Commercial Legal And Institutional Reform (CLIR) - Economic Growth

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COMMERCIAL LEGAL AND INSTITUTIONAL REFORM Diagnostic Assessment Report for the Republic of Bulgaria March 2002 generally perceived to create a debtor-biased system of enforcement. Criticism of the enforcement provisions — especially the lack of effective provisions for expedited enforcement and repossession — was universal among judges, lawyers, lenders, and users. Procedures are cumbersome, too slow, and too expensive for the simple nonpayment claims arising from pledge contracts. The law requires inappropriate proofs by the lender before repossession is allowed, rather than permitting a lender to repossess while providing for sanctions if the debtor can prove that repossession was inappropriate. While other issues are involved in the breakdown of the enforcement proceedings from an institutional side, the legal framework urgently needs upgrading. A multistakeholder group is already proposing revisions to the law, which are expected to be sufficient. Passage of these amendments is crucial and should be a part of any legal reform program. Several stakeholders noted one provision as a serious impediment in the credit industry. Article 348 of the Code effectively permits debtors to reschedule their obligations without the agreement of the lender. The provision provides that if a debtor is in arrears but pays 20 percent of the amount in arrears before a lender’s enforcement action, then the entire debt becomes due and payable over 18 months in equal installments. As a result of this generous gift to debtors, many debtors deliberately default on loans, pay the requisite 20 percent within the 18 months, and thus reschedule their payment plan. While this may have an impact on future loans by the same lender, such defaults do not negatively affect the debtor because little credit information is available. It does have a significant impact on lenders by increasing their risks, decreasing their liquidity, and raising their costs. Taking an even broader view of the legal regime affecting collateral lending, a number of respondents noted the negative impact of Central Bank regulations and the tax code. The Central Bank mandates 100 percent collateral for secured loans to avoid higher reserve requirements. (In practice, banks generally take more than 100 percent for most loans.) As a result, collateral pledges do not adequately lower the cost of capital. This requirement is in part due to the high risk associated with enforcement against collateral, but also stems from an overly conservative regulatory approach that until recently held bankers criminally responsible for insufficiently secured loans. While this stringent approach can be understood as a reaction against lending abuses in the immediate postsoviet period, it does not provide the flexibility needed for the growth of the credit industry. Abuses should be addressed through banking regulations, corporate governance, fraud laws, and allowing greater freedom for financial institutions. With respect to taxes, various stakeholders noted deficiencies affecting the profitability (and thus viability) of the lending and leasing industry. Complaints focused on two main areas. First, respondents noted insufficient allowance under the tax code for depreciation or deduction of costs for various equipment and vehicle purchases or leases, including the cost of maintenance and repair. The tax code thus increases the cost of investment by failing to recognize legitimate expenses. This has affected leasing companies. Second, leasing companies and financial institutions noted that the treatment of VAT on lease payments is a constraint. First, VAT is due based on the payment schedule, not on the actual payment, thus requiring lessors to make VAT payments even when the debtor is in Booz Allen Hamilton Page 28
COMMERCIAL LEGAL AND INSTITUTIONAL REFORM Diagnostic Assessment Report for the Republic of Bulgaria March 2002 arrears. Second, only large companies are given tax credits for VAT payments, but the credit system is subject to serious delays. Worse, small companies receive no credits, putting them at a competitive disadvantage with larger companies as well as limiting their potential profitability. (Additional concerns were raised regarding taxes, which are addressed below.) IMPLEMENTING INSTITUTIONS 1. The Special Pledge Registry. The Special Pledge Registry was recently established in the Ministry of Justice with headquarters in Sofia and six regional offices. Users had high praise for the registry, both with respect to its organization and operations. Stakeholders understand the role, purpose, and function of the registry, although additional awareness is needed among lawyers and lending institutions on the impact of registration on priorities and claims in the event of nonpayment or bankruptcy. The registry is computerized and allows rapid registration of security interests. The law properly requires registration of only the claimed interest, with no supporting documentation required, but in practice many registrar personnel prefer registering the underlying pledge contract. This practice is expected to change over time as users and registrars become more familiar with the pledge notice regime. The registry is sufficiently staffed and funded for current operations, although officials expressed concern that funding levels are insufficient for growth and even future maintenance. Current receipts from filings exceed costs, producing net revenue, but this will not necessarily translate into increased financing for this institution. In fact, developing the computerized system involved budget issues. Some respondents explained that the original plan included an Internet-based system to link the regional offices, but this option was cut for budget reasons despite its low cost. Staff is trained on the job, and this training is considered by all involved to meet training needs. Staff are given handbooks and materials regarding the laws, procedures, and software system, and no sense was expressed that any additional materials are needed at this time. Users and staff agree that the registry has a customer-oriented approach, with staff helping to explain processes and solve problems. Forms for registration are reasonably available, as is information on registration procedures. The registry is currently developing a Web site to disseminate information on procedures, laws, hours of operations, required documents, the fee schedule, and downloadable or printable forms. Even without this additional service, users are satisfied with the access to the information they need and the speed and cost of the process. In general, registration takes less than an hour and consists of a review of required forms and documents, which, once verified, are scanned into a computer and registered. The registry produces statistics on filings, but not regularly and usually only upon request by a government ministry. These reports are not generally made available to the public or even the lending community, but should become accessible as the registry develops. Production of statistics is not yet well developed. The registry cannot provide statistics Booz Allen Hamilton Page 29
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