A Case of a New Bank Bankruptcy Legislation (Bulgaria)

FINANCIAL STABILITY INSTITUTE
Bank for International Settlements

International Seminar on Deposit Insurance
Budapest, November 16 – 17, 2000

A Case of New Bank Bankruptcy Legislation
/Bulgaria/

Presented by
Mileti Mladenov
Chairman of the Management Board
Deposit Insurance Fund
Bulgaria

Deposit Insurance Fund - Bulgaria 2

A Case of New Bank Bankruptcy Legislation
/Bulgaria/

The Bulgarian legislator has traditionally considered the special nature of the
business and legal status of banks as a type of merchant and prescribed special rules
for the legal regime of bank bankruptcies. Under the Law on Banks and Credit
Activity (passed in 1991), and subsequently the Law on Banks (passed in 1997), the
bankruptcy procedure for a bank is regulated in a separate chapter in which special
provisions are established regarding the banks, while for all unsettled issues one
should refer to the general regulation on insolvency under the Law on Commerce.

The special provisions regarding the bankruptcy procedure for banks are aimed at
ensuring the speed of the procedure and increasing control over the trustee’s
activities. Analysis of the practice in applying the Law on Banks shows, however,
that in fact such a speed is not achieved. Moreover, in many cases the trustees of the
banks do not exercise their powers and do not perform their obligations with due
care. Oversight of the trustee’s activity is exercised exclusively by the court. Under
the provisions of the Law on Commerce, the court is the central body to manage
bankruptcy proceedings. It has judicial and administrative functions. Combining
judicial functions with functions of the operational management and control of the
bankruptcy process burdens the court with acts that represent an evaluation of
appropriateness. Such acts, by their essence constitute or represent typical
administrative activity.

The resulting performance of such activity by the court is worse than unsatisfactory.
The activity of operational management and control is not a standard activity for the
courts. It is related to the performance of preliminary in-depth investigation and
examination to ensure the collection of reliable information. The judges do not have
enough time, special training (financial, accounting, etc.), or the appropriate
specialized control mechanism to perform administrative functions adequate to the
volume, peculiarities, and complexity of legal relations that arise when a bank is
declared bankrupt. The current legislative acts do not provide necessary procedures
and mechanisms through which the court should exercise control over the lawful and
suitable performance of the powers of the trustee. These weaknesses of the rules
provided in the Law on Banks regarding the operational control over the trustee’s
activity are also evident in the general rules of the bankruptcy procedure under the
Law on Commerce. In the bankruptcy procedure for banks, however, the negative
impact of these failures is especially strong due to the variety, specificity, and
considerable property value of the rights included in the bank bankruptcy estate.

The Central Bank’s control powers, as well as those of the Deposit Insurance Fund
provided for under the most recent amendments to the Law on Banks (from June
1999), did not lead to a material change in the quality of the bank trustees’ work, as

International Seminar on Deposit Insurance Budapest, November 16 – 17, 2000


the possibility for actual influence of these two controlling bodies on the trustee’s
activities is mediated by the court, which manages the bankruptcy procedure.

Everything stated above leads to the conclusion that the approach used until now in
the regulation of bank bankruptcy is not particularly successful and that a new
special law is needed in which the procedure would be a complete regulation
consistent with the peculiarities of banks as a special type of commercial enterprise.
These peculiarities predetermine a specific legislative approach, not only in
regulating the grounds and procedure for initiating bankruptcy proceedings but also
in providing for the purposes of the procedure, for the bank bankruptcy authorities
and their powers, for the obligations of the bodies to preserve, manage, and enhance
the bankruptcy estate, for the procedure for liquidating the bank’s assets, and for
making the distribution.

The new Draft Law on Bank Bankruptcy attempts to improve the acting regulation,
and where it has been established that this regulation is ineffective, to create a new
regulation. The main points of the Draft are the simplification of the procedures for
liquidation of the bank’s assets, limiting the expenses in the proceedings, and
increasing the effectiveness of the control over the trustee’s acts. The drafters did
not aim at creating a completely different regulation of the bank bankruptcy
procedure compared to the existing one, starting from the assumption that the
regulation of the bankruptcy procedures for the different types of commercial
enterprises should rest on a uniform approach and common principles. In the Draft
are reproduced many provisions of the Law on Commerce, but they are modified to
suit the peculiarities of the bank bankruptcy procedure. The existing approach in the
Law on Banks, to refer to all matters not specifically addressed to the provisions of
the Law on Commerce, is abandoned. When applying the provisions of the Law on
Commerce in practice, considerable difficulties arose due to the contradictory
interpretation and different application of the individual provisions. For this reason
the Draft Law keeps these cross-referrals to a minimum and provides a virtually
complete regulation of the proceedings. Many of the provisions in the new Law are
close to those in the Law on Commerce; the notions regulated in the Law on
Commerce have been used. The Draft Law’s structure is also analogous to the
structure of Part IV of the Law on Commerce. The peculiarities are in the more
detailed regulation concerning the bankruptcy authorities and the procedures for the
liquidation of rights included in the bankruptcy estate. The remaining provisions
reflect the specificities of the bank bankruptcy procedure deriving from their
particular legal regime. The system of bodies managing the bankruptcy procedure
has been restructured.

Despite all specificities in the bankruptcy proceedings for banks, these proceedings
however must remain judicial. The court’s participation in them is inevitable,
inasmuch as where a bank’s license is revoked due to insolvency, as well as in the
process of the bankruptcy proceedings themselves, relations arise that require the
administration of justice. In developing the concept of new bank bankruptcy law a
version was discussed according to which the participation of the bankruptcy court



was totally excluded. This version envisioned the declaration of insolvency and
bankruptcy, as well as the initiation of bankruptcy proceedings, to be made through
an act of the Central Bank (BNB), the BNB and the Deposit Insurance Fund (DIF)
being the bankruptcy authorities. The entire bankruptcy procedure was conceived to
be developed as an administrative one and the eventual legal disputes to be settled
under the general claim procedure and under the procedure of the Civil Procedure
Code. The discussed version was rejected for two reasons at least:

1/ The decision to declare a bank bankrupt with all consequences thereof related to
the termination of the bank’s activity and of its management bodies, as well as with
the initiation of the bankruptcy procedure, changes the bank’s legal status. This
decision has a constitutive effect; it creates a new legal status of the bank and has an
effect on everyone. The decision has an adjudicative effect with respect to the fact
that the bank is in a state of insolvency as from the initial date specified under the
decision and that the bank is bankrupt. The mentioned legal characteristics of the
decision define it to be a judicial act. According to the Constitution of the Republic
of Bulgaria, the court alone may perform judicial functions. As a judicial act, the
decision to declare a bank bankrupt may only be issued by the court.

2/ Additionally, the bankruptcy proceedings, as universal compulsory execution
proceedings, necessitate that certain legal disputes related to these proceedings be
resolved by one and the same judicial authority. Thus integrity and a uniform
approach are ensured in resolving analogous legal cases in the framework of the
proceedings.

Such inherent necessity may not be argued with respect to the performance of
administrative functions by the court. The Draft assigns these functions to the DIF as
a specialized authority for control and management of the activities of bank trustees.
In developing the Draft it was controversial which non-judicial authority should
perform the administrative functions that, under the existing regulation, are
performed by the court. One of the proposals was to envision the creation of a
specialized state agency to be assigned with the administration of the bank
bankruptcy proceedings. It was preferred that these functions were assigned to the
DIF. The principal consideration for this was the relation between this body’s
functions and the bank bankruptcy proceedings. After the revocation of the license
to conduct banking activities, the Fund pays the guaranteed deposit amount to the
bank’s depositors.

The legal status and the powers of the Fund determine it as public institution, whose
basic function is related to the protection of the interests of the banks’ depositors. By
providing control powers to the Fund in bank bankruptcy proceedings, this basic
function is further developed and has its natural continuation in the bank bankruptcy
proceedings. The procedure for decision making by the Fund’s management bodies
as well as the mechanisms for control over this body’s activity, which are provided
for in the Law on Deposit Insurance, stipulate for additional guarantees that within
the bank bankruptcy proceeding the Fund will execute its powers to the best interest



of the depositors and of the other creditors of the bank. The Fund’s powers in the
Draft Law are defined in a way to provide for protection of the rights and obligations
of the creditors of the bank in bankruptcy. In the process of performance of its
controlling powers, the Fund will act to the interest of all the creditors of the bank.
The Fund is a legal entity, created by law. The Fund is not a merchant and its
interests are the interests it has been assigned to protect by the law. The Fund does
not have its own material interests, other than the interests related to the functions it
has been provided for by the law. Under the Draft, the Fund is a controlling body,
analogous to the creditors’ committee in the bankruptcy proceedings for ordinary
commercial enterprises. On the other hand, the DIF is an acting legal entity with
constituted managing bodies, an established administrative apparatus and approved
internal organization regulations. Harmonizing its activity and administrative
structure with the Bank Bankruptcy Law would be significantly easier and more
convenient than creating a new agency requiring funding from the state budget.

Generally the new points of the Bank Bankruptcy Law compared to the current
regulation are the following:

I. Declaring a bank bankrupt has a considerable impact on not just the interests of
the bank’s numerous creditors, but also on the public interest, because a bank’s
bankruptcy damages the confidence of the public in the banking system as a whole.
The damage to the public interest must also be taken into account and protected in
regulating bank bankruptcy proceedings. Therefore, the main goal of the bank
bankruptcy proceedings is formulated differently than the goal of the proceedings
under the Law on Commerce. According to the Draft, the goal of the bank
bankruptcy proceedings places the public interest higher while, without displacing
the interest of creditors, in some cases imposes a restriction, a narrowing of the
possibilities of creditors to protect their rights and interests at the expense of the
speed and effectiveness of the proceedings.

II. The authorities in bank bankruptcy proceedings are the court, the Central Bank,
the Deposit Insurance Fund and the trustees. The functions of these authorities are
regulated, as follows:

1. The court performs only judicial functions: it initiates the bankruptcy
proceedings and declares the bank bankrupt. It considers, as a first instance, the
disputes arising in the bank bankruptcy proceedings: it rules on objections made
against unaccepted or accepted but disputed claims of the bank’s creditors, on the
claims to enhance the bankruptcy estate, on appeals against the other bankruptcy
authorities where such actions can be subject to appeal, on indemnification
claims against the trustee for damages, as well as on other claims provided for in
the Law. The court’s functions are performed under the Civil Procedure Code’s
procedures to the extent that the law does not provide otherwise. The court
approves the list of the claims against the bank.



2. The Deposit Insurance Fund is a specialized body that controls the trustees’
activity. The controlling functions, which under current regulation are performed
by the court, are assigned to the Fund. The criteria by which the Fund exercises
its powers are attaining the goal of the bank bankruptcy proceedings and
protecting the interests of the creditors. The Fund appoints the bank’s trustees
from a list of the trustees kept with the Central Bank and determines their
remuneration. The trustees’ remuneration is determined as a percentage of the
liquidated property of the bank, but not less than the minimum amount
designated in the Law. In order to provide guarantees that the trustees will
perform their obligations with due care, and for the purpose of facilitating the
realization of their liability to the bank’s creditors, a rule is established analogous
to the one under the Law on Commerce. The trustees provide a guarantee for
their management to the Fund. Claims by the bank’s creditors against the trustee
for damages caused on the bankruptcy estate can be collected from the value of
such a guaranty.

The Fund dismisses the trustee where there are one or more of the prerequisites
designated exhaustively in the Law. The Fund may also impose administrative and
penalty sanctions to the trustee.

In order to strictly control the expenses made by the trustee in the bankruptcy
proceedings, it is envisioned that the trustee prepares each month an expense budget,
which is subject to approval by the Fund. This budget includes the ordinary
expenses (remuneration for the personnel, expenses for office supplies, expenses for
preservation and safeguarding the bankruptcy estate, and other similar expenses) as
well as extraordinary expenses – expenses for attorneys, consultants, appraisers, and
others. The Fund is given the possibility to check the implementation of the budget
whenever it deems necessary through the performance of onsite inspections or
through requiring additional information or written explanation from the trustee. The
budget established by the trustee and the monthly report on its implementation is to
be approved by the Fund. If, during the month for which the budget has been
approved, additional and unexpected expenses must be incurred by the trustee, these
expenses can be made only after the prior approval of the Fund. The rule has been
established that all expenses made by the trustee without Fund approval, as well as
the expenses made unlawfully by the trustee, are considered damages caused by the
trustee to the bankruptcy estate, until proven otherwise.

For the purpose of prior control by the Fund over the trustee’s activity of preserving
and managing the bankruptcy estate, the Law provides that some trustee actions may
be performed only after the prior approval of the Fund, such as: disposal of money
funds from accounts of the bankrupt bank; deals or actions with material property
interest; deals or disposal actions against rights of the bankruptcy estate that are not
directed towards their liquidation; the sale of the bank’s assets as a whole;
undertaking of actions to liquidate property rights included in the bankruptcy estate
through a liquidation method designated by the trustee; other actions and deals
provided for in the law.



The Fund can at any time perform onsite inspections and collect information on how
the trustee performs its powers. The creditors, as well as the Central Bank, can
present supported requests to the Fund to perform an inspection on concrete events
or to take measures to discipline the trustee. If the Fund determines on its own or
after notification from the Central Bank, or from a bank’s creditor that a trustee:
-- Breaches the law in performing its powers
-- Does not perform his obligations with due care
-- Harms the creditors’ interests with his activities
-- Unduly delays the bankruptcy procedure

It can enforce disciplinary measures against the trustee such as:

a. Preparing a warning to eliminate breaches of law
b. Oblige him to perform certain actions within a term specified by the Fund
c. Obligate him to cease certain actions or violations
d. Forbid him to perform certain actions or to conclude certain deals
e. Impose a fine on him
f. Reduce his remuneration for a certain period of time
g. Dismiss him from his duties.

The disciplinary measures are undertaken by decision of the Fund’s Management
Board, subject to immediate implementation, and are not subject to judicial appeal
except for the measures under “b”, “e”, and “f”. The adequacy and effectiveness of
the control exercised by the Fund is ensured through regulation of the described
wide range of disciplinary measures over the trustee.

In order to perform subsequent control over the trustee’s activity it is envisioned that
the Fund approves the interim and final distribution accounts prepared by the trustee,
issues orders for assignment, or approves the contracts for sale or other means of
disposing of assets or property rights from the bankruptcy estate.

The Draft envisions the impossibility of court appeal for some of the acts of the
managing bodies of the Fund regarding such administrative powers within the
bankruptcy proceedings, whose exercise require an evaluation of appropriateness –
determination of trustee remuneration, approval of the monthly budget, of the
liquidation program, etc. When performing these powers the Fund acts
independently, guided by the purposes of the bankruptcy proceedings and interests
of the creditors. In these cases, the consideration of to what extent a certain expense
or action of the trustee are appropriate and do not harm the bankruptcy estate is
purely a managerial decision, and such a decision cannot be subject to court control.
This situation corresponds to the Law on Banks’ adopted principle of no judicial
appeal for actions of the Central Bank regarding the performance of its supervision
over the banks’ activities.

III. With regard to the procedure, based on which the bankruptcy proceedings are
developed, the main changes are:



1. It is envisioned that when the trustee assumes the office, it is obligatory to
perform an inventory of the assets and other property rights of the bankrupt bank.
The inventory is performed with the participation of representatives of the Fund.
A copy of the inventory is provided to the Fund. All assets and rights designated
in the inventory are considered given for responsible safekeeping by the bank’s
trustees.

2. Within a specified term after the bank is declared bankrupt, the trustee appoints a
specialized audit company from the list kept with the Central Bank under the
procedure of the Law on Banks to perform a full inventory of the bank’s assets.
The same persons prepare an appraisal subject to approval by the Fund’s
Management Board, which is not subject to judicial appeal. Based on the
appraisal, the trustee undertakes the liquidation of the bank’s property.

3. A new point in the procedure for liquidating estate property is the adoption and
approval of a liquidation plan in which are established the deadlines and
sequence of satisfaction of property rights from the bankruptcy estate. The
liquidation of the banks’ assets is made under a procedure analogous to the
procedure for execution under the Tax Procedure Code. The envisioned
execution procedures in this Code are more modern, flexible, and effective
compared to those in the Civil Procedure Code. The public sale is conducted by
the trustee while the order for assignment is issued by the Fund after ensuring
compliance with the requirements for conducting the relevant liquidation
procedure. The object of the public sale may be individual rights, as well as a
combination of rights or all assets of the bank as a whole. At the request of the
trustee, the Fund approves the chosen liquidation method. If the trustee has not
managed to sell the right or rights that are the object of the auction and if none of
the creditors with approved claims has requested that the right be assigned to it in
payment of such part of its claim as it would have received on distribution of the
bank’s property, the Fund may allow the trustee to perform a sale through direct
negotiation with preliminarily established and approved parameters of the deal.

The Transitional and Final Provisions of the Draft Law excludes its application on
pending bankruptcy proceedings for banks. At present the bank bankruptcy
proceedings are at different stages and it is very difficult, through a transitional
provision, to reflect the peculiarities in each of these proceedings and the effect of
the new regulation to be referred to them. For a part of the closed banks already in
bankruptcy proceedings, the Law on Banks is applied. For some of the banks the
liquidation of the property from the bankruptcy estate has been almost completed,
while for others it has not been started yet. In this case, there is a risk that the
implementation of the new Law on the already bankrupt banks would create
considerable difficulties and delays of the bankruptcy proceedings.


A Case of a New Bank Bankruptcy Legislation (Bulgaria)

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A Case of a New Bank Bankruptcy Legislation (Bulgaria)