Banking Loan Recovery Issues in Latvia
Rīga Stradiņš University
Doctoral Studies Division, Riga, Latvia
As many other countries in the world, Latvia from 2008 till 2013 experienced serious financial crisis. The results of the crisis were significant financial loses in banking area, plenty of foreclosures, plenty of corporate and private bankruptcy processes. By itself it is not extraordinary – these are the consequences of imprudent lending policies, the desire to borrow and live beyond each one`s income, to speculate in real estate market. These are self-evident economic consequences which is common in many other countries that have experienced the financial crisis.
The thing with which Latvia stands out is reaction of some private persons and corporate entities after foreclosure or insolvency proceedings are started. Part of them use all possible means to obstruct foreclosure or insolvency actions. Many of these means are illegal, e.g. making fictitious creditors (to control the insolvency processes of the legal entities), making fictitious residential property lease agreements (to prevent takeover of the apartments or cottages mortgaged by debtors – private persons), wrecking residential properties, etc.
The aim of this paper is to research such illegal activities and to provide possible solutions for these problems to prevent such activities in future.
Financial crisis, banking loan, mortgage, foreclosure, bankruptcy, lease agreement
During the period between 2008 and 2013 Latvia was heavily hit by a financial crisis. The financial crisis considerably increased the numbers foreclosures provided by the banks. Number of insolvency proceedings significantly increased as well – both insolvency proceedings of natural persons and insolvency proceedings of legal entities. These are natural consequences of the financial crisis. Before the recession, residents and companies alike borrowed enormous amounts of money from the banks, whereas many of the borrowers were later unable to meet their obligations due to the crisis. Consequences of these actions are foreclosures or insolvency of the debtor.
Majority of debtors are acting decently also after undergoing collection procedures or being declared insolvent – they abstain from any dishonest activities. However, there are some borrowers (either natural persons or legal entities), who seek all possible solutions to avoid the collection being aimed at the pledged property, obstruct smooth course of insolvency proceedings, and try to prevent the real estate sold in auction from being taken over in freehold and possession of the new acquirer (winning bidder).
2. Overview of Literature References
The range of problems this article focuses on is not researched much, because it is new, and a rare author has paid due attention to them. There are a few articles published by the author of this article in Latvian law magazine “Jurista Vārds”. Jānis Lapsa, an attorney-at-law and the lecturer at the Faculty of Law, University of Latvia, has written about issues with lease agreements in the said magazine, while there is no more academic literature about the issues raised in this article.
3.1. Objective of the Article
The objective of this article is to research key problems the sector of recovering the bank loans is facing in Latvia; and answer a question how to resolve these problems.
3.2. Methods employed
Methods of qualitative research were employed in the article – comparative method, analytic method, inductive method, and deductive method.
4. Results and Discussion
4.1. Fictitious Lease Agreements
One of the ways to stall the new owner from taking possession of real estate is conclusion of a fictitious lease agreement. Article 1415 of the Civil Act of Latvia stipulates that an unauthorised and indecent activity the purpose of which is contradictory to faith, law, or good morals, or aimed at circumventing the law, may not be a subject of a legitimate transaction; such transaction is null and void. On the other hand, Article 2120 prescribes that that a lease or rent payment shall be a true compensation for use of the property, and therefore it may not be set fictitiously. A transaction concluded in contradiction to the present rule, for the purpose to circumvent the law or deceive a third party, shall be null and void.
Article 275(2) of the Criminal Act of Latvia stipulates that a penalty for enforcement or use of a forged document granting a right or releasing from an obligation, if perpetrated for personal gain, shall be incarceration for a period up to three years or a temporarily incarceration, or community service, or a fine.
Notwithstanding the foregoing, dishonest debtors (natural persons) occasionally enter into fictitious lease agreements. It is encouraged by the principle existent in Latvia – “a purchase does not override a lease”. Pursuant to Article 8 of the Law on Lease of Residential Premises, if a residential building or an apartment passes over in freehold of another legal entity or natural person, agreements on lease of residential space concluded before are binding on the new owner.
The debtor, for the purpose to live as long as possible in the apartment or private house mortgaged to a bank, having become aware of the plans to sell the property in auction as a result of collection, enters into a fictitious lease agreement with somebody of his relatives, friends, or acquaintances.
The fictitious lease agreements are concluded with a retroactive effect, and stipulate that the tenant has right to lease the real estate for a long period of time (the longest ever seen is a lease agreement which expires when the tenant reaches 129 years of age!). More often than not, these agreements establish that a rent of EUR 15 000, for example, is already paid in a lump sum payment for several years or the entire period of lease in advance. There have been paradoxes when a lease agreement contains provisions that fees for utility services are covered by the landlord.
After the residential property is sold in auction through the court, a bailiff performs placing the new owner (who often is banks or their subsidiaries) in possession of the residential property. If before placing in possession or during such the fictitious tenant produces the lease agreement, the bailiff has no right to evict such tenant from the residential property. The only way how to do it lawfully is to bring an action in court for recognition of the fictitious lease agreement null and void.
Unfortunately, judicial proceedings in Latvia are protracted – if the opposite party employs all available means to delay the course of judicial proceedings, overall litigation may take from 3 to 5 years. During such a long time of litigation the new acquirer of the residential property may not use the property purchased in auction – irrespective of whether the property is bought to live in, or for commercial purposes – lease out or sell. As a result, market value of the residential property drops, and the new owner incurs losses.
As already mentioned, the Criminal Act establishes liability for forging documents. However, when the new owner approaches the Economic Police with a request to launch criminal proceedings for forgery of documents and fraud, he virtually always receives a formal answer that it is a dispute falling under the civil law that should be resolved under civil-law procedure in court.
As a result, the only legal remedy for the new owner to protect his interests is a long-drawn, costly, and infeasible litigation.
The solution of this issue is quite simple – Article 8 of the Law on Lease of Residential Premises should stipulate that a lease agreement shall be binding on the new owner only if it is registered with the Land Register. If such principle was incorporated in the law, it would prevent an option in future to use lease agreements as means of obstructing smooth auctioning of real estate.
4.2. Fictitious Creditors in Insolvency Proceedings
Another problem the banks and other actual creditors are facing is creation of fictitious creditors in insolvency proceedings of legal entities. The Insolvency Act of Latvia stipulates pro rata share of votes necessary to make decisions during insolvency proceedings of a legal entity. Thus, for instance, Article 42(3) stipulates that an action plan of the legal protection proceedings shall be approved, if it is supported by:
1) in the group of secured creditors – those secured creditors whose principal claims altogether form two thirds of overall amount of principal claims of the secured creditors;
2) in the group of unsecured creditors – those unsecured creditors whose principal claims altogether form more than a half of overall amount of the principal claims of the unsecured creditors.
Concerned parties (shareholders of the company), for a purpose of financial gain from the debtor’s insolvency proceedings by having full control over it, create fictitious creditors who have majority vote in the group of both secured and unsecured creditors. Frequently, the fictitious creditors are off-shore companies who have acquired claim rights by way of assignment.
The fictitious creditors make decisions by voting at meetings of creditors which are unfavourable for real creditors, including banks, while favourable for ultimate beneficiaries of the fictitious creditors – shareholders of the insolvent company.
For example, a claim of secured creditor for the amount of EUR 11.73 million was created in the insolvency proceedings of Ltd. „Biznesa centrs „TOMO”” for the purpose to outvote the actual creditor – JSC „Latvijas Krājbanka”. It was done by pledging car GAZ M20 of 1955. It is unknown whether this car is restored; however, value of such restored car is ~ EUR 12,000 anyway, that is, 977 times lower than the secured claim! On the other hand, the claim of the bank as a secured creditor is EUR 5.41 million. As a result, the fictitious creditors control the insolvency proceedings, freely deciding how to dispose of a valuable hotel – business centre at Raunas iela 44, Riga. The bank has managed to win in the court of first instance in this mater; however, the fictitious creditors have appealed the court ruling, and continue obstructing the judicial proceedings to control the valuable real estate as long as possible and gain profit from it.
On 25 September 2014 the Parliament of Latvia adopted amendments to the Insolvency Act providing for a number of means to combat dishonest insolvency administrators and fictitious creditors. However, majority of them may fail upon enforcement, because dishonest insolvency administrators and owners of companies will always find a way to circumvent the law. The solution of the issue is simple – effective performance of the Economic Police has to be ensured.
Currently, economic crimes are among the worst investigated types of crimes. Staff of the Economic Police is underpaid, whereas they investigate matters involving millions. This aspect considerably increases the risk of corruption. If proper salaries were paid to the staff of the Economic Police, qualified personnel was selected, then this problem would be solved to a significant extent. In absence of actual sanctions pending, dishonest administrators and owners of companies develop a sense of immunity that encourages spreading of such crimes. Whereas, if actual punishment was imposed on such dishonest persons, it would deter many from perpetrating similar unlawful activities.
4.3. Demolishing of Mortgaged Property
Another problem banks in Latvia encounter is demolishing of mortgaged real estate. After the recovery proceedings of the loan are launched against the debtor (natural person) and a writ of execution is obtained, some debtors demolish the mortgaged property before vacating it. All fixtures of the real estate are tore down: heating system (boiler, pipes, fireplace), flooring (parquet, laminate), power installations (plugs, switches), gates of private houses, etc. After demolishing the value of the property drops considerably. Sometimes costs of repair even exceed EUR 50,000 causing damage to the new owner.
Usually, the new owner of such property who has bought the property in auction is completely unaware of what is going ont. At the time of auction the property has been in a normal condition, whereas after the auction and before the property is vacated the debtor tears the place to pieces.
Solution of the problem is to establish criminal liability by incorporating a special provision in the Criminal Act that would stipulate that in case the mortgaged property is demolished criminal sanctions shall be imposed on the debtor.
In a short while after regaining independence Latvia has been hit by two bank crises, has undergone rapid economic growth and even harder fall during recession. Unfortunately, during these economic processes some residents of Latvia resort to all possible illegitimate means to defraud creditors, banks, and the state.
In certain cases the solution is amendments to the law – to prevent problems with fictitious lease agreements and to resolve problem of demolished mortgaged property. On the other hand, the problem with fictitious creditors in insolvency proceedings of companies requires tougher actions on the part of the Economic Police investigating economic crimes which can be achieved by serious reforms aimed at increasing budget of the Economic Police and selecting qualified staff.