Where has the Money Gone?

For the last 5 years, the state-run Deposit Guarantee Fund (hereinafter — the Fund) has become a significant player on the banking services market. The reason for this situation was the collapse of around 100 Ukrainian banks. World history encompasses only a few such cases. In Ukraine the scale of crisis in the banking sphere has, indeed, been staggering. According to the Fund, the liquidation of 48 banks (14 of them in 2020) had been completed as of 1 January 2021, and a further 47 banks are engaged in the liquidation procedure to be completed in the near future.

Along with objective factors of deterioration of the financial health of banks (such as crisis phenomena in society), there are also subjective factors, in particular, performance of high-risk transactions by banks, including excessive lending to bank-related persons and concealment of these transactions from the regulator via the submission of unreliable financial reporting.

The total amount of claims from creditors against insolvent banks claimed for refund reached 287 billion hryvnias (more than US dollars 10 billion). A little over 100 billion hryvnias of these claims have been repaid. Such a low level of satisfaction of creditors’ claims is closely connected with the critical insufficiency of assets in liquidated banks and the low level of asset quality. Moreover, the actions of bank owners and management have become a common reason for bank insolvency. Realizing “the beginning of the end”, quite often bank management has actively withdrawn assets ​​from a bank, and sometimes — outside Ukraine before introducing administration of it by the Fund.

In order to enhance accountability of former owners and other bank-related persons responsible for the problems in financial institutions, in 2015 the Ukrainian Parliament adopted respective amendments to Ukrainian legislation. Thus, the new Article 52 appeared in the Law of Ukraine On The Deposit Guarantee System for Individuals. It established that the Fund or an authorized person of the Fund should, in the event of insufficiency of bank assets, set up a claim for recovery of damages caused to the bank against a bank-related person, whose actions or omissions caused damages to the creditors and/or bank, and/or against a bank-related person, who as a result of such actions or omissions received material benefit directly or indirectly.

At the same time, existing normative-legal regulations are obviously insufficient for proper practical implementation of all mechanisms of such accountability.

Thus, in 2015, the Law of Ukraine On The Deposit Guarantee System for Individuals, introduced such a concept as “insufficiency of bank assets” — exceeding the amount of bank liabilities in accordance with the register of accepted creditors’ claims over the estimated value of the insolvency estate of the bank, except for bank assets being a pledge and used exclusively for priority satisfaction of the pledgee’s claims.

A very simple algorithm was used to calculate the insufficiency of ­assets:

1. The register of accepted creditors’ claims was approved (within 90 days from the beginning of the bank liquidation procedure).

2. The estimated value of the insolvency estate of the bank was determined (within 14-20 days from the approval of the insolvency estate of the bank, for which the Fund had 6 months from the beginning of the liquidation procedure).

3. The Fund defined the difference between the first and second figures as insufficiency of assets; in the opinion of the Fund the result of such a difference was damages caused to the bank.

It should be noted that by 2020 the Law of Ukraine On Amendments to Certain Legislative Acts of Ukraine for Improving Mechanisms of Banking Activity Regulation (better known in Ukraine as the “anti-Kolomoiskyi” law) excluded the concept of “insufficiency of assets” from the Law of Ukraine On The Deposit Guarantee System for Individuals. However, the reference to this concept in Article 52 remained, which might add uncertainty to the regulation of accountability of bank-related persons, which was a far from perfect one.

After the legislative changes made in 2015, the Fund (in view of lack of voluntary recovery of damages caused to the banks), began the process of applying to the courts of Ukraine with respective claims for recovery of damages caused to the banks.

At the same time, when resolving this category of disputes, a number of both procedural and material controversial issues arose to be discussed in detail.

The first such claims referring to Article 52 were filed in 2017. They were sent to courts of general jurisdiction. It was quite possible to understand the logic of the Fund as, after all, all defendants in the cases were individuals.

However, not all judges agreed with this logic. Some of them decided that since the Fund controlled and disposed of bank assets during the liquidation procedure, which in effect was inherent in the owner of a legal entity, the dispute between the Fund and bank officials for recovery of damages caused to a third party should be considered under commercial law. Finally, the Grand Chamber of the Supreme Court made just this conclusion in its ruling dated 19 June 2018. After that, all initiated cases were closed by courts of general jurisdiction, and the Fund had to re-initiate proceedings in commercial courts.

After passing to economic jurisdiction, new procedural problems arose. In order to save time and, apparently, court fees, the Fund decided to prosecute claims on the “all-to-all” principle. That is, the whole amount of insufficiency was taken as the price of the claim, all who corresponded to the “bank-related person” criterion — as defendants and, in fact, the claim for joint and several recovery of damages was filed.

Some judges did, nevertheless, commence proceedings for such class suits. However, most of them saw it as a violation of the rules for consolidation of claims. The courts came to such conclusions taking into consideration the fact that each transaction was an independent legal relation, being the basis for emergence of civil rights and obligations for the parties of this legal relation. The establishment of the circumstances of each of these transactions was evidenced with uncorrelated facts (different agreements, decisions of different divisions of the bank, etc.). Thus, according to the judges, the claims for recovery of damages in the amount specifically determined by the plaintiff for each particular loan agreement were independent claims uncorrelated not by grounds of emergence nor by pieces of evidence provided, and were not basic and derivative from each other, as satisfaction of claims of one kind did not depend on the satisfaction of claims of another kind. This, in turn, complicated their joint consideration.

Eventually, the situation once again became the subject for consideration by the Supreme Court of Ukraine. The first was the ruling of the Commercial Cassation Court dated 15 February 2019 (the claim against related persons of the Professional Financing Bank, which confirmed the violation of rules for consolidation of claims). The Cassation Court then stated the same position in the ruling dated 25 July 2019 (the claim against related persons of Imexbank). In the end, a similar conclusion was made by the joint chamber of the Commercial Cassation Court in its ruling dated 16 October 2020 in the case of Delta Bank.

However, the biggest problem for courts in the Fund’s disputes with former bank owners and managers was the issue of determining the term when the Fund acquired the right to apply to a court with claims for recovery of damages.

There are two approaches of judges to this issue. The Grand Chamber of the Supreme Court has to decide on the legitimacy of one of them in the case of Ukoopspilka Bank (as of the time of writing of this article, the case was still ongoing and scheduled for consideration on 30 March 2021).

The first approach. In the course of conducting the inventory (i.e. actually before the end of the liquidation procedure) the Fund is already aware that the satisfaction of all liabilities of the Bank is impossible and that damages have been caused. Therefore, the statute of limitations begins at the end of the inventory.

There is a certain logic, because after forming the insolvency estate and determining the number of creditors’ claims, the Fund is already able to understand whether the bank’s assets are sufficient or not, even without understanding the exact amount of claims (to be adjusted in the course of legal investigation).

The second approach is that before the liquidation procedure has actually been completed, the Fund has no legal grounds to state the damages caused to the bank. That is, the judges, in fact, come to the conclusion that the claims are premature.

There is also logic, because until the end of the liquidation procedure it is impossible to predict how much money the bank will receive from the sale of assets (in view of the sale by auction, the sale price is not fixed, and in practice — it is obviously less than the estimated one) and what the size of the final insolvency estate will be (it is often adjusted in the course of the bank liquidation procedure). At the same time, some creditors, whose claims have not been recognized by the Fund, recognize such rights in court, which leads to the making of adjustments to the register of creditors. It seems that in the case of Ukoopspilka this interpretation of the law by the Supreme Court of Ukraine is more probable, especially in view of the exclusion of definition of the concept “insufficiency of assets” from the Law.

The situation was such that the same judge applied the first approach in one case, and the second approach — in another case (in another bank). Now everything is in the hands of the judges of the Grand Chamber of the Supreme Court, which has to solve this exceptional legal problem.

Despite the absence of progress in Ukrainian courts, the Fund decided not to wait for something to happen and started actively seeking its fortune in foreign jurisdictions. Former top managers of the banks and their beneficiaries are not only wealthy people, but also cautious individuals. Realizing that sooner or later they would be “asked” for the damages caused to a bank, most of them quickly became “poor” in Ukraine, and instead they acquired assets abroad, and sometimes even moved abroad as far as possible from Ukrainian courts.

Therefore, in 2019, the Fund began looking for foreign experts through open tenders to carry out work in order to establish damages, determine those accountable for each episode of their task with the most important thing being recovery of these damages in courts of foreign jurisdictions.

Foreigners actively participated in competitions, as a result of which, as of the beginning of 2021, the related persons of the banks Delta, Finance and Credit, Imexbank and National Credit received related teams of foreign “hunters”. In particular, according to open source data, the team in the case of Delta is headed by the British firm DWF Law, and in that of Finance and Credit by British firm Gateley PLC. A few more tenders for other banks are on their way. Several tenders are scheduled to take place in 2021. MORIS GROUP is not standing aside from these processes and, as a member of the team (the leader is a top international law firm), also participates in some of the announced tenders.

The tender itself, or more precisely the evaluation of submitted proposals, consists of three stages. At the first stage the experience and capabilities of a participating team and its compliance with formal requirements of the law are analyzed. At the second stage the strategic plan of future services with regard to the prospects and methods of team work is evaluated. The third and decisive stage stipulates evaluation of price proposals from those participants who have successfully come through the first two stages. The valuation method can be described in short like this — the lowest price wins.

The law regarding the liability of bank-related persons certainly needs to be improved. It is impossible to regulate complex issues running into hundreds of billions of hryvnias by means of one paragraph in the law. This will inevitably lead to complex litigations and the absence of results for the Fund. In fact, this is what we are seeing now. The more precise the way that recovery rules and mechanisms are stated, the fewer abuses there will be in the future on the part of unscrupulous bank owners.

I would solve the problem of caused damages by creating an effective mechanism of voluntary compensation of damages in exchange for a certain “discount” of such damages and termination of criminal prosecution of bank owners. I think many would agree. Moreover, it will be much more effective for the state to receive recovery of a part of the damages here and now than to waste time and resources on cases heard in courts around the world.