Enhancing of Efficiency of Enterprises Bankruptcy Process in Lithuania

Enhancing of Efficiency of Enterprises Bankruptcy Process in Lithuania

Vytautas Juščius

KlaipedaUniversity

E-mail:

Legal institution of bankruptcy in different forms exists in all the market economies, however, by being a legal institution bankruptcy is firstly an economic tool, which helps markets to get rid-off inefficient firms and reallocate the assets of insolvent debtors.

There is private creditor-debtor law which allows the creditors to collect the assets of the debtors and at the same time, helps to achieve the same aims as bankruptcy. By definition the private law is usually more economically efficient than the public one. Only the failure of the private law should allow using of regulations. Why then at some point this private creditor-debtor law should not be applicable any more and unified state-regulated bankruptcy procedure should step in? What should be the aims and essence of this unified bankruptcy procedure?

Lawyers often forget these essential questions. Especially this is notable in the so-called countries of transition economies with no traditions of market economic relationships. As a transition economy Lithuania is not an exemption. From 11 March 1990 when Lithuania recovered its independence, the country started the transformation of the economy from plan to the market. For that the efficient bankruptcy system was started to create.

Lithuanian Law on Enterprise Bankruptcy

The first Lithuanian Law on Enterprise Bankruptcy was introduced in 1992. After its introduction during the five years the law was amended and supplemented several times. In 1997 the major amendment resulted in completely new version of the law. And this new version was already subject to several amendments.

The purpose of the Law was regulate enterprise bankruptcy procedures and applyed to all enterprises, public institutions, banks and credit unions (enterprises), registered in Lithuania in the manner set forth by the laws of the Republic of Lithuania. Some peculiarities of bankruptcy procedures implemented in banks, credit unions, insurance companies, agricultural enterprises, brokerage firms, investment companies and other enterprises and institutions were specified by other laws regulating the activities of said enterprises and institutions. In 2001 the Law on Restructuring of Enterprises providing the alternative procedure for the insolvent companies was introduced.

Under effectual legal acts of Lithuania the definition of insolvency is used only speaking about legal entities. Legal acts regulating bankruptcy of natural persons is going to be draftedfollowing the best world practice.

According to the Enterprise Bankruptcy Law an insolvency is the state of an enterprise when it fails to settle with the creditor/creditors after the lapse of three month from the deadline prescribed by laws, other legal acts as well as by agreements between a creditor and the enterprise, or upon expiry of the said time period after the creditor/creditors demands/demand the discharge of the obligations where the deadline has not been set in the agreement, and the overdue obligations/debts are in excess of over a half of the value of the assets on the enterprise’s balance.

The purpose of bankruptcyproceedings is: to ensure a uniform treatment of requirements of creditors and satisfy requirements of creditors after having realized a debtor’s assets in the order established by laws.

The aim of the restructuring procedure is: to capacitate enterprises that have temporary financial embarrassments and that have not seized their economic – commercial activity to maintain, develop the activity, repay obligations, renew solvency and avoid bankruptcy.

Under effectual laws, restructuring, as insolvency proceeding, may only be formal. Bankruptcyproceedings can be both formal and informal. Bankruptcy proceedings may be enacted not following judicial order if there are no cases in court wherein there are material claims including claims regarding labour relations, also if an enterprise is not being levied under enforceable instruments issued by courts or other institutions.

There are two equivalents of formal insolvency proceedings for administration purposes in Lithuania – restructuring and making a composition with creditors in bankruptcy proceedings. Formal insolvency proceeding for liquidation purposes is declaration of bankruptcy of an enterprise and its liquidation

The main provisions on bankruptcy proceedings are contained in the Enterprise Bankruptcy Law (Įmonių bankroto įstatymas) No. IX-216 (20 March 2001) that came into force on 1 July 2001. The previous Law on Enterprise Bankruptcy No. VIII-270 (17 June 1997) remains applicable to bankruptcy proceedings that opened under it, and with respect to extra-judicial bankruptcy proceedings initiated prior to 1 July 2001. In the same way, proceedings opened under the 1993 law and still pending would be governed by its rules. In addition, the Law on Restructuring of Enterprises (Įmonių restruktūrizavimo įstatymas) No IX-218 (20 March 2001), which also became effective in July 2001, regulates restructuring of enterprises and public agencies in temporary financial difficulties with the goal of averting liquidation. Certain aspects of bankruptcy procedures are regulated in the Civil Code, while proceedings of commercial banks, credit unions and insurance companies are governed in part by other laws.This dynamics of bankruptcy system with the need to follow the often changes of the legal regime and not covered by a single concept stresses to concentrate at the legal side.

The process of bankruptcy in Lithuania has been slow and inefficient since the beginning, while the pace of filings continues to outflank closings, leading to an ever increasing backlog of bankruptcy cases and congestion in the courts.Filings have increased at an annual rate of roughly 2 to 2.5 times, significantly outpacing the administration and closing of cases. The rise in filings in 1997 was due mainly to the adoption of a new Law on Enterprise Bankruptcy in 1997 containing provisions for compulsory filing or announcement of insolvency, while, in 1998-99, the increase was due in part to the Russian financial crisis that resulted in a contraction of Lithuania’s exports to the CIS countries, and had a heavy impact on trade enterprises and import growth (Purlys, Rainys, 2001).

A new Enterprise Restructuring Law became effective in July 2001. The new law regulates restructuring of enterprises and public agencies in temporary financial difficulties with the goal of averting liquidation. Under the old law, amicable settlements and creditor compromises were possible. Between 1993-2000, of the cases closed, only 4 of these involved reorganization, while 7 were compromise arrangements, and 14 concluded amicable settlements. Although there are many cases that could potentially benefit from restructuring, as of November 2001, only two cases have been filed under the new law, both initiated by Turto Bankas. A growing consensus considers the new law unworkable and unfavorable to creditors. Administrators negotiate with the management for their duties and compensation. Duties to creditors are either unclear or conflicted. The process has been hampered by a lack of clear guidance on rules and procedures, lack of training and understanding by relevant players, and misperceptions.

The new law facilitates an accelerated restructuring and approval process. A restructuring plan may be drawn up prior to the filing in the court of a petition to initiate the enterprise restructuring proceedings. In this case, enterprise management or a representative of the creditors files the plan contemporaneously with the petition to initiate the enterprise restructuring proceedings, together with evidence of the plan’s acceptance by the creditors, a decision of the managing body of the enterprise, and an opinion of an independent expert about plan feasibility and implementation measures. After receipt of these documents, the court approves or disapproves the restructuring plan of the enterprise within 15 calendar days. Otherwise, the plan process and requirements are generally consistent with international best practice and contain features of a modern corporate rehabilitation system.

The Law on Courts sets out the basic structure for the court system in Lithuania. Insolvency cases are handled by the civil law section of one of five District Courts. Judges have little training in commercial matters, or in the specialized areas on bankruptcy and restructuring. Though they acknowledge that specialization would enhance efficiency, judges oppose it because they view bankruptcy cases as boring and an administrative burden. The role of the district court judge in a bankruptcy case is limited to approving the administrators’ and creditors’ actions, resolving claims, and other almost clerical tasks. Issues of fairness are not decided by them. In a restructuring proceeding, the judge initiates and closes restructuring proceedings, appoints an administrator to prepare the plan, ensures appropriate notice to creditors, certifies approval of the plan, and generally oversees the restructuring process, but has no input into the process. Requests to open a criminal investigation against an officer of the debtor are directed to the prosecutor’s office. Further education regarding bankruptcy cases and the role of judges may promote specialization, and thus efficiency.

Decision-making in bankruptcy cases is fragmented and complicated by multiple insolvency laws contemporaneously in effect. All court decisions, including rulings of the Supreme Court, are not binding on any court for purposes of deciding future cases even on the same issues. The exception to this general rule is that the Senate of Judges (composed of the judges of the Supreme Court) can by its vote determine that a particular ruling is of such general applicability and importance that it will be binding on lower courts. The Supreme Court has in the past assembled collections of its decisions in particular areas, to guide, but not bind, other judges. Some of the District Courts also collect and distribute decisions in particular areas for guidance and informal education of the judges in the District Court. Although some District Court also collect bankruptcy decisions in their particular courts, the process would be aided by aggregating decisions and experience from all such courts.

The implementation of the Government restructuring and bankruptcy policy in Lithuania

Institutions involved into bankruptcy process are : Department of Enterprise Bankruptcy Management under the Ministry of Economy, National Association of Business Administrators, National Association of Bankruptcy Administrators, The State Social Insurance Fund Board, State Tax Inspectorate.

The Ministry of Economyis responsible for the the implementation of the Programme for Enterprise Restructuring and Bankruptcy aiming to reduce the number of companies in temporary financial difficulties and still continuing their business activities, and to speed up the bankruptcy processes of insolvent enterprises.

The way to achieve this goal is to use the measures of improvement of the legal and economic environment as well as organisational measures for implementation of the laws and accompanying legislation. Legal and economic measures mean improvement of legal framework in the area of company restructuring and bankruptcy. The main measures are as follows:

• amendments to the Enterprise Bankruptcy Law and the Law on the Restructuring of Enterprises adopted in 2003 in order to adjust these laws to the provisions of the Labour Code, and the opportunity to launch bankruptcy proceedings for companies that are in arrears on wages to their employees;

• the amended Procedure for Submitting and Publishing the Data on Enterprises under Restructuring and the Process of Restructuring, Procedure for Authorising Natural and Legal Persons to Provide Services of Enterprise Bankruptcy and Restructuring Administration as well as the adopted Procedure for Agreeing on the Candidacy of the Administrator of Enterprises in Bankruptcy and Bankrupt Enterprises.

Organisational measures:

• The international Phare project LT 0002.01 Promotion of Competetiveness /Enforcement of Financial Discipline for Enterprises was implemented in the Ministry from 4 April 2002 to 30 September 2003 (Phare project LT 0002.01). One of the composite parts of the project was bankruptcy and enterprise management. Around 50 per cent of the output of the project was targeted at the improvement of the processes of bankruptcy and restructuring in Lithuania . The project gave the following outputs:

• Supplementing provisions proposed to the bankruptcy and restructuring laws;

• Comparative analysis of insolvency processes was done in line with the best in the EU ( Denmark , Ireland and UK and Hungary ). These countries were chosen because experts believed that they best reflected the similarities and differences between bankruptcy and restructuring processes;

• Analysis of the performance specifics of judges and institutions administering insolvency processes, and proposals submitted on the improvement of the performance thereof;

• Sixty judges and 150 other experts from the Enterprise Bankruptcy Management Department under the Ministry, State Tax Inspectorate, SoDra and company administrators took part in training and seminars dedicated to bankruptcy and restructuring issues. Twelve representatives of different institutions went on a study tour to Ireland ;

• Around 50 participants from the Ministry, State Tax Inspectorate, Lithuanian Confederation of Industrialists and other institutions took part in training on financial enterprise management;

• Methodology for restructuring enterprises was introduced, serving as an outline for restructuring plans of companies of all types and industries;

• Guidelines for enterprise bankruptcy and restructuring management have been prepared embracing laws, principal accompanying legislation of the laws and examples of documents needed for these processes.

Key tasks of the Department of Enterprise Bankruptcy Management under the Ministry of Economy (hereinafter referred to as DEBM) include implementation of the Government policy in the activity, restructuring and bankruptcy areas of loss-making enterprises, activity analysis of enterprises undergoing the processes of restructuring and bankruptcy as well as bankrupt enterprises. Furthermore, DEBM implements supervision and control of the aforementioned enterprises within the powers granted by the Government and/or the Ministry of Economy.
Within the process of problem analyses and decision-making DEBM follows the principle of improving business conditions thus pursuing the following targets:To make the conditions for ineffectively operating economic entities as well as those willing to terminate their operation to withdraw from the market; and to restructure the viable economic entities by the process of decentralisation and commercialisation.

The Bankruptcy Management Department of the Ministry of Economy, the primary regulator for administrators, lacks capacity to effectively implement and monitor the system. The Bankruptcy Management Department is responsible to ensure that administrators comply with the requirements of relevant laws and court decisions, and execute resolutions of the meetings of creditors and creditors committees.The Department lacks the necessary staffing to carry out this supervisory function on a large scale and systematic basis; rather, it responds to complaints lodged with it by participants in the proceedings. Another responsibility of the Department is to establish the licensing standards and criteria and to administer professional examinations for prospective administrators.

Qualification standards and licensing procedures are inadequate and result in the licensing of professionals that are ill-equipped to handle the duties of an administrator.The “Commission for Certification of Administrators” has been qualifying administrators and issuing the license necessary for appointment as an administrator since 1997. The qualifying test, generally preceded by a preparatory training course, does not address management or other practical skills often required for handling insolvency matters, and does not require an adequate understanding of the law. The Commission has the authority to request MoE to revoke an administrators license if the administrator violates the terms of any legal act, or the ethics code. An administrator’s license may be revoked for other reasons relating primarily to formal qualifications to act in this capacity.

Restructuring administrators are responsible for supervising the debtor enterprise during the period when the restructuring plan is being prepared, and in law are accountable to the enterprise or the creditors for any damage their actions cause. However, the concept of damage by such a professional is not well-developed in Lithuania, and the administrators are not required to either post bonds or, unlike accounting professionals, carry professional liability insurance. Judges complain that administrators lack the requisite knowledge of the law, forcing judges to handle routine tasks administrators. Results have been more positive where the administrator is a legal entity that engages a number of different professionals (including some lawyers). Even among legal entities, however, the level of skills and services provided is inconsistent (Bivainis, Garškaitė ,2006)

On 1 July, 2006 the number of legal persons entered in the Register of Legal Persons amounted to 285 568, including 116 848 (i.e. 40.9 per cent) that had been removed from the register. During the period from 1993 till 1 July, 2006 bankruptcy has been instituted in 4910 enterprises, this number accounted for 1.4 per cent of the total number of legal persons registered. In 4712 enterprises the bankruptcy proceedings have been instituted in court while 198 enterprises have been subjected to extrajudicial bankruptcy procedures. Bankruptcy procedures have already been completed in 3578 enterprises; this number accounts for 72,9 per cent of the total number of enterprises in bankruptcy and bankrupt enterprises. Of that number, 3502 enterprises have been liquidated, 3 have been reorganised, 14 have been sanified and in 59 enterprises the bankruptcy procedures have been terminated or composition with the creditors have been concluded. In 1332 enterprises the bankruptcy procedures are still in progress: 844 enterprises are under liquidation procedures, 2 are being sanified and in 486 enterprises a decision concerning the execution of bankruptcy procedures has not been adopted yet (Department of Enterprise Bankruptcy Management, 2007)

The existing bankruptcy procedure usually lasts for two (40%) or three (30%) years. In 2002, 6% of bankrupt enterprises completed their bankruptcy procedures in one-year period and in 2003 - 11,1%. Recent tendencies have shown that the number of completed bankruptcy procedures has increased nearly twice. This clearly demonstrates that the enterprise bankruptcy process is getting shorter and faster.

Over I half-year, 2007 bankruptcy procedures have been instituted in 404 enterprises, which the LTL 116.6 million creditors’ claims allowed by the court (in case of extrajudicial bankruptcy process – by the creditors’ meeting). In the beginning of bankruptcy processes debt of all enterprises in bankruptcy and bankrupt enterprises to their creditors amounted to LTL 8712.6 million. During the period from 2002 till 1 July 2006, the share of creditors’ claims per one bankruptcy procedure decreased. In 2002, the average share of creditors’ claims made up LTL 1.6 million, in 2003 – LTL 1.2 million, in 2004 – LTL 0.8 million, 2005 – LTL 0.6 million while in I half-year 2006 – only LTL 0.3 million (Department of Enterprise Bankruptcy Management, 2007).