Right of trust in Ukraine. What are the implications of this right for citizens and businesses

Right of trust in Ukraine. What are the implications of this right for citizens and businesses

Right of trust in Ukraine. What are the implications of this right for citizens and businesses

On 11 October 2019, the President of Ukraine signed Law No. 132-IX (hereinafter - the “Law”) that establishes security trust as a new security instrument. Security trust is aimed at minimizing the security-related risks of creditors, allowing them to get around obstacles with conventional security instruments in Ukraine, such as pledges and mortgages. Upon default, a trustee may sell property under trust ownership without restrictions. Debtor property under trust ownership is not included in the estate being liquidated; thus, the commencement of a debtor’s liquidation procedure must not prevent foreclosure of assets under trust ownership. The Law also provides that the moratorium on foreclosure of residential real estate does not apply to security trust.

Under the security trust agreement, the settler of the trust (debtor) transfers its property to a trustee (creditor) to secure the principal obligation under a credit (loan) agreement. Once trust ownership has become effective, the legal title to the property is transferred to a trustee.

What is the essence of security trust?

Security trust is both a measure of securing the fulfillment of obligations and a special type of property right.

The obligations under a credit (loan) agreement can be secured by the security trust. The parties shall enter into a written agreement to establish trust property ( if real estate is transferred to the trust, the agreement shall be notarized). According to this agreement, the settler of the trust (debtor) transfers its property to a trustee (creditor) to secure the principal obligation under a credit (loan) agreement.

The property right of a person who transferred his or her property under the security trust agreement shall be terminated from the moment of establishing the security trust (for movable property the moment of conclusion of the agreement, for the real estate - the moment of registration in the State Register of Real Rights to Real Estate).

So, basically, if a person wishes to credit or loan money, he or she may suspend his or her ownership of the property for the period of repayment of the debt, partially transferring such right to the creditor (trustee).

Given that the introduction of security trust aims to reduce the risks of non-repayment of credit funds and thereby to reduce the interest rates on borrowed money, the Law enshrines the obligation of the creditor to offer the debtor on less favorable terms a loan secured by other measures of securing the fulfillment of obligations than the security trust, for example, by the pledge.

The peculiarity of the security trust as a type of property right is that the creditor (trustee) may only dispose of the property under clearly defined terms, while the person who has transferred property or another person specified in the agreement may use the property.

The property owner may foreclose on the trust property in case of within 20 days from the date of the debtor’s continuing default (within 30 days, if a part of a debtor’s principal obligations has not been fulfilled).

In this case, the creditor (trustee) must notify the trust (debtor), the user and the trustee about the intention to sell the property not later than 15 days prior to the conclusion of the contract of sale, and the latter can purchase the given property by notifying the trustee within 5 days from the receipt of the notice of the sale from the creditor (trustee) and depositing into the deposit account of the notary the minimum amount reported by the creditor (trustee).

The trustee foreclose on the trust property in the following cases: state registration of the termination of the legal entity - trust (debtor) or creditor (trustee); recognizing the trust (debtor) or creditor (trustee) as a bankrupt and opening the liquidation procedure; the death of the debtor, declaring as incompetent or deceased.

A security trust agreement may also provide for other terms of foreclosure on the trust property, as well as the right of the trustee to become an owner of the trust property at the expense of the debtor's default.

The trust property is terminated as a result of the termination of the principal obligation, in particular, the full repayment of the debt by transfer of the trust property to the trust (debtor) under the act of acceptance-transfer, which shall be notarized (the right of ownership of the new owner for real estate arises from the moment of registration of such right in the State Register of Real Property Real Estate).

How will the introduction of a trust institution impact credit relations and what are the possible risks of this novelty for individuals and businesses

The lawmakers state that the introduction of a trust institution is caused by high risks of lending in Ukraine, as a result of which creditors set excessively high interest rates.

The existing measures of securing the fulfillment of obligations are quite outdated. They do not work properly and do not provide effective protection of creditors' rights.

According to lawmakers, the transfer of property into a trust property leads to a reduction of the risk of non-repayment (untimely repayment) by the debtors of their received loans. As a result, the interest rates on using credit funds will be reduced by expanding access to the credit resources of the banking system to citizens and businesses.

By analyzing the Law, it really appears that the security trust owns many advantages over other ways of securing the fulfillment of credit obligations, in the most similar to the security trust - a mortgage.

Unlike the mortgage, a creditor (trustee) does not have to go to court to foreclose the property transferred to the trust property, if the debtor breaks his obligation to repay the loan. However, the extrajudicial procedure to foreclose the property may also be stipulated by the provisions of the mortgage agreement. The creditor (trustee) may foreclose the property and repay the loan under the security trust agreement without a long legal burden.

Unlike the mortgage, the trust property cannot be seized and levied against the debtor's obligations to other persons, since the debtor legally ceases to own the property from the moment of its transfer to the trust. However, the third party to whom the debtor is liable may repay the debt of the debtor on the loan and require the trustee to foreclose the specified property in his favor. Such actions by a third party creditor will make sense if the value of the property transferred to the trust is sufficient to repay both the amount of debt and the money spent by the third party creditor to repay the debtor's debt to the trustee.

During the bankruptcy procedure of the debtor, the moratorium on satisfaction of creditors' claims will not be extended to the trustee foreclosure on the trust property and such property will not be included in the liquidation mass. In the case of a mortgage, the mortgagee spends much time and other resources to foreclose the encumbered property.

The Law provides that if the dwelling which is transferred to the trust property, all of those, who live in this dwelling or those, who obtain property rights to the relevant property, have to leave it on the written request of the creditor (trustee) if a creditor forecloses on the trust property. If the dwelling is not vacated, the creditor (trustee) may take legal action on this legal ground to forcible eviction. In the case of a mortgage, mortgagee often have problems with tenant eviction from a mortgaged dwelling, although the mortgage law has similar provisions, but the period for voluntary eviction of tenants is longer (one month after receiving a request) compared to a voluntary eviction at the request of the trustee (ten days after receipt of the request). And probably, the case law relating to the eviction of tenants from the trust property may be more favorable to a creditor (trustee). 

So, the introduction of security trust as a new measure of securing fulfillment of obligations has a positive effect to reduce the risk of non-repayment.  The debtors may benefit from a reduction in interest rates.

However, reducing the risk of creditors will lead to increased risks for debtors. As the right to dispose of the trust property transferred from the debtor to the trustee there is a risk that such property may be sold by the trustee, even if the debtor considers that it is properly fulfilling its obligation to pay the loan. This is the ground to initiate legal action  by the debtor. 

At the same time, a trust property can be used as a tool to protect  the property rights of debtors from outside encroachment on it. After transferring the property to the trust, the person ceases to be the legal owner of the property, however, he or she still may use the property. Thus, such property remains protected from third parties' recourse, and the debtor continues to use it and slowly repay its loan. Not bad, right?