Secured and General creditor: Game of Positions
The definition in the bankruptcy procedure of the creditor's affiliation with a group of secured and / or general creditors allows one to immediately understand the prospects of a certain creditor in enforcement of its rights. As a result of long-term processes of bankruptcy law reform, the banking sector gradually promoted the priority of secured creditors, which was a logical and anticipated step of the legislator.
Provided privilege or unrealized rights?
The version of the Law of Ukraine "On Restoring the Debtor's Solvency or Declaring it Bankrupt" of 19.01.2013 (hereinafter - the Law) substantially expanded the rights of the secured creditor and provided for an opportunity to block the adoption of important decisions within the bankruptcy procedure.
The law provides for a definition of secured creditors - these are creditors whose rights are secured with collateral property of the debtor (property guarantor). The basic guarantee and privilege of the status of secured creditor is that the property securing its right is not included into the liquidation mass and is used separately to enforce rights of such a creditor. The creditor, in fact, acquires the guaranteed status of the secured creditor, since its inclusion in the register is not limited to any time period or by the duty to apply to the court with the respective claim. Instead, the secured creditor is not entitled to vote at the meeting of creditors, but only takes part with the right of an advisory vote.
Regarding the procedure for determining the volume of rights of a secured creditor, in recent years there was particularly actualized the discussion, which manifests itself in the ambiguity of the positions of courts of different instances. Looking ahead, let us remark that the correlation of the forces of general and secured creditors has been radically changed by the Grand Chamber of the Supreme Court (hereinafter referred to as the GCh of the SC) it its resolution dated May 15, 2018 in case No. 902/492/17, whose content will be discussed below.
Looking for a model to determine the amount of claims.
The law does not provide details of the procedure for determining the volume of rights of secured creditors. At one time court practice formulated a single approach, according to which the volume of rights of secured creditors is determined as the value of the collateral in mortgage / pledge, specified in the respective contract.
That approach allowed to promptly determine the amount of claims/volume of rights of secured creditors. If the debtor acted both as the property guarantor and as the debtor under the main obligation, the creditor could obtain the status of a secured creditor in the amount of the value of the collateral in mortgage / pledge, and in case of insufficiency of the property to completely discharge the debt, the creditor received the status of a competitive creditor in the part of the rights that are not secured.
However, the banking sector appealed to such a position of courts, noting that determination of the volume of rights of secured creditors at the level of value agreed by the parties in mortgage / pledge agreements often does not correspond to the realities both at the time of determining the amount of claims/volume of rights within the scope of bankruptcy proceedings and at the time of sale of the property in order to enforce rights of such a secured creditor. Indeed, this position is grounded, since most of the credit relations of 2006-2008 went bankrupt in 2012-2015, when the estimated or contractual value of the collateral in the hryvnia equivalent significantly changed in the direction of its increase.
Thus, it is possible to model the situation in which the property will be sold at auction at a price higher than the estimated or contractual value in accordance with the mortgage agreement, which value was included separately in the Register of creditors’ rights. In this case, the difference in the form of surplus should be applied to pay to the general creditors. However, in the absence of full repayment of the main obligation, this directly violates the rights of the secured creditor and does not coincide with the actual amount of liability of the property guarantor. Therefore, banks stressed the need to determine the amount of secured rights at the level of the entire amount of debt, because before the satisfaction of since until the moment of satisfaction of claims through realization of collateral, the latter provides the entire amount of debt.
However, in 2012-2016, the stable position was formed to reject such explanations of secured creditors. The courts unequivocally stated that in determining the amount of creditor’s claims secured by the debtor's property, consideration must be given to the appraisal value of the property agreed upon by the parties in the relevant collateral pledge/ mortgage agreements.
The above legal position was expressed by the Supreme Court of Ukraine in its ruling No. 14/030 dated 03.06.2014 in case No. 25/5005/6641/2012, as well as in the ruling dated August 26, 2014 in case No. 5024/948/2012. The ruling of the Chamber of Court in commercial cases in the Supreme Court of Ukraine of 03.06.2014 in case No. 5005/6641/2012 states that Part 1 of Art. 11 of the Law of Ukraine "On Mortgage" provides that the property guarantor is liable to the mortgagee for failure by the debtor to perform his main obligation exclusively within the value of the collateral. The courts sometimes even pointed out that the determination of the amount of the secured rights of creditors at the level of the total amount of indebtedness secured by the collateral resulted in artificial increase in the total amount of creditor’s claims of such property guarantor, which contravened the principles of the Law. In 2017, the Supreme Court of Ukraine, in its resolution No. 3-1591 / 16 of March 29, 2017 in case No. 918/169/16, reiterated that the liability of the property guarantor as a mortgagor who is not simultaneously the debtor in the main obligation, is limited to the contractual value of the mortgaged property.
However, the GCh of the SC by its decree dated May 15, 2018 in case No. 902/492/17 radically changed the balance of power of creditors in the bankruptcy procedure. In particular, by departing from the above-mentioned conclusions of the Supreme Court of Ukraine, the GCh of the SC confirmed the position of the bankers, noting that the secured obligations in the meaning of Art. 1 of the Law and the rights of the secured creditor mean all rights of the creditor under the main obligation that are considered valid at the time of recognition of rights and that can be enforced at the expense of the property of the bankrupt, which is the collateral in accordance with the terms of the security agreement and applicable law.
The Grand Chamber emphasized that, when defining the size of the secured creditor’s rights and including them separately into the register, the courts should apply the provisions of Art. 19 of the Law of Ukraine "On Pledge" and Art. 7 of the Law of Ukraine "On Mortgage", to establish on the basis of appropriate and admissible evidence which of the creditor’s rights indicated in his claim are secured with mortgage, as well as the composition and amount of these rights.
Thus, the GCh of the SC has developed a new approach to determining the amount of claims of secured creditors, according to which the amount of such claims can not be limited to the contractual value of the collateral in the pledge / mortgage agreement and is equal to the amount of debt under the principal obligation. However, by departing from the conclusion of the Supreme Court of Ukraine in the case of establishing the amount of secured rights in the case of bankruptcy of a property guarantor different from the debtor, the Grand Chamber has not identified or specified the exact limits of the application of such an approach.
The root of the problem
The approach expressed by the GCh of the SC raises a problem in the event that the debtor, in respect whereof the bankruptcy proceedings are being conducted, is simultaneously the debtor under the main obligation and the property guarantor.
Prior to the resolution of the GCh of the SC dated May 15, 2018, the courts acted in accordance with a simple arithmetic algorithm - the amount that corresponded to the value of the mortgaged property in accordance with the relevant contract was separately included into the register as secured rights, and the difference between the total debt and the value of the collateral - in the requirements of the competition. However, as of today, the conclusions of the GCh of the SC of Ukraine dated May 15, 2018 effectively prevented the courts from using such an option.
Obviously, when the debtor and the property guarantor merge there is no possibility of recognizing the creditor secured for the entire amount of debt and including it as a creditor for the same amount as this situation will lead to duplication of the same obligation to the creditor.
It is significant that the Commercial Court of Cassation in the Supreme Court has already applied the above-mentioned legal opinion of the GCh of the SC in its ruling of 05.06.2018 in case No. 914/3734/15, in which the person against whom proceedings are initiated is simultaneously the debtor under the main obligation, and property and financial guarantor.
Also, it is indicated that it is necessary to relegate all rights to secured rights: "If the creditor's – holder of the security interest - believes that the sale value of the collateral will be different from the value of the collateral specified by the contract, the real value of the collateral is determined by the results of the sale of the collateral, whereafter the rights not secured by the collateral move to 4th or 6th order of precedence of creditors if the debtor in the bankruptcy case received a loan or provided a financial guarantee and it is still effective."
At first glance, such a procedure is logical, corresponds to the opinions of the GCh of the SC and maximally protects the interests of the creditor in parts of its secured rights, but at the same time it creates uncertainty as to the distribution of the balance of the general and secured creditors. In particular, such a creditor loses the right to vote in the procedure for disposal of property and is deprived of operational control over the entire procedure.
If competitive creditors accept a plan of rehabilitation or enter into a settlement agreement, when a secured creditor vetoes, the competitive creditors have the right to redeem the right of such a secured creditor in accordance with the Register of rights of creditors. However, if earlier creditors had to redeem that volume of rights of a secured creditor which was equal to the contract value of the collateral, now the entire debt is subject to redemption, although the real value of collateral may be ten times as small. At present, neither law nor court practice determines the correct order of actions in such a situation.
In fact, the Great Chamber has broadened the interpretation of the Law. With the aim of strengthening the rights of secured creditors, the GCh of the SC deprived creditors of the voting rights in the procedure for the disposal of property, provided that the debtor and the property guarantor merge. By turning the judicial practice to 180 degrees, the GCh of the SC generated more problematic moments than ever. It is worth noting that the Draft Code of Ukraine on Bankruptcy Procedures (Bill No. 8060), which is waiting for the signature of the President, in the process of determining the amount of claims of secured creditors applies the approach that the creditor is secured by collateral only in part of the value of the collateral.
The outlined problems require legislative regulation and the creation of system algorithms for determining the amount of secured claims, while maintaining a fair balance between general and secured creditors.