in a loan agreement that provide for acceleration and cancellation of the lender’s commitment in the event of the bankruptcy or insolvency of a Kazakhstan borrower may be deemed unenforceable under the New Bankruptcy Law.

The New Bankruptcy Law introduces a definition of affiliated party in bankruptcy/rehabilitation proceedings. There are three important changes arising from the newly introduced definition.

- First, the creditors’ register (i.e., the list of creditors having a claim to be satisfied from bankruptcy estate) will not include claims of founders (participants) of the debtor. It is, however, not fully clear whether this provision operates to exclude (a) claims of any participant regardless of the amount of the interest it has in the debtor and (b) claims of shareholders of the a debtor that is a joint stock company (as opposed to participants of the debtor being a limited liability partnership).

- Second, in addition to the grounds set out in the Old Bankruptcy Law, the rehabilitation manager will also have the right to refuse to fulfil executory contracts entered into with an affiliated party. Note that the definition of affiliated party for that purposes expressly refers to both shareholders and participants.

- Third, an affiliated party of the debtor does not have any votes at the creditors’ meeting until satisfaction of claims of other non-affiliated creditors.

Most notably, the New Bankruptcy Law introduced a new (fifth) category of claims - payment of losses, penalties and fines - which comes after payments to unsecured creditors, but before distributions to shareholders. Under the Old Bankruptcy Law, payment of losses, penalties and fines were to be included in the generic category that covered claims of unsecured creditors. It is likely that amounts payable pursuant to a standard indemnity clause and, with a lesser degree of certainty, a default interest clause such as those found in English law governed finance documents would be considered as payment of losses and fines, as appropriate. As a result, it is likely that indemnity/default interest payments would be subordinated to payments due to claims of unsecured creditors.

The New Bankruptcy Law generally preserves the list of grounds to invalidate transactions/transfers of property which were entered into by a debtor prior to initiation of bankruptcy/rehabilitation proceedings under the Old Bankruptcy Law and confirms the three year “claw back” period for most of these grounds. Notably, the New Bankruptcy Law now provides a new ground for challenging a transaction entered into by a debtor within a three year period prior to initiation of bankruptcy/rehabilitation proceedings – entering into a non-arm’s length transaction that resulted in a financial loss to the bankrupt entity.

Under the Old Bankruptcy Law, in a bankruptcy proceeding a secured creditor effectively lost the rights to the collateral. The New Bankruptcy Law introduces a new mechanism for satisfaction of claims of secured creditors where a secured creditor may take the collateral. In particular, the creditors’ meeting may decide, upon a secured creditor’s request, to transfer the collateral in-kind to the secured creditor in exchange for repayment by such secured creditor of all claims of creditors of the first level of priority (which include claims for payment of salary, compensation for damage to health, claims for payment social security and pension contributions and certain other employee-related claims). The difference between the value of the collateral and the amount of the repayment should be paid either:

- by that secured creditor to the bankruptcy estate if the collateral is worth more than the amount of the first category claims; or

- to that creditor as an unsecured debt (which will be treated as a fourth category claim) where the amount of the first category claims exceed the value of the collateral.

The New Bankruptcy Law introduced substantial changes regarding the administration of the insolvency proceeding.  These changes include, among others, elimination of external supervision procedure, introduction of an interim manager who has the responsibility to control the affairs of the debtor until the court makes a decision on the bankruptcy of the debtor, increased scope of obligations of insolvency managers, debtors, debtor’s corporate bodies and controlling shareholders, and introduction of the concept of a creditors’ meeting in bankruptcy proceedings.

References:

1. The Russian Federation. Federal law. On insolvency (bankruptcy). - M.: Os-89, 2008. (Current law).

2. Stepanov, VV Insolvency (Bankruptcy) of Russia, France, England and Germany. - M.: "The Statute", 2003.

3. Proceedings of the Committee on the Insolvent Debtors Ministry of Finance of the Republic of Kazakhstan. - http://www.minfin.kz

4. The Republic of Kazakhstan. The law on bankruptcy. - Almaty: Lawyer, 2014.