The Essence of Sanation as a Bankruptcy Procedure

By Maria GORDIENKO
Vronskiy, Vronskaya & Partners

The On Renewal of Debtor’s Solvency or Its Acknowledgement as a Bankrupt Act of Ukraine foresees four different stages of bankruptcy proceedings: the managing of property, sanation, liquidation and an amicable agreement.

The financial recovery of a debtor can be carried out in two procedures mentioned above – sanation and an amicable agreement. Sanation differs from other legal stages in a bankruptcy proceeding by the list of members and presence of a special mechanism, which is carried out by a special officer on the basis of the sanation plan affirmed by the court. Article 1 of the Act states that sanation is the system of measures which are carried out during proceedings in a bankruptcy case with the aim of preventing the acknowledgement of a debtor as a bankrupt and his liquidation.

Sanation is directed on the recovery of a debtor’s financial position as well as full or partial satisfaction of creditors’ claims by means of loan allocations, restructuring of the enterprise, debts and capital and/or change of organizational legal and production structure of the debtor.

The sanation procedure takes 12 months and can be prolonged for not more than six months. Part 1 of Article 17 of the Act says that prolongation of the term is possible only on petition by the creditors` committee or sanation assignee.

Sanation is introduced by the ruling of a commercial court under the petition of creditors’ committee and follows on the procedure for managing property. In accordance with Part 1 of Article 17 of the Act, the commercial court ruling on the sanation procedure should be passed in term not overriding the validity of the procedure for managing property.

In the sanation procedure it is important to decide three tasks. First, it is necessary to choose the means for debtor’s solvency recovery. Second, to arrange the terms for implementing such means. And, third, to carry out all the tasks which are set and to pay the debts owed to all creditors. On the basis of the above, it is possible to differentiate between types of sanation, unplanned and planned. Unplanned sanation is a set of measures aimed at removing negative legal consequences, carried out by a debtor that was the result of bankruptcy, and also support in the normal economic mode of production and commercial activity of the debtor’s enterprise. Planned sanation is implementation of the planned means of bankruptcy proceedings of a debtor and payment of debts owed to all creditors.

The measures taken to renew a debtor’s solvency in the sanation procedure are listed in Part 2 of Article 18 of the Act. It could be: restructuring of the enterprise, reprofiling, shutting down of unprofitable industries, accounts payable liquidation, part sale of debtor’s property and other measures. The above article includes a wide range of measures but it is not an exhaustive one.

A special place in the process of sanation is occupied by measures of a financial and economic nature, which render financial relations that arise in the process of mobilization and use of internal and external financial sources of recovery of enterprises.

The primary aim of financial sanation is mobilization of financial resources for:

1. Improvement of an enterprise’s solvency and liquidity.

2. Forming the financial capital for the leadthrough of sanation measures of a production and technical nature.

The total capital of an enterprise consists of proper and borrowed assets. Thus, financing of sanation can be carried out due to the own funds of the enterprise (self-finance), financial means of proprietors, by creditors and, in exceptional cases, through the receipt of state sponsorship. Some measures to attract financial resources in the sanation procedure are denoted in Part 2 of Article 18 of the Act. Sanation can be aimed at restructuring assets or restructuring liabilities. Formal signs distinguish two types of sanation:

a) sanation without the involvement of additional financial resources on the enterprise;

b) sanation with the involvement of fresh financial capital. In the first case sanation can be carried out in these forms:

• the recession of nominal capital of the enterprise;
• the conversion of a property in a debt;
• the conversion of a debt in a property;
• the prolongation of the terms of a debt payment;
• the voluntary recession of a debt;
• self-financing.

Sanation with the involvement of fresh financial capital can be carried out in these forms:

• alternative sanation;
• recession of nominal capital with a subsequent increase (two-level sanation);
• irretrievable financial help from the proprietors;
• irretrievable financial help to personnel;
• emission of conversion state bonds;
• involvement of additional loans.

The sources of mobilization of financial resources can be divided into autonomous sanation (own funds of an enterprise and capital of its proprietors) and external sanation (the facilities of creditors and states). An investor’s appearance as a procedural person in a bankruptcy proceeding is possible on condition of an application being filed by the investor for permission to take part in the sanation of a debtor. In accordance with Part 4 of Article 14 of the Act such applications are filed to the property manager. A separate type of enterprise sanation can be selected — with the help of state sponsorship. The financing of sanation measures by the state can be carried out on a turning or irretrievable basis. In addition, in separate cases the state can resort to the indirect methods of sanation assistance of the subjects of management: tax deductions, creation of special terms of entrepreneurial activity, etc.

Sanation measures of an organizational and legal nature are aimed at improving the organizational structure of the enterprise, organizational and legal forms of business, upgrading management, and freeing the enterprise from unproductive production structures as well as improving production relations between members of the works team. In this context sanation can be conducted both with the maintenance of the existing legal status as an enterprise-debtor and with the change of legal form and legal status of the state-owned enterprise (reorganization). The implementation of organizational and economic, financial, legal, technical measures aimed at reorganizing of the enterprise in Article 1 of the Act was named “restructuring”. Sanation without changing the status of the enterprise as a legal entity has forms like debt of the enterprise repayment due to the facilities of a budget, debt of the enterprise repayment due to having a special purpose bank loan, transfer of a debt to another legal entity, bonding and other promissory securities under guarantee of a turnaround company (investor). Sanation with a change of status of the enterprise as a legal entity under sanation has forms like confluence, takeover, division, conversion into an open joint stock company, transfer by lease.

Production and technical sanation measures are related, above all else, to modernizing and updating production funds, with a rise in the quality of production, reduction of technological time, improvement in product quality and fall in its prime cost, improvement in the price, improving the range of products produced, by a search and mobilization of sanation backlogs in the field of production. Because sanation of an enterprise is connected, as a rule, with reducing superfluous personnel, sanation measures of a social nature have a large value, especially if this touches the financial recovery of giant enterprises or cities dependent on large enterprises. In such cases the dismissal of workers can result in social instability in a region. For this reason it follows to conduct a moderate policy of dismissal in unison with implementation of a social plan of the sanation project. Such measures can be foreseen here, like the creation and financing of a system of retraining of shots, search and proposals regarding alternative jobs, additional payments for unemployment, issue loans to dismissed workers and others.

The basic measures of a bankruptcy proceeding: restructuring of the enterprise, reprofiling, closing down unprofitable production, and recovering the creditor debt, sell off of a part of the property of a debtor, fulfilling the commitments of a debtor by a proprietor or investor, sale of the debtor property as an integral property complex and other efforts.

The sanation process is not possible without restructuring of debts. Restructuring of debts is preparation and implementation of a number of agreements between the enterprise, its creditors and debtors, where an enterprise looks for the possibility of receipt of certain concessions from the creditors: reduction in the size of the debt, debiting of interest, a reduction in interest rates, postponement or arranging of payment in installments without the approval of penalties and the like.

Though the problem of enterprise debt is very acute, most issues can be resolved if they are examined gradually. That is why at the first stage of the debt restructuring process a competent study of the state of matters of the enterprise is needed. That is, the size of the debt, terms of its redemption, interest rates. In addition, an enterprise must total up the sum claimed from debtors. As a result of a careful and thorough study of this information, the size of the real credit arrears can be reduced considerably.

The choice of a specific measure of financial recovery of a debtor depends on a series of factors: type of production, presence of social sphere, depletion of fixed assets, sum of credit backlog, organizational and legal form of the debtor and other similar factors.

Thus, the sanation process actually combines in itself financial sanation and production and economic restructuring. The latter is impossible without the leadthrough of valuable and all-embracing financial sanation. On the other hand, financial sanation will not be effective and will not be able to ensure positive changes for a long period without the leadthrough of proper measures on restructuring.