Debt Restructuring in Ukraine from a Foreign Creditor’s Perspective
The last 4-5 years can be called the “era of big cross-border debt restructuring” in Ukraine, as we saw many high-profile debt restructuring projects in the private and public sectors which have established certain market practices and have provided a vector for further development of debt restructuring practice in Ukraine. I believe that you’d hardly find a foreign bank with exposure to Ukraine which has not faced non-proper performance by a borrower and the necessity to restructure debt. Based on the experience gained from work on numerous projects for all types of clients (residents and non-residents, banks, credit unions, ECAs, production companies, bondholders, etc.) during these years, I have attempted in this article to highlight certain features and peculiarities of cross-border debt restructuring with a Ukrainian element, which should be taken into account for the structuring of new loans and certain ongoing debt restructuring projects.
The set of legal and financial instruments to be used for each particular project depends on a number of factors.
For example, the number of creditors and their jurisdictions, size of debt, involvement of local creditors, type of debt (i.e. bond debt, bank debt, ECA covered debt, secured or unsecured, etc.), borrower’s structure and financial conditions, and many others.
And, obviously, a borrower’s willingness to get the deal with the creditors and actual cooperation in the course of the restructuring has a predetermining effect on the whole project.
In case of voluntary debt restructuring, the majority of cross-border deals are structured under English law using instruments that are standard for deals governed by English law. In forcible restructurings creditors very often have to utilize various legal instruments in those jurisdictions where the borrower’s companies are registered and/or assets are located. This requires a bigger legal team with particular experience in such cases and strong representation in respective jurisdictions (either via their own offices or established relations with colleagues).
In problem-type cases the first and foremost thing to be done is to prevent any leaking of the borrower’s assets and funds (especially if the debt is unsecured) and preserving the borrower’s business as a going concern. From my experience, such solutions as an English court worldwide freezing order or
taking control over the borrower’s business via initiation of insolvency proceedings in relation to a holding company of the borrower’s group could be very efficient. They may be implemented relatively quickly and without the borrower’s involvement (or with limited involvement). In practice the successful steps of a creditor in either freezing the assets of a borrower or taking control of the borrower’s business, or even a high risk of the same, make borrowers much more cooperative in terms of debt repayment or restructuring.
For restructuring the debt of so-called “blue-chip” borrowers, where the majority of the debt is owed to bondholders or syndicates, the English law scheme of arrangement has become very popular and has been used on several occasions.
In general the scheme of arrangement is very convenient as it enables the “cram-down” of dissenting creditors and is subject to relatively light-touch court supervision (normally requiring two short court hearings). At the same time, it has never been tested with Ukrainian courts and it is difficult to predict the success of the scheme’s implementation in cases with dissenting Ukrainian creditors. However, in general, challenges by dissenting creditors in the scheme’s process are very rare and are usually unsuccessful.
Foreign and local creditors
There is a big difference in the approaches taken by foreign and local creditors to the process of restructuring. Local creditors are usually more aggressive (in a good sense) in their actions, which is not surprising as, on the one hand, most of them do not have sufficient experience of complex restructurings and, on the other hand, they are much better positioned for enforcement actions in Ukraine in comparison with foreign creditors. Thus, while foreign creditors tend to agree on moratorium and standstill schemes, local creditors often tend to avoid such arrangements and have a big appetite for judicial enforcement. Though such aggressive actions by local creditors can be quite beneficial for them, they are very often destructive for the entire restructuring process. Thus, sometimes foreign creditors and their advisors have to use significant efforts to keep locals within the perimeter of actions agreed with the borrower in the course of the restructuring process.
As a matter of practice, the participation of local creditors in one restructuring process with foreign creditors makes the process more complicated and narrows the set of legal and financial instruments that can be used for restructuring.
For example, in complex cases which include restructuring of different types of debt, including bond and bank debt, the restructuring solution may provide for the possibility for banks to exchange their claims for new bonds issued by a borrower, which may give them more flexibility in dealing with their claims. However, Ukrainian creditors would be quite reluctant to accept such a solution, since for them obtaining bonds issued by a foreign company in exchange for their claims under loan agreements may be considered as investing abroad, which will require an individual license from the National Bank of Ukraine. Though it is not impossible to obtain such a license, the whole process is quite burdensome and usually local banks prefer to refrain from such solutions by making a choice in favor of more conservative instruments.
Another quite illustrative example of how some local creditors may affect the entire process of restructuring, even
without doing anything destructive, is the case involving several banks, including subsidiaries of foreign banks, where one such subsidiary assigned its claims to
another Ukrainian bank with quite a tough reputation. On such an assignment, the borrower reconsidered the security package and took up a more careful position in relation to collateral it was going to provide to the club of creditors. Moreover, the borrower’s position, in general terms, became more conservative than it was prior to the assignment, which entailed additional negotiations and delay with closure.
One distinctive feature of recent debt restructurings is the creation of additional security which, sometimes, covers all classes of creditors, including bondholders (which was not a market practice before). This requires quite a sophisticated security structure involving local and international security agents or a single security agent acting for all creditors.
The issue of involvement of a security agent has always been important and, at the same time, disputable. Generally, there are three very common security agent concepts: security trustee, parallel debt and the joint and several creditor concept.
The most convenient solution would normally be a security trustee structure. However, due to the fact that the concept of security trust is not recognized in Ukraine, a security trustee structure is extremely risky for creditors and is not advisable for Ukrainian security. Nevertheless, in several restructuring cases we have seen syndicated loans using a security trustee structure for Ukrainian security. In the course of debt restructuring such a structure was substituted by a less risky parallel debt structure and, where possible, by joint and several creditor structures.
The concept of parallel debt has not been tested in Ukrainian courts and, to put it very mildly, still involves some uncertainty as to its recognition in Ukraine.
To be more precise, only a joint and several creditor structure is directly recognized by Ukrainian law and does not create risk for validity and enforceability of the security held by the security agent. At the same time, this structure is the most inflexible in terms of assignment of claims by a creditor which is the security agent, since in case of such assignment either a new creditor or another initial creditor should become a security agent simultaneously with the assignment. Otherwise, the whole security package held by the security agent-assignor may be exposed to significant risk of invalidation. Sometimes, this peculiarity of security agent joint and several creditor is omitted in loan documentation, enabling the latter to assign its rights as a creditor without actual transfer of the security agent role. As a result, creditors bear significant risk of becoming actually unsecured in case of challenge of the security by the borrower or security providers. We have faced such a situation several times and overcame it by, first and foremost, implementing respective changes to loan documentation and, secondly, appointing a new proper security agent and substituting all existing security agreements with new ones executed with the new security agent. Of course, this involves significant unexpected costs for all the parties concerned and delays the entire process, but only this approach can totally eliminate existing risks and restore security.
By the way, it is quite telling that local banks do not usually accept a parallel debt structure, while foreign creditors are much more flexible in this regard.
Furthermore, some complex cases require a well-tailored enforcement proceeds sharing mechanism, which is complicated by Ukrainian currency control rules and the imperfections of local tax legislation.
Local currency control rules remain extremely tough and, to a great extent, complicate the cross-border debt restructuring process. However, in 2017 the National Bank of Ukraine (NBU) implemented several long-awaited, positive initiatives.
The first one is connected with loans from international financial institutions (IFC, EBRD, EIB, etc.) and cancels the requirement of registration of loans from IFIs with the NBU.
The second one relates to registration of loan agreements or changes to them with the NBU in case of assignment of rights under a loan agreement by the initial lender to a new one. Previously, only a borrower could initiate registration of changes to a loan agreement with the NBU. This requirement de facto blocked assignment of rights under NPLs in most cases due to lack of cooperation from the borrower’s side and, as a result, the impossibility of registering changes to a loan agreement with the NBU.
Now lenders are free to initiate registration of changes to loan agreements in case of assignment and this may bring more professional foreign investors to the Ukrainian market of NPLs in foreign currency with an approximate value of several dozens billion US dollars.
By Oleksander Plotnikov is a partner at Arzinger