Ukraine: Self-Regulation Of Bankruptcy Trustees: Shall We Wait Or Have To Develop?

Last Updated: 21 March 2019
Article by Sergiy Donkov

The Verkhovna Rada (Ukrainian Parliament) adopted the Code of Ukraine on Bankruptcy Proceeding (the Code) on 18 October 2018. It's a public knowledge that the IMF and the World Bank experts were directly involved in revision of bankruptcy legislation. Macroeconomic goal of the Code is to improve Ukraine's Doing Business ranking, which reflects foreign investment prospects of our country.

Unfortunately, though, the final version of the Code is still not available. According to web-site, the Code was transmitted to the President for signature on 21 December 2018. We can make some preliminary assessment of the Code provisions based on draft Law number 8060 and amendments thereto adopted by the Verkhovna Rada at the second reading. As specified in its transitional provisions, the Code shall enter into force after expiration of six months following the date of its official publication. The Code consists of four titles. Title two (BANKRUPTCY TRUSTEE) shall envisage improvement and enhancement of bankruptcy trustees self-regulation. Why is it crucial for the development of insolvency mechanism in our country?

In Ukraine, institution of self-regulation was introduced almost six years ago. The institution was brought into force along with the new version of the Law of Ukraine on Restoring Debtor Solvency or Declaring a Debtor Bankrupt (the Bankruptcy Law), which became effective on 19 January 2013 pursuant to Law of Ukraine dated 22 December 2011 No. 4212-VI. What did make it necessary to dramatically change the legal regulation of this institution?

The legal framework for activities of a self-regulatory organization (the SRO) in the sphere of bankruptcy proceedings is set forth in article 117 of the Bankruptcy Law: "A self-regulatory organization of bankruptcy trustees is an all-Ukrainian  public organization that unites bankruptcy trustees and exercises regulatory powers in respect of activities of bankruptcy trustees. A self-regulatory organization of bankruptcy trustees is a legal entity acting on the principles of self-regulation; its activities are not aimed at generating profit. Establishment and operation of a self-regulatory organization of bankruptcy trustees are governed by laws on association of citizens subject to special provisions set forth in this Law" (boldface by the article writer). All boldface parts of the SRO definition demonstrate that draft Law experts are not aware of the nature and main goals of the professional self-regulation; or they may result from the lack of political will to implement a new legal mechanism into the Ukrainian legal framework whereby functions of control and governance in respect of bankruptcy trustee are transferred from a government agency to the self-organised community of professionals. International experience convincingly positive that a professional SRO is not a pubic organization and that an SRO's power is not public but rather professional regulation. Such organization shall be responsible for professional admission, control over proper professional conduct and, most important, imposition of sanctions for violations, including professional disqualification of a bankruptcy trustee.

Why do we make such bold statements? Let us begin with the definition of "a self-regulatory organization" and its peculiarities compared to public organization.

How did SROs appear?

For the first time the term "self-regulatory organization" was used in the United States legislation in the early 20th century, when President Franklin D. Roosevelt enacted the New Deal to recover from the Great Depression. At that time, formation of such organizations was regulated by the Securities Exchange Act of 1934, whereby associations of securities dealers acquired the status of SRO. They were authorised to establish rules binding upon their members or persons accountable to these organizations. This new legislation was primarily designed to cut budget spendings. The US experience of self-regulation in various economic sectors proved to be quite efficient and was thereafter implemented into sector-specific laws in the UK, Germany, France, the Netherlands and other mature countries.

What should a SRO look like?

A general trend can be seen based on analysis of major SRO models existing worldwide. Organizations are considered to be self-regulatory if sector-specific legislation provides an opportunity to set up SROs and lays down particular requirements applicable to them.

Self-regulatory organizations are characterised by the following: members join an organization on a voluntary basis; members are professionals in a specified field; there is a close relationship between the government and organization in the meaning that an organization exercises a part of powers delegated by the government. Mandatory functions carried out by SROs include: elaboration of standards, rules and regulations (the rule-making function); setting up bodies aimed at controlling compliance with the above (the controlling function); imposing sanctions on members who violate rules established by SRO (the punitive function). Constituent documents and internal regulations may envisage both individual and collective liability of the SRO's members.

SROs may perform other optional functions, such as: to perform a function of non-judicial (provate) dispute resolution platform among SRO and its members, clients consuming their services; to set up special property or monetary funds for the compensation of damages caused to clients; to implement a system of collective professional liability insurance of SRO members; to represent SRO members before governmental authorities and local self-government bodies.

By the subject of regulation, self-regulatory organizations can be divided into organizations of sector-specific self-regulation and organizations of professional self-regulation.

Delegation of powerы to a self-regulatory organization should be stipulated by special laws. That is, the law may entrust this organization with some of business regulation functions in a specific economic sector.

As a general rule, in case a business regulation function in certain area is delegated under the law, all business entities and/or professionals operating in such area shall mandatory become SRO members.

What is the current situation with self-regulation in Ukraine?

Effective system governmental regulation has certain shortcomings: excessive powers of governmental authorities with regard to establishing rules and standards of the professional conduct; low efficiency and high expenses related to supervision and control exercised by governmental authorities; lack of institutionally established mechanisms of communication between industry professional communities and governmental authorities related to authorisation and supervision. This results in significant expenditures for the state and for business entities, which are necessary to maintain inefficient system of control.

The Cabinet of Ministers of Ukraine approved the Concept for Reforming Self-Regulation in Ukraine by its order dated 10 May 2018 no. 308-р. The Concept provides for preparation of the draft Law of Ukraine On Self-Regulatory Organizations. This is not the first concept for the development of professional self-regulation in our country that referes to preparation of specific legislation. By its order dated 23 August 2016 number 615, the Cabinet of Ministers approved the Action Plan on Deregulation of Business Activities. However, above law on SROs has not been adopted so far.

Analysis of the Ukrainian legislation provides there are 15 sectors where self-regulation is permitted. These sectors include: appraisal activities; land evaluation; land management; architectural activities; wholesale agricultural markets activities; agricultural advisory; professional activity on the securities market; activities of bankruptcy trustees; administration of non-state pension funds; activities of credit unions; insurance activities; organization, formation and handling of credit histories; tourism; activities on the electricity market; activities of employers' organizations/associations.

In Ukraine, twenty four organizations operating in six sectors are officially recognised as self-regulatory organizations. They include eight self-regulatory organizations in area of appraisal activities, including land evaluation, two – related to land management, four related to – architectural activities, five – related to professional activity on the securities market, five – related to activities of bankruptcy trustees.

What is the role of a self-regulatory organization in solvency restoration and bankruptcy areas?

We have to admit that, after expiration of six years following introduction of a mechanism, self-regulation in bankruptcy has not yet begun to operate properly. The fact that SROs may nominate representatives to qualification and disciplinary commissions of bankruptcy trustees is the major and the only instrument of deregulation and self-regulation.

Article 108 of the Law creates considerable confusion in respect of the status of an SRO by stipulating that a disciplinary commission of bankruptcy trustees shall consist of seven persons, including four persons elected by "...self-regulatory organizations of bankruptcy trustees." In my opinion, reference to multiple SROs resulted in division of experts in the ares and of bankruptcy trustees both geographically and due to market competition. It is unclear whether it was a clerical error made by law-drafters or a built-in market mechanism. It was most likely an error, since similar article 101 regulating establishment and operation of bankruptcy trustees qualification commission, states as follows: "...are elected by a self-regulatory organization of bankruptcy trustees." Unfortunately, this error resulted in legal implications and was repeatedly introduced into the Procedure for Supervision of Bankruptcy Trustees Activities. It is unclear which SRO shall represent and protect interests of bankruptcy trustees is case they are members of several organizations.

In Ukraine, there are currently 7 professional non-governmental organizations in the bankruptcy sector. Period of their active operations ended about three and a half years ago following  formation of qualification and disciplinary commissions

During the foregoing period, the article writer worked in a disciplinary commission of bankruptcy trustees, and did not see any examples of contribution to inspection of activities of bankruptcy trustees by the "most experienced and highly qualified bankruptcy trustees" who can be engaged in inspecting their colleagues as described in article 106 of the Bankruptcy Law and who shall be SRO representatives pursuant to clause 4.5.6. of the Procedure for  Supervision of Bankruptcy Trustees Activities.

Provisions of article 11 of the Law, which set forth the following SRO's functions and powers, remain declarative:

  • to control compliance of bankruptcy trustees activities, who are members of the organization, with the Law, other laws and regulations;
  • to take part in drafting laws and regulations;
  • to take part in training bankruptcy trustees and their continuing professional training;
  • to protect interests of members of a self-regulatory organization of bankruptcy trustees before government authorities and local self-government bodies;
  • to inform the public about practices and issues of solvency restoration or bankruptcy proceedings.

Wondering of prospects of self-regulation in our country, I find it relevant to refer to Vyacheslav Dzhunia, author of "The Institution of Insolvency. Global Development and Implementation in Ukraine", 2006, whereby he outlined direction of SRO development: " would be appropriate to establish one professional organization with mandatory membership of all licensed bankruptcy trustees. Professional organization of bankruptcy trustees should be set up as a SRO; as it evolves, some of government functions should be gradually delegated to the organization, in particular: licensing; monitoring the conduct of bankruptcy trustees (with disciplinary powers); organising training and continuing education; acting as an insurer under agreements on mandatory professional liability insurance of bankruptcy trustees and their professional risks."

To be united under one umbrella is a must for all stakeholders: bankruptcy trustees – in order to protect their interests during inspections and in cases they are subject to disciplinary actions; creditors – in order to strengthen protection of their rights and interests in terms of bankruptcy proceedings. Debtors activities are influenced by professional background and qualification of bankruptcy trustees appointed in bankruptcy proceedings; investors require investment protection guarantees as well as clear and reliable system of acquiring and protecting ownership rights.

What novelties are provided the Code on Bankruptcy Procedure as regards SRO?

Having analysed Code provisions made available after its adoption by the Verkhovna Rada at the second reading, we may opine as follows.

The most recent version of the Code envisages establishment of the one self-regulatory organization with mandatory membership of all bankruptcy trustees who are registered in the Unified Registry of Bankruptcy Trustees.

By carrying out reviews of activities, this SRO must exercise control over activities of bankruptcy trustees ensuring that they comply with laws, regulations and the Code of Ethics and Professional Conduct. There is a continuing vigorous debate within professional community about boundaries and scope of control, stemming from the fact that powers are apparently overlapping: governmental control exercised by the governmental bankruptcy agency, judicial control exercised during bankruptcy proceedings and professional control exercised by the SRO under the Code.

As prescribed in the Code, a self-regulatory organization of bankruptcy trustees shall be established by the meeting of bankruptcy trustees of Ukraine and may not be re-organised. Final provisions of the Code state: "No later than one month following the date of entry into force of this Code, the Ministry of Justice of Ukraine shall convene the constituent meeting of bankruptcy trustees of Ukraine and set out its rules of procedure." The Ministry of Justice shall also "...notify each bankruptcy trustee of the meeting no later than 10 days before the date of the meeting." It is not clear whether each bankruptcy trustee should attend the meeting in person or via delegates or authorized representatives. In the first case, almost one thousand and five hundred trustees have to be gathered together in one place at one time. This would create some organizational difficulties for both meeting administrator (the Ministry of Justice) and bankruptcy trustees from different regions of Ukraine. Due to very tight deadlines, local organisations may fail to timely elect their delegates.

We can only hope that the Ministry of Justice will provide an adequate regulatory framework as required by the Code. According to a tentative estimate, more that twenty regulatory acts need to be adopted.

The procedure for the formation of qualification and disciplinary commissions still remain the same: SRO shall appoint four members to a qualification commission and four members to a disciplinary commission. In this regard, expectations have not been met: powers related to professional admission and disqualification of wrongdoer have not been transferred to SRO in full.

Structure of the prospective SRO is mentioned very briefly. Meeting of bankruptcy trustees should set up the SRO Board, elect the Board Chairperson and Deputy Chairpersons, the Auditing Committee, approve the Charter, the Code of Ethics and Professional Conduct, internal regulations and budgets. SRO structure must certainly be much more complex. In addition to governing bodies, main working bodies must be set up, such as: the Commission for Supervision of  Bankruptcy Trustees Activities, the Scientific and Expert Board, the Ethics Commission. The Code provides for regional boards of bankruptcy trustees, however, it does not set forth the procedure for their formation, notwithstanding importance of procedural issues for carrying out controlling functions, as well as for the election of authorised representatives (delegates) to take part in the Meeting of bankruptcy trustees.

Undoubtedly, adoption of the Code on Bankruptcy Procedure was an enormous step towards reforming the insolvency practice in Ukraine. Unfortunately, this step was taken by governmental authorities, not by professional community of bankruptcy trustees. It is  bankruptcy trustees who impact enhancement of their professional development, international recognition, gaining public confidence and trust of demanding investors who are expected to ensure financial recovery of our economy. Actually, nothing prevents bankruptcy trustees from launching the process of establishment of the self-regulatory organization right away without waiting for orders, regulations and rules of professional conduct mandated by authorities. There is no point in waiting for self-regulation, we must create it ourselves every day.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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