The banking and finance sector in Ukraine has proved to be one of the most susceptible to the latest political events. The dramatic devaluation of the Ukrainian Hryvna has significantly influenced the discharge of borrowers of their obligations to financial institutions. The rapid measures of stabilization have appeared to have a rather controversial impact. And while a new portion of measures are on their way, we would like to ask experts to share their views on the current situation.
The National Bank of Ukraine (the NBU) established a working group to develop mechanisms to mitigate the adverse impact of the Hryvna’s devaluation on fulfillment of obligations by borrowers. How can the NBU simplify the mechanism of repayment of credits in foreign currencies? What experience from other countries can be enlisted by the NBU?
The NBU’s working group aimed at mitigating the negative impact of the Hryvna’s devaluation for borrowers will not need to reinvent the wheel.
Since mid-2008 Hungarian debtors have faced a similar problem: the forint has plunged 43% against the Swiss franc while Hungarians hold about USD 15 billion worth of foreign-currency loans, or roughly 12% of the country’s economic output. In early 2011 Hungary’s government and commercial banks agreed to burden-sharing on foreign currency mortgage loans.
Under that agreement banks assumed two-thirds of the loan burden that exceeded the exchange rate fixed for borrowers at a below-market rate.
The government’s share was one-third. Foreign currency mortgage loans overdue by more than 90 days were converted to the forint and one quarter of the outstanding amount was written off.
However, that measure had a reverse effect: the forint weakened further and exacerbated the problem for remaining holders of foreign currency loans.
However, Hungarian lawmakers did not settle until suggested new probation for their suffered electorate. Hungary’s government says banks did not make the risks clear enough to their customers and required the Constitutional Court to interpret the situation. In response the Court specified that “contracts can be retroactively amended only in extraordinary cases when circumstances changed significantly in a way that couldn’t have been foreseen at the time of the contract’s signing”.
Obviously, such quite clumsy steps increased investors’ distrust towards Hungary and reduced the ability of banks ability to attract capital, which may inevitably weaken the forint further.
Such experience of interference by the state in private relationships between creditors and borrowers may not be considered as a successful example.
In developing measures for unburdening the debtors, officials shall maintain the balance between the interests of both parties and follow the common methods of loan restructuring: interest rate reductions, forbearance plans (special terms for circumstances involving financial hardship), moving payments to the end of loan agreements.
It seems the working group shall concentrate on developing the procedure of relieving borrowers whether through the special governmental program developed for banks, legislative initiative or special state agency.
And most importantly they shall also determine the sources for covering the losses that inevitably arise when someone is going to gain.
Given the current situation in the currency market of Ukraine, would you predict any growth in demand for debt restructuring? What restructuring options will be requested the most?
Despite certain political optimism inspired by the results of the recent presidential election, the economic situation in Ukraine remains difficult. Accordingly, we expect many businesses will not be able to meet their debt obligations, especially those nominated in foreign currency. We are already seeing some big restructurings starting, mainly in the sectors affected by the current crisis. In particular, some Ukrainian banks have initiated the consent solicitation process in respect of their Eurobonds by asking noteholders to extend the term of the notes. At the same time, Ukrainian banks are facing a similar request from their borrowers domestically as the cash flow of many businesses has fallen off. Another dominant trend is the absence of new money, as all lenders are only willing to restructure existing debts, but are reluctant to lend. While at the present time all borrowers only tend to extend the maturity of their debt, often at a higher rate or with additional fees, later this year we expect to see more complex restructurings providing for a joint security pool for all creditors or even structural changes in the borrower’s business.
What was the recent practice of the courts’ application of the legislation governing relations between borrowers, guarantors, and banks?
As per the results of analysis of court disputes for the last few years in the area of the credit legal relationship, it is worth noting the main tendency: the debt must be returned. In such disputes the claims of creditor are usually satisfied, unless there are gross violations upon conclusion of credit agreements, agreements concluded as security for returning of debt (suretyship, mortgage, pledge) or upon their performance.
Regarding debt recovery from a borrower — courts usually pay attention to: the timeliness of filing a lawsuit (consequences of running the statute of limitation are applied by the courts only upon a respective claim from a defendant), accuracy of accrual of interest and penalties, due performance by a bank of the undertaken obligations in a timely manner and due payment of a loan.
Upon addressing claims to sureties:
1) The practice is quite varied and sometimes contradictory in this area. A unified approach on a number of issues (inter alia, on terms of addressing to sureties) is still absent.
Most suretyship agreements contain a clause on the validity of an agreement until full execution of obligations by a borrower. If so, the courts consider the term of validity of a suretyship agreement as not specified. In this case provisions of Part 4 Article 559 of Civil Code of Ukraine are applied: if the creditor does not demand payment from surety within 6 months upon the maturity date, the suretyship is deemed to be terminated. As practice shows, a lawsuit submitted to a court or claim to surety on recovery of indebtedness are treated as such a demand.
In this case the issue of timeliness of demand addressed to the surety is disputable: either addressing with the letter of demand within 6 months with the subsequent filing of a lawsuit (within a limitation period of 3 years) would be enough, or both a letter of demand and lawsuit to the surety must be submitted within 6 months from the maturity date for returning credit funds.
2) Increase of credit obligation as grounds for termination of suretyship.
Certainly, there is always a need to take into account specific provisions of a credit agreement and suretyship agreement. For example, the extent of the surety’s responsibility (full or limited with certain amount), surety’s consent to amending the credit agreement without his approval and others.
Suretyship is usually considered to be terminated if amendments to the credit agreement, which result in extension of the surety’s responsibility, were introduced without his approval. Extension of surety’s responsibility may be caused by: increase in the credit amount and/or interest rate, change in the terms for returning the loan.
It is also worth mentioning some established practice of courts: obtaining an individual license from the NBU is not obligatory for conducting transactions with currency values (provision of credit facilities in a foreign currency); application of norms, regulating suretyship relations, to mortgage relations; termination of mortgage/pledge/suretyship because of liquidation of a debtor — legal entity (subject to absence of valid court judgment regarding foreclosure on mortgage/pledge, recovery of indebtedness from surety upon liquidation); no need for consent of another spouse on concluding credit agreement, suretyship agreement; need for notarized consent of another spouse for concluding of mortgage agreement (regarding assets being joint property of spouses). In such disputes many questions have arisen in connection with the mortgaging of assets of private enterprises and assets acquired by an individual for performance of entrepreneurial activity (individual-private entrepreneur). The point is that an individual who is a private entrepreneur is not regarded as a separate owner, as the property is actually owned by individual. The Constitutional Court of Ukraine has clarified with its judgment No.17-rp/2012 of 19 September 2012 that the charter capital and property of a private enterprise is considered to be the joint property of spouses. This judgment is also applied by courts with respect to individuals-private entrepreneurs. However, the Supreme Court of Ukraine has clarified with its resolution of 2 October 2013 that the property of an individual-private entrepreneur, acquired and used in his entrepreneurial activity with the aim of generating profit, shall be regarded as his individual private property.); illegality of transfer into mortgage of proprietary rights on objects of unfinished construction (according to agreements concluded before 14 September 2009); illegality of transfer into mortgage by a developer of proprietary rights on apartments/non-residential premises, which were fully paid by an investor upon conclusion of a mortgage agreement — without the investor’s consent; possibilities for creditor of addressing with demands to surety/mortgagor/pledge or even upon availability of court judgment regarding recovery of indebtedness from a debtor — if such court judgment has been not enforced yet.
The devaluation of the Hryvna affected borrowers fulfilling their obligations. How did this fact affect the portfolios of orders that lawyers received from their clients — banks and borrowers?
Depreciation of the national currency and the economic crisis caused by the unstable social and political situation in the country has resulted in a situation in which many borrowers have become unable to meet their obligations to banks. This is especially true of credit agreements in foreign currencies. It is well known that such agreements were widely used in Ukraine, even in instances where the purpose of the credit was not to make payments in foreign currencies (for example, mortgages and car loans).
When faced with the probability of debt enforcement and loss of their collateral, debtors are turning to lawyers to find loopholes that would enable them to reduce the amount of the loan or the interest, to get a deferral or an installment plan, or even to completely terminate or invalidate a credit agreement or additional agreements (mortgage) or suretyship agreements.
All possible remedies that could be applied in such cases have already been tried after the crisis of 2008-2009. Therefore, lawyers can now derive their actions from the court practices of that period and evaluate the prospects of a particular strategy. For example, in view of the usual practice, the chances are low that a credit agreement in foreign currencies can be terminated pursuant to Article 652 of the Civil Code of Ukraine (due to significant change in circumstances), or invalidated due to the fact that the bank does not possess an individual license from the National Bank.
As to financial institutions, they always have more issues as to “problem“ debts during a crisis. Besides, a number of contentious issues arose due to the most recent numerous regulations of the NBU. External advisors are usually engaged in tackling the most resonant situations in these areas, when in—house legal departments fail to settle them.
What obligations in the banking sector did Ukraine undertake when it signed the memorandum of 13 May 2014 on the macro-financial assistance of the European Union (EU) in the amount of EUR 1 billion? Would it affect the lawyers’ work in this area?
The Memorandum of Understanding (the Memorandum), which was signed by the parties on 13 May 2014 and ratified by the Ukrainian Parliament on 20 May 2014, specifically establishes only the following three obligations of the state of Ukraine in the banking area: the NBU must issue standards and rules regarding systemic banks for their further adoption by the end of 2014, currently, a systemic bank is a bank whose liabilities are not less than 10% of overall liabilities of all Ukrainian banks; implementation of legislation regarding disclosure of banks’ ultimate owners, including by publishing of the relevant information on the official site of the NBU by 1 September 2014; the government of Ukraine must prepare and submit a bill to Parliament amending the On Financial Services and State Regulation of Financial Service Markets Act of Ukraine regarding disclosure of information.
While disclosure of banks’ owners is not a new procedure under Ukrainian legislation and is just being improved, the standards and rules for systemic banks are bound to become a completely new piece of regulation aimed at the biggest players on the market. It is anticipated that systemic banks will have more reporting duties and so in-house lawyers at such banks should be prepared to work with the new requirements of the NBU. Overall, obligations in the banking sector are aimed at bringing more transparency and it is not expected that they will significantly affect the work of banking lawyers.
Notably, the Memorandum refers to the Stand-By Arrangement (the SBA) for Ukraine of the International Monetary Fund, and even conditions of disbursement of the loan to proper performance of the SBA’s terms, which, as expected, will provide for more obligations to be taken on by the state of Ukraine to reform its legislation and improve implementation of the latter.
What measures to stabilize the financial market can be taken in the near future by the NBU, the Ministry of Finance of Ukraine, and other government agencies?
With respect to the measures which the NBU may undertake in order to stabilize the financial sector, it should be observed that Ukraine has undertaken to comply with its obligations to the International Monetary Fund, stipulated in the Memorandum of Economic and Financial Policies. Therefore, we can expect implementation of the commitments stated therein. Thus, the NBU will definitely abstain from using administrative regulations and restrictions as a substitute for conventional monetary policy tools. Direct interference in the exchange rate will not be exercised on the part of the state regulator. Moreover, the NBU will participate in the currency exchange market so as to accumulate reserves through market purchases. Furthermore, Ukraine has undertaken not to impose new restrictions affecting foreign exchange operations. In this regard it could be expected that no new restrictions in terms of foreign exchange operations will be introduced. However, the requirement on the mandatory sale of 50% of income nominated in foreign currency will be preserved.
In addition, the NBU will assess the financial resilience and take steps to ensure adequate capitalization of the financial sector. For this purpose a diagnostic study will be launched in order to reveal weak banks which should be recapitalized by their shareholders. If shareholders fail or become unwilling to recapitalize such “weak“ banks such institutions will be brought to insolvency.