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Reform of insolvency legislation

The new insolvency law of 2020

by Dr Hans Janus

Berlin/Tbilisi, November 2020

About the German Economic Team Financed by the Federal Ministry for Economics and Energy, the German Economic Team (GET) advises the governments of Moldova, Georgia, Ukraine, Belarus and Uzbekistan on economic policy matters. Furthermore, GET covers specific topics in other countries, such as Armenia. Berlin Economics has been commissioned with the implementation of the consultancy.

C O N T A C T Sebastian Staske, Project Manager Georgia [email protected]

German Economic Team c/o BE Berlin Economics GmbH Schillerstraße 59  10627 Berlin Tel: +49 30 / 20 61 34 64 0 [email protected] www.german-economic-team.com

Our publications are available under https://www.german-economic-team.com/georgia.

About the author Dr Hans Janus worked for more than 30 years for the Euler Hermes AG in the field of state Export Credit Guarantees of the Federal Republic of Germany and was member of the board from 1994 until 2014. From 2003 to 2005 he was President of the Berne Union, the leading association for the global export credit and investment insurance industry. Since 2015 he works as an independent lawyer and business consultant in Hamburg. Hans Janus is a financial expert for Eastern Europe and Central Asia. He is board member of the Ger- man-Russian Lawyers Association. From 2018 until 2020 Hans Janus has been a member of the Super- visory Board of Belarusbank, Minsk. Mr. Janus is the author of various publications in the field of bank- ing law, public business law, international finance and trade law. Also, he is one of the authors of the Banking Law Handbook and editor of the German-Russian Law Review DRRZ. He studied Law and Rus- sian Language at the universities in Bochum, Hamburg and, as a post-graduate, at the Moscow State University (Lomonossov University).

© 2020 Berlin Economics All rights reserved.

Content

Background ...... 1

1 The February 2020 draft law ...... 1

2 Changes to the February 2020 draft law in the legislative process ...... 2

3 Topics for future consideration ...... 3

4 Coming into force and amendments of other legal acts ...... 5

5 Conclusion ...... 5

Background

The German Economic Team (GET) has covered the modernisation of Georgia’s insolvency legislation for many years. Starting with an analysis of Georgia’s 2007 “Law on insolvency proceedings” carried out in 2016, GET came to the conclusion that in the current legislation there are so many shortcomings that a completely new approach would be needed. GET recommended to issue a new insolvency law considering international organisations’ recommendations and based on international best practice.1 With this proposition GET was in full conformity with other domestic and international institutions involved in the assessment of Georgia’s insolvency legislation. In the years 2018 and 2020 draft new insolvency laws have been made. GET has analysed and commented on both of them.2 The assessment included a Technical Note on “Legal grounds for insolvency and order of creditors” and one on “Insol- vency legislation and COVID-19 pandemic”. The 2020 draft law of Georgia “On rehabilitation and col- lective satisfaction of creditors” approved by the Cabinet of Ministers of Georgia on 6 February 20203 went through parliament in September 2020 and has been published on 27 September 2020 in the Legislative Herald of Georgia after the parliament’s final approval. The purpose of this paper is to com- pare the approved legal act with the draft law of 2020, approved by the government in February.

1 The February 2020 draft law

When assessing the February 2020 draft law, GET came to the following results: The 2020 draft law “On rehabilitation and collective satisfaction of creditors”, which is based on the 2018 draft law, would be, if adopted, a quantum leap forward for Georgia’s insolvency legislation. The most substantial change is a complete redirection of philosophy and objectives of insolvency proceed- ings from liquidation of the enterprise to its rehabilitation. Some striking findings in comparison with the law currently in force are: a) With 123 articles the draft law is considerably longer than the law currently in force (51 arti- cles). This fact alone reduces the risk of misunderstandings, vagueness, circumventions etc.

b) The title of the draft law for the first time ever in Georgia mentions rehabilitation as a core objective of insolvency proceedings.

1 Janus, Avoiding the insolvency of Georgia‘s insolvency law, GET Georgia, Policy Briefing No. 03/2016; Janus, Avoiding the insolvency of Georgia’s insolvency law, GET Georgia, Policy Paper No. 01/2016; Saha, Janus, Reform of the insolvency law: A priority for economic policy, GET Georgia, Newsletter No. 9, March-April 2016; Janus, Migriauli, Georgiens schwieriger Weg zu einem modernen Insolvenzrecht, WiRO 2016, p. 336-338. 2 Janus, Draft Law 2020 „On Rehabilitation and Collective Satisfaction of Creditors”: A preliminary assessment, German Economic Team, Technical Note No. 01/2020; Janus, Legal grounds for insolvency and order of creditors: The draft insolvency law of 2020, international best practice and future options for Georgia, German Economic Team, Technical Note No. 03/2020. 3 http://gov.ge/index.php?lang_id=ENG&sec_id=547&info_id=75099.

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c) Purposes and principles have been defined completely different: From asset sale and distribu- tion of proceeds to rehabilitation of the enterprise (Art. 1, 2, 21-42, 69-96). This is an important improvement, positively addressing the main weakness of the current legislation.

d) The newly introduced “regulated arrangement” strengthens the concept of survival of the debtor by offering a pre-insolvency (out-of-court) procedure under the supervision of an in- solvency practitioner (Art. 11, 21, 24).

e) Physical persons are not subject of this draft law (Art. 4). This is different to the draft law of 2018. The draft law does also not apply to banks, non-bank depository corporations and insur- ance companies.

f) The physical continuation of debtor’s business operations can be protected by the court by prohibiting contractors to discontinue their critical services (Art. 57).

g) “Insolvency” and “expected insolvency” remain the grounds for opening insolvency proceed- ings (Art. 6). However, Art. 7 (Concept of insolvency and presumption of insolvency) extends the grounds for opening insolvency proceedings by “assumed insolvency” including, amongst others, insufficient level of assets in relation to aggregate liabilities (over-indebtedness, Ger- man: Überschuldung).

h) The position of “insolvency practitioner” (Art. 11, 12) is being introduced as mandatory, thus addressing one of the most important shortcomings of the current legislation and current in- solvency procedures in Georgia.

i) Creditors’ rights to apply for insolvency procedures (Art. 43) strengthened by abolishment of various previous restrictions (minimum claim amounts, presentation of positive court deci- sions against creditor, applications only jointly by two or three creditors etc.).

j) Important steps of the process will be made public in the “electronic system” (Art. 19) or on the website or the print edition of the Legislative Herald of Georgia.

k) Voidable acts (Art. 65, 66) regulated much more detailed and closer to international standards.

l) The debtor himself can be approved by court as insolvency manager under the control of a supervisor (Art. 64) as new form of rehabilitation management (German: Eigenverwaltung, Schutzschirmverfahren).

m) Cross-border insolvency much more detailed (Art. 111-117).

n) High level of transparency established by manifold obligations to publish important steps of insolvency procedures.

The conclusion of this assessment was: The recommendation to replace the Law on insolvency pro- ceedings by a completely new law has been followed. The new draft law from 2020 is a modern, well structured, transparent and economically sound legislative act.

2 Changes to the February 2020 draft law in the legislative process

There are not only few amendments of the draft law which were included in the text during the legis- lative process. These changes, however, are of minor relevance, at least most of them, or they bring

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the new law in line with other legal acts of Georgia. The more important amendments are the follow- ing:

• Mutual deduction agreements4, based on the law of Georgia “On financial pledge, mutual de- duction and derivatives” are to a large extent excluded from the application of the 2020 insol- vency law5, as laid down in Art. 4 paragraph 3 (new) by the following definition: “Insolvency proceedings or insolvency proceedings against a person participating in a financial pledge pro- vided for by the Law of Georgia on financial pledge, mutual deduction and derivatives shall be conducted in accordance with this Law and the special provisions of the Law of Georgia on financial pledge, mutual deduction and derivatives”. The said law “On financial pledge, mutual deduction and derivatives” has been amended in Art. 4 par. 1, 4, 6 and 7 correspondingly and can be regarded as the more specific legal act (lex specialis) which takes precedence over the insolvency legislation.6 These amendments will enter into force simultaneously with the new 2020 insolvency law. • The new law stipulates in Art. 47 par. 2 and Art. 62 that the issue of declaring an insolvency application admissible shall be considered by the court through an oral hearing, unless the factual circumstances of the case are not disputed. In the February 2020 draft law this has been regulated exactly opposite, i.e. the oral hearing was treated as the exception and not the rule. This provision enhances the transparency of the procedure. • In a regulated agreement procedure this procedure can be terminated even if there is a minor violation of the terms of the agreement. Art. 42 par. 1 b) and par. 7 offer a higher degree of flexibility and a concise definition of what means “minor” in this sense. • There have also been a number of linguistic improvements, clarifications and deletions of re- dundant text.

3 Topics for future consideration

There are some aspects of the new law, which deserve deeper consideration and possibly may lead to amendments in the future, after sufficient experience has been gained with the new law.7 a) The new law does not include a consumer bankruptcy procedure (Art. 4 par. 2 a)). A legal reg- ulation of consumer insolvencies should either follow as separate legal act or be incorporated in the new law.

b) Physical persons acting as “individual entrepreneurs” are excluded from the applicability of the new law (Art. 4 par. 1 a)). It is recommended to re-consider this exemption.

4 Sometimes also translated as “netting agreements” or “offsetting agreements”. 5 Although it is not stated in the law explicitly, it may be assumed, that this exemption applies only to mutual deduction agreements concluded prior to the opening of insolvency proceedings. 6 This preference is of broad and general nature, unless it is clearly evident that a payment or the assumption of an obligation was made with the intention of causing damage to another creditor of the insolvent party. 7 For more details see also Janus, Draft Law 2020 „On Rehabilitation and Collective Satisfaction of Creditors”: A preliminary assessment, GET Georgia, Technical Note No. 01/2020.

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c) Insolvencies of banks and non-bank depository corporations are excluded from the applicabil- ity of the new law (Art. 4 par. 2 c)). Particularly because of the high importance of the financial sector and the enormous impact of insolvencies in this area on the real economy and taking into account the disruptive developments of the global financial crisis of 2008 such possible insolvencies deserve specific legal regulation. The 2019 modernization of chapter VII of the “Law of Georgia on commercial bank activities”8 addresses this need for reform. Whether the amendments made in the banking law are appropriate and sufficient should be analyzed sep- arately. Vast experience of many other countries which have modernised the insolvency legis- lation for the financial sector will help. The National Bank’s regulations on announcing a com- mercial bank insolvent and bankrupt (2003) and on the liquidation of commercial banks (2003 with later amendments) need to be checked whether they are still compatible with the new law.

d) For insurance companies the insolvency regulations are contained in chapter VI of the “Law of Georgia on insurance”. These regulations are from 2013 and thus much older than the new insolvency law. Here as well it should be checked whether they are still compatible with the new law.

e) The over-indebtedness is designed as a refutable legal presumption for the debtor’s insolvency (Art. 7 par. 3 a)). It is worth to be considered whether over-indebtedness should represent a ground for insolvency by itself and consequently has to be inserted in Art. 6 of the new law.

f) Insolvency practitioners (Art. 11, 12) become extremely important for all types of insolvency procedures. The insolvency practitioner can be a qualified, experienced and impartial physical or legal person (Art. 11 par. 2). He can act as bankruptcy manager, as supervisor in the case of a regulated arrangement, as rehabilitation manager or rehabilitation supervisor (Art. 11 par. 3). The authorization of insolvency practitioners will be done by the National Bureau of Enforcement under supervision of the Ministry of Justice. The minimum professional qualifi- cation required and the obligation to preserve/increase professional knowledge need to be clearly regulated. It is strongly recommended to further specify this in a legal regulation on the profession of insolvency practitioners.

g) Voidable acts: clarification in Art. 65 is recommended that omissions (non-actions) by the debtor’s management can be a ground for voidance too and are to be treated equal with ac- tions.

h) Ranking of creditors, regulated in Art. 103-105, and in particular the “waterfall” in Art. 104 could be worded clearer for the purpose of avoiding misinterpretations. The definitions of “preferential claims”, “preferential tax claims” and “non-privileged claim” are better placed in Art. 104, where they had been in the 2018 draft law, than in Art. 3 of the new law, because these terms do not appear in any other place of the law. The abolishment of an unconditional preference of all tax claims follows current international practice. For claims of indirect taxes, however, a certain preference continues to exist.

8 Law of Georgia No 5655 of 20 December 2019 and Law of Georgia No 5682 of 20 December 2019.

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4 Coming into force and amendments of other legal acts

The law “On rehabilitation and collective satisfaction of creditors” will enter into force on 1 April 2021. At the same time a few amendments of other legal acts will enter into force as well. These other legal acts are the law of Georgia “On financial pledge, mutual deduction and derivatives” (see above), the law of Georgia “On entrepreneurs” concerning amendments of enterprises’ registered data and the “Tax code of Georgia”. In the transition period the Ministry of Justice has to ensure that the electronic system for insolvency proceedings, foreseen in Art. 19 has to be established and operational (s. Art. 122). With coming into force of the new law the previous law of Georgia “On insolvency proceed- ings” of 28 March 2007 will lose its validity.

5 Conclusion

The overall positive judgement on the February 2020 draft insolvency law remains valid and fully trans- ferable also to the new legal act “On rehabilitation and collective satisfaction of creditors”. The amend- ments made between February and September are to a large extent of a more technical nature but in sum they improve the quality of the legal act. The major changes have been made in connection with pre-insolvency mutual deduction (offsetting) agreements which are exempt to a large extent from ap- plication of the insolvency law. There are a few aspects which deserve a deeper consideration for pos- sible future amendments of the law. With the coming into force of the new insolvency law a few amendments of other legal acts of Georgia are necessary and the respective law-making decisions have already been taken. With the new Law “On rehabilitation and collective satisfaction of creditors”, Geor- gia will enter a new era of insolvency proceedings, modern, transparent and reflecting international best practice.

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