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Closing of nonviable enterprises that do not have prospects for further development plays an important role in the process of planned economy transformation into a market economy. It should prevent unnecessary expenses caused by unprofitable and unreasonable operational activities. Such resources as land plots, equipment and machinery should not remain unutilized (as it is now) at the unprofitable enterprises. This concerns highly educated specialist as well. Their capacity and skills should be reorganized to meet the needs of the national economy. Those parts of the enterprise that are capable to undergo reorganization and the basic production facilities should be separated form the dead production facilities and parts of enterprises and “returned to life”.

At late 1999 a new legal act on bankruptcy was adopted that stipulates creation of the Agency for prevention of bankruptcy. The Agency should conduct the reorganization and improve position of potential bankrupt enterprises. In addition, the reorganization of such enterprises should be financially supported. And finally, the government bodies and the State Treasury should be bound to release the enterprises from a portion of their liabilities.

Just the last item is very important for the countries of Central and Eastern Europe, in which non-payments of taxes and non-payments for consumed electric power is a common practice in critical situation. This results in such increase in the amount of penalties for non-payments and such increase in the accumulated debts that repayment of the penalties and debts in the reorganization process seems unrealistic.

In this connection the following questions concerning the privatization process in Ukraine are emerging:

• How to succeed in the restructuring of Ukrainian industries?
• Is it possible to privatize enterprises that are now in the state ownership?
• How to increase competitiveness of the fully or partially privatized enterprises?
• What is the role of the liquidation of enterprises in privatization process? Do the existing now bankruptcy law and enterprises’ bankruptcy procedure and practice fit the process adequately?
  In market economy enterprises are competitive only when they are able to meet competition at the international level. They should not work at a loss or exist at the expense of subsidies. In addition, to be competitive or get chance to become competitive their structure should be adjusted to meet the requirements of market economy. Only in such way they may become interesting for investor in the course of the money-driven privatization. This means that there is a necessity to restructure all originally state-owned enterprises to ensure their long-term viability.
  
  Restructuring Process
  
  Regarded in the time aspect, the restructuring process may be divided into two subsequent steps associated with different strategies.

  Stabilization of an enterprise (which is often defined as quick restructuring) should make it possible to ensure viability of an enterprise in a short period of time. The second phase, that is a strategic restructuring, is intended for a long term. Its objective is to ensure long-term competitiveness of an enterprise.

  The stabilization means implementation of long-term measures aimed at quick improvement of general situation at the enterprises without significant costs. These measures include maximization of productive efficiency of the existing equipment without cash expenditures or by the attraction of a small amount of financial resources, i.e. without attraction of investments. They also include measures to improve liquidity of an enterprise, i.e. reduction of stock reserves, sale of the part of property and decrease in liabilities. In addition, to increase sales and to decrease expenses the number of redundant staff should be reduced. And finally, in the frames of stabilization short-term and quick actions to improve product quality are implemented.

  Real, or strategic restructuring means the establishment of the potential necessary to ensure a long-term efficient operation of the enterprise and to make it competitive for a long period of time. The restructuring includes not only the improvement or replacement of obsolete equipment through investment but improvement of technological processes, introduction of new types of products and search for additional fields of business activities as well. It is also necessary to establish new management bodies and institutions.

  
  Corporate Governance in Restructuring
  
  Those who are interested in restructuring and improvement of the position of the enterprise should have influence on the painful restructuring process. Such form of influence is called “Corporate Governance” in the USA. Corporate Governance implies the influence on the enterprise through:
• the owner who has a right of disposal and is interested in maximum increase of its capital investment and profit;
• the large majority of the shareholders who are interested in the success of the enterprise and increase of its importance;
• a threat to hand over the enterprise to the competitors when the shares price is low because the Board of directors is not capable to successfully manage the enterprise;
• through the law that envisages the possibility to bring an action for bankruptcy of an enterprise (bankruptcy proceedings) and its liquidation in case of poor management.
  These are the factors that make it possible to put pressure upon the board of directors in order to restructure the enterprise with the goal to make it successful.
  
  Liquidation and Bankruptcy
  
  To consider the topic “liquidation and bankruptcy” it is necessary to clarify the meaning of some terms. In our case liquidation means stopping operation of an enterprise, its closing and shutdown voluntarily or by the decision of the shareholders. An enterprise may be liquidated without bringing an action for bankruptcy.

  Bankruptcy means legal enforcement actions in the frames of the juridical proceedings in order to satisfy to the fullest extent the claims of creditors in case when there are complications with payments, i.e. the enterprise is insolvent. Present laws on bankruptcy protect not only the interests of creditors but interests of a joint-stock company as well, consisting in the reorganization of the enterprise and accordingly, retention of jobs which are very important for national economy. To bring an action for bankruptcy it is necessary to state the reasons for bankruptcy of a debtor, for example its insolvency and net debt. Bankruptcy does not compulsory lead to the liquidation of the enterprise. In addition, even a viable enterprise may be found in the state of bankruptcy.

  In the functioning market economy the bringing of actions for insolvency and bankruptcy of the enterprise may cause the liquidation of the enterprise in the majority of cases. There are legal norms for cases of insolvency, bankruptcy and composition to prevent bankruptcy regulating the liquidation of enterprises that were not able to successfully withstand competition and failed. In Germany there are two reasons for bringing an action of bankruptcy: net debts of the enterprise (when there is not enough property at the enterprise to repay debts) and insolvency. When the case for bankruptcy is started an independent trustee in bankruptcy or of bankrupt’s assets is appointed. He is independent in the management of the case, he manages the insolvent enterprise during the legal proceedings and he, however, is responsible only to commission of creditors. Forfeiture of the debtor’s assets and complete satisfaction of the creditors’ claims through the sale of the existing objects of property is a classical aim of the case of bankruptcy. Advanced laws on bankruptcy are also aimed at attempts to save (to reorganize) enterprises in order to minimize the damages to the national economy and the number of lost jobs.

  
  Advantages and Drawbacks of Bankruptcy Proceedings
  
  There are some advantages and drawbacks in the bankruptcy and insolvency proceedings. The drawbacks include the fact that the reorganization of an enterprise begins too late and only when the critical situation is highly developed. Thus, in the majority of cases only liquidation (i.e. the closure of an enterprise) is possible. In addition, the fact that the trustee of bankrupt’s assets acts usually in the interests of creditors and not in the interests of the national economy is also a shortcoming. This often results in the splitting-up of the enterprise in order to sell it and to repay at least the part of debts. The better solution might be to reorganize the enterprise and to save it.

  The situation of corporate governance that is created through the appointment of the trustee of bankrupt’s assets is the advantage of this regulated by the law process. The trustee has an influence on the preceding management body to take necessary steps concerning the sale of the property that is still at the disposal of the enterprise and the reorganization of the enterprise if he would like to do it.

  
  Liquidation of Enterprises in Eastern Germany
  
  During the transformation process in Eastern Germany the (nonviable) unprofitable enterprises that had not had prospects for development were liquidated at the early stage of privatization process. Treuhandanstalt, the Agency responsible for privatization, was implementing it in the following way.

  At first, all East German enterprises have been incorporated. Sectoral Directorates became responsible for the enterprises in their sectors of economy. They undertook the rights and obligations of the 100% shareholder.

  Treuhandanstalt introduced the practice of inspection of enterprises’ capability to be reorganized and liquidation of nonviable enterprises. Treuhandanstalt was organized in such way that its sectoral directorates had tasks to stabilize their enterprises and prepare privatization of them within the frames of the corporate governance. For this purpose large firms and integrated plants were divided into smaller units. This made it possible to make them eligible for privatization and to sell them.

  In addition to this, the enterprises’ viability (capability for reorganization and future development) was appraised by the independent Steering Committee consisting of experts and economic inspectors. These experts analyzed and assessed the concepts of the enterprise development elaborated by the enterprises, gave and advisory opinion concerning restructuring and determined whether the enterprise may be reorganized or not.

  The firms that were recognized by the experts as (nonviable) those with no prospects for development or not eligible for reorganization were to be transferred from the sectoral directorate to the directorate “Abwicklong”.

  Directorate “Abwicklong” had a task to find the most acceptable way for closing the enterprise (i.e. to chose whether it will be done through liquidation or through bankruptcy) and carry out liquidation or final closing of the enterprise.

  
  Examination of the Enterprises’ Viability
  
  Examination of the capability of the enterprises to be reorganized and improve their position was conducted according to the precise plan based on the concept of the enterprise development. The concepts of development submitted by enterprises had to include several components:
• description of the enterprise;
• analysis of the enterprise’s position;
• the basic scheme for its further development;
• measures for further management or reorganization;
• proofs that the enterprise is capable to finance the concept.
• The Steering Committee has also analyzed enterprises according to the clear plan and by the following criteria:
• description and evaluation of the commercial system of the enterprise;
• estimation of the situation with earnings and expenditures;
• assessment of the targeted results as well as the property and financial situation;
• description and assessment of the previous attempts to privatize the enterprise;
• advisory opinion of the group of experts and Steering Committee;
• general assessment in the form of gradation.
  In addition, the assessed enterprises were divided by the Grades given below:

  Grade 1. The enterprise is profitable. There is no need to reorganize it. It should be quickly privatized.

  Grade 2. The enterprise will become profitable in ….... There is a little need to reorganize it. It should be quickly privatized.

  Grade 3. The submitted concept of the enterprise development seems to be successful.

  Grade 3.1. The sectoral directorate should compulsory attract an investor, otherwise the enterprise will be in the situation corresponding Grades 5 or 6.

  Grade 3.1.1. The enterprise needs small amount of working capital to hold out for a period until it is privatized. The sectoral directorate should find an investor during a certain period of time.

  Grade 3.2. The concept of the enterprise development seems to be successful even without attraction of investor. Regardless of this the enterprise should be privatized.

  Grade 4. It seems possible to reorganize the enterprise and to improve its position. However, the concept of the enterprise should be more thoroughly elaborated. Alternative concepts should be elaborated.

  Grade 4.1. It seems possible to save the whole enterprise.

  Grade 4.2. There is a possibility to save the important parts (structures) of the enterprise.

  Grade 5. The capability of the enterprise to improve its position is quite doubtful. It is necessary to additionally analyze the enterprise.

  Grade 6. The enterprise cannot be reorganized in order to improve its position. It is necessary to make a decision on bringing an action for bankruptcy or compulsory liquidation.

  
  Results achieved in Eastern Germany
  
  Due to Treuhandanstalt’s approach demonstrated above the following results were achieved during the transformation process in Eastern Germany in 1991—1995.

  At the beginning of the process, nearly 8000 enterprises passed into the hands of Treuhandanstalt. Their number grew up to 12000 through breaking into smaller units and division.

  Sectoral directorates have prepared the enterprises to privatization through the stabilization measures and by breaking them into smaller units. At the same time the directorates conducted the preliminary examinations of the concepts of the enterprises development worked out by the Boards of directors, which were afterwards submitted to the Steering Committee. The sectoral directorates liquidated some enterprises or part of the enterprise to cover the expenses incurred in the course of the enterprise reformation and to make the financial position of the enterprise tolerable for its subsequent privatization. In case of unsuccessful management the sectoral directorate substituted the Board of directors.

  Nearly 2/3 of the enterprises became the property of investors through privatization. Due to the policy of Treuhandanstalt to sell the enterprise to one investor if possible, the investors got a possibility to exert a real influence on the enterprises, i.e. Corporate Governance. They made accessible for the enterprises the markets and know-how that were known to them and backed the investments. However, they had to carry out a real, strategic restructuring.

  Nearly 30% of enterprises (that accounts for 3700) were considered as nonviable (those that do not have prospects for development). At the early stage of the transformation process they were transferred to “Abwicklong” for liquidation. This was a painful procedure but it made it possible to escape a long period of struggling for survival which might be caused by the senseless attempts of the board of directors to reorganize the enterprise and to prevent the waste of the economically important resources.

  The task to sell assets and to close enterprises was set before the liquidators. However, special attention was paid to the attempts to separate and save those parts of enterprises that could be reorganized and updated. Nearly 30% of the initial number of jobs at these enterprises have been retained in such way.

  German experience in the liquidation of non-viable enterprises that were not capable to undergo reorganization shows the following:

• Centralized examination of the viability of the enterprises made it possible to identify nonviable enterprises (that were not capable to undergo reorganization and updating) at the early stage and by this saved resources;
• Liquidation of enterprises instead of bankruptcy proceedings made it possible for Treuhandanstalt to remain “the master of the process” and to ensure interests of the national economy, in particular, to save the viable (capable to undergo reorganization) parts of the enterprises;
• Nearly 30% of the jobs at the overall liquidated enterprises have been retained through partial reorganization/partial privatization during the liquidation process;
• The threat “to transfer enterprises to Abwicklong” positively affected the activities of the sectoral directorates. This threat forced the boards of directors of the enterprises and the sectoral directorates to concentrate their efforts on the reorganization of enterprises.
  
  Liquidation and Mass Privatization
  
  During mass privatization in the other countries of Eastern Europe and at the early stage of privatization in Ukraine the assessment of the viability of enterprises was not conducted in the privatization process. After the incorporation, the enterprises were privatized for vouchers. Such privatization has not resulted in creation of the influential majority of the shareholders (Corporate Governance) who would be interested in the starting of the painful restructuring process. These enterprises competed in the market though they had the old, nonproductive structure. The market was the first to test their viability. Therefore, the liquidation of enterprises (in case the bankruptcy law existed and was actually applied) took place at the later stage of privatization. Restructuring of enterprises in case of bringing actions for bankruptcy (that is the usual goal in the West and it is frequently successfully accomplished) takes place even more seldom. Thus, nonviable enterprises are identified at a very late stage and therefore, this action is not efficient.
  
  Guidelines for the Further Actions in Ukraine
  
  Based on the experience of East Germany and other countries of Eastern Europe the following guidelines may be identified for the discussion within the framework of the transformation process in Ukraine:
• The state-owned enterprises of the former planned economies should be restructured to make them competitive;
• Enterprises the only way out for which is liquidation will be also identified in Ukraine;
• Only the perfect bankruptcy law will resolve the problem concerning necessary restructuring of industries but only in case it is really put into force and applied;
• Determined application of the bankruptcy law and a threat to bring actions for bankruptcy may serve as means of pressure to force enterprises and their boards of directors to achieve success, to ensure Corporate Governance, to release enterprises from debts and to restructure privatized enterprises that were not successful.
• Trustees in bankrupt’s assets should be highly educated, take firm position and strictly supervise the process through the courts or central institutions consisting of the respective experts;
• To implement quick and efficient restructuring of industries that still are not privatized it would be useful for Ukraine to follow the experience of East Germany, i.e. to conduct centralized assessment of the enterprises’ viability by the experts applying a systematic analysis after the pattern introduced by Treuhandanstalt. Thus, even under the corporate management it is possible to have more influence on the enterprises and their boards of directors concerning organization and implementation of the restructuring measures. After all, the identification of nonviable enterprises and their liquidation might take place at the early stage;
• Such approach could be useful in preparation and formation of the team of qualified independent trustees of bankrupt’s assets.

Copyright© 2000, The Ukrainian Economic Monitor